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

Good afternoon. I'm Claire Lee from KRAFTON's IR team. I would like to extend my appreciation to analysts and investors from both home and abroad for joining the company's first quarter 2023 earnings release. Please note that today's earnings presentation is based on K-IFRS consolidated estimates, and as such, business and financial information may be subject to change upon the independent auditor's review. With that, I will invite our CFO, Dong-geun Bae, to run through the highlights of business and financial results.

Hello. I'm Dong-geun Bae, KRAFTON's CFO. Allow me to present on the earnings results for Q1 2023. KRAFTON reported a record high quarterly revenue in the first quarter. PUBG PC and Console posted a growth of a whopping 70% year-over-year, which is a testament to our strong IP power. After the free-to-play conversion performance has been notched up to a new level, once again affirming the sustainability of PUBG IP. Last quarter during the earnings release call, we mentioned that KRAFTON's 2023 objective is to drive both the revenue and operating profit growth, underpinned by PUBG IP preparing for next year's cycle of expansion of new titles. To that end, under a new strategy of scale up the creative, we are currently working on around 24 pipelines within the KRAFTON ecosystem. Supported by robust earnings, we made investments into 4 global studios in the first quarter were equipped with competitive strength expanding the lineup for a second party publishing to more than 6 titles and increasing the number of studios we invested to 12 in total since the IPO. This year in the face of rapidly changing global game industry, KRAFTON is poised to solidify its global IP, which is PUBG's competitive advantage and speed up the process for new titles that are fresh and creative to better meet users' growing expectations. I would once again like to thank our investors and analysts who have always been supportive of KRAFTON's challenges and vision as well as each member of KRAFTON and creative studios for your passion and hard work. Now moving on to major business highlights. In Q1, PC and Console revenue saw a steep growth largely driven by promotions on weapons and upgrade system features through the Guardians collection in January on PUBG PC and Console, which was popular among global users. This promotion offered content which both high paying and nonpaying users could all enjoy bringing record high in-game revenue for PUBG PC Console combined. All in all, it led to more than a twofold year-over-year growth in combined in-game ARPU from PUBG PC and console with continuing monetization backed by large-scale traffic, which displays higher prospects for future growth. PUBG PC and Console celebrated 6 year anniversary last March and is in its seventh year of service. Its light [client] system equipped with a stronger social feature and the Arcade center servicing a variety of modes nonstop offer entertainment beyond what is Battle Royale. Supercar collaboration, most awaited by the users as well as many more updates, including release of a new map that features new metaplay will all work to drive higher growth which will help to sustain the uptrend from last year. Q1 Mobile business defended its top line on the back of a more stable global mobile game market and sustained traffic supported by PUBG Mobile's content update despite the sanction of BGMI. Things are looking quite positive, especially for PUBG Mobile as in step with mobile game growth in emerging markets, which is a recent market trend, we are seeing there has been a more pronounced traffic growth from some of the emerging countries considered to be our noncore markets. During Q1, in the UGC game [Playmode], World of Wonder, we introduced a feature whereby users can freely craft maps and generate sessions. Such creative content of PUBG Mobile produced by many different users is currently receiving very good feedback. This year, PUBG Mobile will expand paying user base underpinned by new traffic and will also drive growth by further advancing live services, so as to increase monetization efficiency from the current user base. As mentioned during the previous earnings conference call, we at KRAFTON have chosen scale of the creative as the company's strategic direction in order to expand on our business competitiveness as a global game publisher. Under the new scale of the creative strategy, KRAFTON will not only expand on its own development pipeline, but also titles and pool for second party publishing will be sourced through our minority equity investments in order to further maximize growth potential. To that end, we are seeking to drive scale up of the production process built on the footing of sound communications between KRAFTON's head office and the studios. The new strategic direction will allow leaders of virtual organizations built for each game project unit work in mutual collaboration and become advisers to each creative studio so that these studios can continue to challenge and focus on game development. KRAFTON's head office, we're focused on supporting these studios content work while conducting a more thorough review and test across the whole game production process so that we may explore, scale up and maximize diverse array of creative. KRAFTON will line up more games in the pipeline and by laying down a system for rigorous production management that can increase the likelihood of a game title success. We will be able to roll out new titles that are of higher quality and place greater momentum behind future growth. KRAFTON has researched deep learning technologies and made preemptive investments into these projects which helped to make production, publishing and operation of these gains more efficient, while it is contributing to discovery of new gameplay as well. Most recently, KRAFTON's Deep Learning division published a research paper on ACL 2023, which is the most reputable international academic society in the field of natural language processing. The research was on a methodology for designing a chat box that can retain mid to longer-term memory using large-scale language models without requiring the use of [chat] data, which was a testament to KRAFTON's competitiveness and deep learning research. This technology was used in an in-house demo game called Deep Date Night. Powered by deep learning, chat box can see here, remember and talk and freely engage in conversations on different topics, both in and outside of the game. We also laid down technological basis that allow gamers to employ collaborative play in which a virtual friend or lover will suggest strategies based on this understanding of the game acquired through reinforced learning. These various deploy technologies are being used in Migaloo, which is a UGC open-world game platform developed through a joint cooperation with NAVER Z and will be used to shorten the production cycle for upcoming new titles and will be used to implement various in-game features which will help to scale up the company's prospects for future growth.

