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

[Interpreted] Good morning, and good evening. Thank you all for joining the conference call for the KRAFTON earnings results. [Operator Instructions] Now, we will begin the presentation on KRAFTON's second quarter of fiscal year 2024 earnings results.

[Interpreted] Good afternoon. I'm [ Sophie Lee ] from KRAFTON's IR team. I would like to extend my appreciation to everyone, including analysts and investors for joining the company's second quarter 2024 earnings release. Just to remind you, today's earnings presentation is based on K-IFRS consolidated estimates which are subject to change upon the independent auditor's review. We will invite CFO, Dong-geun Bae, to present on the business and financial highlights.

[Interpreted] Good afternoon. I'm Dong-geun Bae, CFO of KRAFTON. During the first half of '24, KRAFTON strengthened PUBG IP through a variety of live services, while continuing with new game development and investments for future growth. First half revenue thus reported KRW 1,372.9 billion, which is a historical record in terms of our half-year sales, with operating profit reporting KRW 642.6 billion, securing clear visibility into annual growth. We've seen results, not simply financially, but also in terms of engagement, in user engagement, that is, in PUBG's variety of in-game and out-game content, once again cementing its solid positioning as a highly regarded game from the gamer community. Under the strategic direction of Scale-up the Creative, we are improving the level of completeness for the release of Dark and Darker Mobile and inZOI, and have invested into 11 game studios just in the first half of the year in order to secure mid- to longer-term pipeline of game titles. Next, the key business performance and strategies behind new titles and our mid- to longer-term growth strategy. First off, on the PUBG IP franchise, PUBG PC and mobile released wide-ranging content, including map updates, collaboration, which won positive feedback from the global user base, and which in turn drove traffic and higher revenue efficiency. For PUBG PC and Console, we ran campaigns for returning users in the Western market, leveraging the Erangel Classic map as we sustained traffic uptrend since the Rondo map released during the fourth quarter. New Jeans collaboration also was met with great reception and user engagement. We thus saw PUBG PC and Console MAU increase by more than 40% year-over-year, while paying user increased 130% for the same period. In the second half, we plan to sustain the high traffic trend backed by collaborations with Lamborghini and wide-ranging in-game updates so as to drive higher growth riding on the tide of last year. PUBG Mobile and BGMI have received positive feedback for its localized content, and with paying model upgrades, growth is continuing. PUBG Mobile saw sizable traffic and revenue contribution from collaborations with popular Middle Eastern celebrities and ex-suit progressive costume skin. BGMI is actively leveraging UC Bonus Challenge and localized content, including collaborations with a popular local cricket team. We're expanding also into new user base from geographic areas with low BGMI penetration by actively leveraging local language and localized content. We believe PUBG IP's performance and metrics we achieved during the first half of this year will form a fertile ground for the company's sustainable growth into the future. Our investment and development efforts will not stop in making PUBG IP into a franchise that will be loved regardless of generation and regions underpinned by its one-of-a-kind identity. Next, I will walk through the new game lineup for the second half of the year. First, Dark and Darker Mobile is a new genre, a blend of Battle Royale, Dungeon Crawlers, and RPG. To make it fit the mobile platform, we've made adjustments to the original game by adding third-person perspective, an easy game control and interface, and also added non-battle contents like cooking and fishing. To test and verify the unique aspects of mobile, we ran second-phase testing across 4 nations where we expect people would be receptive to Dark and Darker Mobile. After showcasing the game in gamescom Germany, and based on the results of the second test phase, we will be enhancing the game's completeness to do a soft launch in Canada in October under a target of global release in Q4. For inZOI, our goal is to grow the game into a long-term IP in the life simulation genre, whose popularity has been already proven in the Western market for the past 2 decades. We are sharing views on the development process and the content with the inZOI fan community, which was naturally formed after the game was unveiled back in Q4, and we are developing the game together with the fan base. inZOI offers high degree of editing features for cities and architecture and realistic character customizing, enabling gamers to live the life they wish inside the game. Powered by Unreal Engine 5 and lifelike graphics, AI technology can also be easily used on-device backed by KRAFTON's internal deep learning technology. By using community simulation, gamers will be able to experience what only life simulation games can offer. For instance, what happens when an incident like flu pandemic and rumors break out and how they spread across the entire community. Like Dark and Darker Mobile, inZOI will be showcased in the upcoming gamescom and we will also be setting up demonstration booths to test and see the level of anticipation and reception we will get from the Western users. Next is on KRAFTON's mid-to-longer-term growth strategy. KRAFTON continues to explore second-party publishing opportunities and invest to diversify platform and genre. Since making minority investments back in 2021, we've completed a total of 27 investments so far, including 14 companies in North America and 8 in Europe, broadening the 2PP game zone across action, adventure, RPG, simulation, etcetera. And as of August 1, we secured a sizable development team in Japan, completing strategic integration of the development team of Tango Gameworks, which used to be a studio under Microsoft. Tango Gameworks, cemented its position in the survivor horror game market through The Evil Within series, coming up with games like Ghostwire: Tokyo, Hi-Fi RUSH, to expand into other genres, proving its creativity and development capacity. Their most recent title, Hi-Fi RUSH, is a rhythmic