With that, we now move on to Q1 2023 financial highlights.

So such business results that I have just walked through are translating into KRAFTON's financial performance. Q1 '23 consolidated revenue was KRW 538.7 billion, up 14% Q-on-Q and 3% year-over-year breaking the quarterly record. PC revenue, in particular, was up 28% Q-on-Q and 68% year-over-year, accounting for 33% of total sales, driving growth to a higher notch. Mobile revenue reported lower year-over-year growth, mainly due to suspension of BGMI-India services. While for console, there was a base effect following the release of the Callisto Protocol last quarter. All in all, driven by solid revenue growth from core business based on PUBG IP Q1 operating profit was up 124% Q-over-Q, recording KRW 283 billion and recording OP margin of 53%. Excluding the impact of stock-based compensation, Q1 operating profit came in at KRW 293 billion, up 12% versus KRW 261.7 billion of the previous year. Adjusted EBITDA, which includes the impact from SBC and depreciation, was up 14% year-over-year, reporting KRW 319 billion. Moving on to normal operating profit, which is inclusive of other income and financial income it was up KRW 428.5 billion Q-over-Q, recording KRW 79.4 billion, driven by the base effect from impairment of intangible asset previous quarter and rise in FX-related gains in light of the strong dollar. Last but not least, Q1 consolidated net profit was up KRW 432.7 billion Q-over-Q and KRW 22 billion year-over-year coming in at KRW 267.2 billion with net profit margin at 50%.

This brings us to the end of the earnings presentation for Q1 of 2023. We will now entertain your questions.

Now Q&A session will begin. [Operator Instructions] The first question will be provided by Dong Hwan Oh from Samsung Securities.

Thank you for taking my question and I would like to be congratulate you on the earnings surprise. I would like to ask you 2 questions. Firstly, if we look at -- if we look at your revenue for the first quarter, PC and Mobile, was much higher than what we had expected, I would like to understand whether there was any one-off drivers behind your mobile revenue, for instance, have you renewed your licenses or contracts in China? I ask you that question because compared to the projected figures, especially if you look at the applications for app commission income, it was lower, but still your revenue increased quite a bit. So I would like to get some color on whether there was any one-off impact on your sales. Second question relates to your cost items. There has been also a much larger extent of cost savings. I would like to understand whether there were any one-off factors behind that cost saving and going forward, should we continue to expect this level of cost savings?

Now regarding your first question for whether there were any one-off factors behind this high level of sales or revenue that we've seen for PC and Mobile new. There weren't any one-offs. You also asked about whether there was a renewal of the contract in China that was not an impact. Basically, this performance was driven by our key strategy, where we had a focus on driving our revenue efficiency by expanding the user traffic. And I think you could just taken the figure as is. This actually is an outcome of that specific strategy. Regarding also the part on the cost side, and you also mentioned the data from Sensor Tower. Of course, the third-party data can be used as a reference point and one can look at it and see how the trajectory will play out. In terms of the cost, there will be fluctuations on a quarterly basis. But no, there has not been any particular extraordinary one-off savings that we had driven during the first quarter. And as I mentioned at the very beginning, on a year-over-year basis, if you look at our stock-based compensation last year, there was a reversal. And this year, because of the rise in the share price, I guess you could say that it had it had come back to a normalized level. But despite there being a [indiscernible] cost factor, I guess, some may think that the performance of the results that we were able to drive were cost driven, but that really is not the case. The earnings and the results that we were able to bring this quarter was revenue driven. So I would like to make sure that, that is clearly understood. Now having said that, the management has a very clear stance in wanting to operate this business in a very steady footing. And so I can tell you with certainty that there will not be a case where the company will arbitrarily try to reduce the cost in order to create earnings. As mentioned during the beginning of the year conference we said that there will not be any significant releases of those strategic game titles such as [ PCP ] or the New State. But we've made it quite clear that we will be able to drive both the revenue and operating profit growth based off of our core PUBG IP. And I think that the results that we've seen in the first quarter actually is a testament to that fundamental strength that [customers] have. And PUBG is a game that if it was a game that really depended on, for instance, play-to-win or if it was like other MMO -- other MMO RPG games where the sales of the equipment in game equipment were important is PUBG IP -- PUBG game. On the other hand, is a game that really appeals with it's core game play and also the revenues are driven based off of the attractive products that game products that it actually provides. So as long as we don't undermine the gamability of this game title and as long as we are able to provide attractive products with appeal then we believe that we will be able to sustain the very strength of PUBG as an IP.

Next question please.

The following question will be presented by Stanley Yang from JPMorgan.

Congratulations on your good earnings. I see that your PC revenue has been quite stellar. Is this driven by growth in user traffic, which with that is driving this Q1 result? Or is it because of more expansion of monetization. If you could provide some color on the key driver behind this good results, that would be helpful. And also, you've mentioned your mobile business growth was quite pronounced from the emerging markets. I'm wondering whether this growth is attributable for the PC game is the growth coming from your core market? And also, has there been any conversion between [big] user base from mobile to PC -- mobile between the mobile and the PC users. And the Q1 earnings is quite elevated. We'd like to know whether you think that this trend will continue on into Q3 to 2 and 4 as well. Second question relates to the distribution of your operating profit. Usually, you seem to have higher OP during the first quarter in the mid-30s to around 40s and also up margin is higher during Q1, probably this is because of the contribution you're getting from the Chinese market. But anyhow, do you think that the same pattern will be repeated this year? Or will the OP contribution that we've seen in Q1? Do you think it's going to sustain into Q2, 3 and 4?

[I have] more than two questions, but anyhow. Regarding PUBG, whether the good performance is attributable to traffic or monetization, it actually depends on the timing. So if you were to make the comparison before, we had free-to-play conversion, then yes, traffic is definitely higher. But if you were to compare after -- immediately after free-to-play, like comparing Q1 of previous year, it was not necessarily the higher level of traffic. That is quite obvious because once we convert to free-to-play, there was a significant amount of users that were onboarded, but not all of those users who started to play the game would, of course, be retained. So it depends on the timing. Now also if you look at Q1 of this year, there were a slew of products that we introduced, which was very competitive. So it was thanks to the strength of these introductions that we were able to really drive growth. And so just in a nutshell, if you asked me this question, I would have to say that we were very good and efficient at monetization. [Responding] to your second question, you asked whether there's been any change in the overall geographical mix of the breakdown in terms of the contribution we are seeing on our PC revenue, though the revenue patterns are more or less the same compared to the past. It's just that the absolute basis the number itself has grown. So in terms of the PUBG PC, once again, I come back to the point that during the first quarter, we were able to introduce in with these very attractive products and competitive as well. You also asked whether there's been a migration of the users from Mobile to PC platform. We don't necessarily track that specific, but I do not think that, that was the main driver behind the results that we've seen. There has been, as I mentioned before, growth that was quite pronounced from the emerging markets. And if you look at these markets, their mobile phone features are not that advanced. And also in order for you to play PUBG on a PC platform, you require quite highly featured or a high level or high spec PC. So I do not -- I would not think that the growth that we've seen was due to the mobile users migration to PC platform. So as such, I do not think that there will suddenly be a cannibalization between our PC service and mobile service. But if in terms of the revenue, if the PC mix increases from a platform commission perspective, PC actually is better for us versus mobile. So if there is a change in the revenue mix, there could be and there is an impact on a positive note to -- on the operating profit. Your last question on Q1 operating profit, it's trend on a quarterly basis and what it's share is out of the total annual per annum operating profit. If you look at our quarterly earnings over the past years, I'm sure you clearly know that there is a seasonality. Yes, we seem to have an elevated level of operating profit during the first quarter. This is because of a very long winter vacation as well as New Year holidays that's included in that quarter. So obviously, second quarter results was obviously falls short of the results that we see in the first quarter. And also, there is a large scale promotions that take place in Q1. And as we enter into the second quarter, there's also a fatigue relating to these paying users. So hence, naturally, the Q2 figure would be lower versus the Q1 figure. You also asked the percentage of operating profit mix for the first quarter as against the per annum operating profit, although I cannot put that into a specific ratio and give you a number. And the reason is because there will be other variables or factors that would impact us such as release of new titles and the amount of operating expense. But once again, Q1 OP, operating profit at KRAFTON, the percentage is higher. And as we enter into the second quarter, that figure will fall short of what we've seen in the first quarter. But as I've mentioned before, going forward, we will continue to drive growth based off of the PUBG IP as we have done during Q1 of this year.

Next question, please.

[Foreign Language] The following question will be presented by Ha Jeong Kim from DAOL Investment & Securities. Please go ahead with your question.

I would like to ask a couple of questions. When can we look forward to the stabilization of services like craft ground? And also, do you have any additional plans to carry forward with AI-based projects? And also, can you provide a little more color with respect to services like Migaloo. Second question is, under your scale of the creative strategy, I know because you are in the first year, you may not be at that level. But once this strategy takes a deeper route how many projects or large-scale projects can we expect on an annual basis?