action game with cartoon-like graphical design, superb sound effect, well-knit story narrative and creation, and it has won multiple awards and high ratings from users. And we are planning on close cooperation, so that we can continue the legacy of Tango Gameworks. We will also continue to invest to speed up discovery of IPs with great potential so as to be equipped with mid- to longer-term pipeline, which will scale up our business. Next is on India and our AI initiative. Through BGMI, we are building up on localization experience within the Indian market and bringing that to bear on KRAFTON's future publishing business. Coupled with marketing campaigns optimized for various different local languages and culture, and by hosting eSport events, BGMI is focusing on expanding the touch point with diversified user base in India. We are offering better access to eSport events by adding venues in new regions, delivering a lot to see and ample amount of experience. Also, BGMI was the only game company whose advertising campaign received awards across many categories at India's most reputed advertising convention, which helped broaden KRAFTON's influence inside the Indian market. We are also exploring to find new gameplay powered by AI technology. ReLU Games took a step further from using AI for gaining development efficiency to using AI to create the fun factor through its games called Magical Mic Duel and Uncover the Smoking Gun. Magical Mic Duel uses speech-to-text technology, offering a brand new game experience called voice-based role simulation, designed to give different magical effects depending on the user's voice tone, pitch, and emotions. Many famous streamers are playing the game voluntarily, and we were able to see that the new gameplay driven by and powered by AI can win the interest of gamers. And unlike conventional mystery solving games, Uncover the Smoking Gun is a conversation-based AI game using a language model. And since its official launch on Steam in June 24th, the game has received very positive review ratings on Steam as the user feedback. Although, it's a small attempt at this point, and because of that, the revenue share from AI-based games are small, we will continue to explore new gameplay powered by AI technology. Lastly, on KRAFTON's mid-to-long-term plan, early this year, we shared our vision of exploring original creatives and developing IPs into a service that brings long-term growth through content updates and service enhancements in order to drive a stepwise growth for the company. During the first half of this year, we gained confidence on the strategic direction of the company in terms of PUBG IP performance and second-party publishing investment. For the PUBG IP, coupled with the core products that we are servicing, a new title lineup across wide-ranging platform and genre, we will not think of East and West markets as separate regions, but expand and grow the franchise so that the new generation of gamers will continue to flow in from across all regions. And in terms of securing new IPs, it will not just be 2PP expansion, but we eventually want to find creatives that can be made into an IP franchise based on in-house development or M&As, et cetera. Based on our know-how and confidence gained from PUBG IP franchise, KRAFTON will continue to expand its second-party publishing model and actively make investments. We will share a more scaled-up version of our mid- to longer-term strategy together with our CEO at the earnings release beginning of 2025. Next, I will move on to the financials. Q2 revenue was KRW 707 billion, yet again riding a new record for the quarter. Operating profit came in at KRW 332.1 billion on the back of solid revenue sustained from PUBG IP. First, on the revenue breakdown, if you look at second quarter PC revenue, it reported KRW 191.3 billion. Despite it being a slow season, supported by Erangel Classic Map and New Jeans collaboration and appealing content, there was 64% year-over-year growth. Q2 mobile revenue increased 24% on quarter and 104% on year, reporting KRW 499.9 billion, driving the total top line growth for the second quarter. PUBG Mobile featured wide-ranging IP collaborations and progressive costume skin, which were met with raving user reception, underpinning our mobile revenue growth, while BGMI posted Q-over-Q growth based on local marketing and localized content. Console revenue for Q2 was KRW 8.8 billion, down 24% on quarter and 54% versus last year. All-in-all, total revenue for Q2 once again hit quarterly record, driving half-year revenue above KRW 1 trillion mark for the first time since the company's establishment. Next is breakdown of operating expense and operating profit. Labor cost was up 7% Q-over-Q and 26% year-over-year, reaching KRW 129.6 billion on increase in hiring for multiple number of new game lineup and PUBG IP franchise. Platform fees and cost of revenue fell 10% Q-over-Q on lower PUBG PC revenue, but was up 141% year-over-year to KRW 77.5 billion due to the resumption of BGMI services and PUBG PC revenue expansions. Commissions paid saw an increase of 25% on quarter and 8% on year, reporting KRW 76.4 billion on increases in outsource and development expense for new title development and hosting of PGS, the eSsports event. On the back of PUBG PC and BGMI marketing campaigns and increase in marketing spend for new titles, marketing expense was up 71% Q-over-Q and 145% year-over-year, reporting KRW 21.2 billion. Stock-based compensation declined 16% Q-over-Q to KRW 35.2 billion due to falling share price, but increased 289% compared to last year. All-in-all, second quarter operating profit was up 7% Q-over-Q and 153% year-over-year, reporting KRW 332.1 billion. First half operating profit increased 55% versus first half of last year, reporting KRW 642.6 billion. Adjusted EBITDA, accounting for stock-based compensation for '24, was up 2% Q-over-Q and 131% year-over-year, to KRW 394 billion, while for the first half, adjusted EBITDA increased 59% compared to the previous year, coming in at KRW 772.5 billion. For non-operating accounts, strong dollar drove up FX-related gains, ending with KRW 126 billion in non-operating profit for the second quarter. Thus, net profit for Q2 increased 166% year-over-year to KRW 341.4 billion, and first-half net profits are 74% growth, reporting KRW 690 billion, which is bigger than last year's net profit for the whole year. This ends the presentation, and thank you.

[Interpreted] This ends the presentation on the financials and business performance. We will now take your questions. Please go ahead with any questions you may have.

[Interpreted] [Operator Instructions] The first question will be provided by Eric Cha from Goldman Sachs.

[Interpreted] First up, before asking the question, congratulations on good results this quarter as well. I have 2 questions. My first one relates to your revenue. If we look at your Q-on-Q revenue growth for the second quarter, it has outperformed even above and beyond what was projected by the market. I would like to know whether this is 100% attributable to your own organic growth, but do we also have to consider for some non-recurring items? If there's also an impact from non-recurring items, will this item actually -- recur again, maybe not on an annual basis or maybe not periodically, but sometime in the future? Will we have to consider for that going forward as well? And the second part of this question is that, if you look at your net profit in terms of your organic growth, we'd like to know as to what the July trend looks like in terms of the traffic and monetization compared to the Q2 figure in terms of your PUBG PC and mobile. Second question relates to the key audience for the game inZOI. Are you targeting people who used to have played The Sims, the simulation game in the past, or who are actually at this point playing that game, or are you completely targeting a new audience? To answer the first question, it may be a problem in terms of expression, but in fact, it's all organic.

[Interpreted] Regarding the first question, answer the first question, first. I guess, it's just a matter of terminology, but all of the revenue that we will generate is part of the company's organic revenue. Now, with that being said, in terms of our business and with our business partners, there are specific details that we cannot disclose openly, but I can tell you that the impact was from the PUBG IP franchise's performances, so there was a specific revenue that we recognized which was in line with the PUBG IP franchise, and that amount or that revenue is -- has a recurring characteristic, so it will sometime in the future also be recognized, but in terms of the cycle or how often or regarding any details, we won't be able to share with you all the specifics due to the arrangement that we have with our business partner. Regarding the details of the contract that we have or the agreement that we have with the partners, because it is not open to the outside, I understand that it would be quite difficult for the market and the analysts to come up with the appropriate projections regarding this. So I understand where you're coming from, but I can tell you with certainty that this number that we have recognized this quarter is from the company's performance, the business performance and achievement that the company has made. Now, moving on to your question relating to the July metrics, we see that for PUBG PC and Console, the MAU has been showing an elevated growth of about 50%. Traffic, I can tell you, is very healthy as we speak. Monetization process is also ongoing in a quite healthy manner, so the health of our PC platform is very good, and it is growing as we speak. If you look at Mobile as well, it's on a monthly basis. It is recording a quite significant growth rate, and if I just take a look at the July number, I can tell you that it is very high and it's historical, I say, and so in light of that, I think that the performance that we can look forward to for KRAFTON in the third quarter would also be very promising, supported by the competitive servicing that we are providing, which is driving sound growth. Regarding the question about inZOI and the key audience that we are targeting, as you know, this whole segment of life simulation game came to being in the early 2000s and over the 2 decades. It's been loved and played by many gamers. But in recent days, we see that there has not been any development of competing titles, as well as development and discovery of new IPs, and also the existing current games have started to show some of the shortcomings, the weaknesses that was intrinsic in the game, and recently, we've also heard that some of the attempts at coming up with other life simulation games have been discontinued, which we believe forms quite positive backdrop for inZOI going forward. Of course, when you think about life simulation, our natural target audience would be the people who used to play life simulation, so we will begin there as well, but through inZOI, we're also going to broaden out into acquiring new users from Asia, Middle East, and Latin America who have not played these types of games in the past. So we're not just focusing on the Western core fandom. So in the upcoming next week's gamescom, we will be unveiling specific gameplay of this game, so I look forward to your support.

[Interpreted] We'll take the next question.

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

[Interpreted] Congratulations on your good earnings result. I have 2 questions, I would like to ask. First one has to do with your mobile game revenue growth. On an year-over-year basis, we see 100% growth. So compared to PC, where it was -- where we could project because of the solid traffic and collaboration impact, but on the mobile side, it actually was a surprise. So can you give a bit more color as the driver behind this very high mobile game growth? Was it traffic? Was it paying user growth? Or was it ARPU and also any geographical impact? Because previously, we've seen your revenue really go Westbound, meaning more revenue coming from countries like Saudi Arabia, Turkey, Russia. We'd like to know as to the geographical impact as well. Second question is the monetization strategy, and particularly relating to the collaboration impact, the Gotcha impact. I believe that these collaborations have contributed quite a bit to your revenue, and collaboration is becoming, I think, more important as we speak. And in Q2, that was the case as well, the collaboration with Lamborghini. I see on the YouTube a lot of people are spending money to find that collaboration item. And also you've collaborated with K-pop and the girl groups as well. So we'd like to know and understand, your strategy for collaboration and that its contribution to your monetization. I mean, would you have plans to have collaborations on your inZOI game as well, so to provide us with more color in terms of collaboration vis-a-vis monetization?

[Interpreted] Now, responding to the first question, you would know that traffic on a month-by-month basis, it does go up and down quite a bit. But if you compare to the previous year, on a year-over-year basis, I can tell you that our traffic is good, and that very solid traffic form a very strong basis for good performance. And so it is based upon this very solid traffic that actually drove improvements in all of the metrics that you've mentioned, like increases in APRU, the paying user trend and everything, and that contributed to good earnings performance. And that is the basis for our confidence in our earnings. You also asked about monetization strategies regarding collaboration in Gotcha. But what's more important than this is how popular the content is that we are bringing to our users. You've mentioned Westbound as well. As we build-up our know-how and experience in servicing through the mobile platform globally, have been able to build up a know-how as to know which content actually works in which different markets. And that is fueling the growth behind our business. For instance, on our global mobile platform, we've ran a mommy content, which was very popular. The efficiency was very high for that. And as such, you can see that the know-how that we've built over the years is paying off. Although, we don't give you a country-by-country breakdown, even other than Saudi Arabia, we've seen Q-on-Q revenue growth, quite solid growth across Middle Eastern countries. And all of the metrics, including user traffic, paying users in ARPU, have been quite good. And the contents that we have been offering them is working well in terms of user engagement. So we look forward to continuing growth. Second, on the collaboration question, yes, collaborations do bring big impact on our business performance, and especially in the past, where we had separate collaborations for PCs and for mobile. Under the PUBG IP franchise approach, we're taking one stance and one view and collaborating with well-reputed and well-known brands and has given us, I guess, a leverage in being able to engage with such large collaboration partners and really go close to our user base. So our competitiveness as a collaboration partner has also gone up. And also another aspect is that in the second quarter, you mentioned Lamborghini, and yes, that did have an impact, but it is different from our previous car brand collaborations because in the past it was just simply a collaboration and the similarities would only exist on the exterior of the vehicle. But this time around for Lamborghini collaboration, we really paid attention to the details. And if you go inside the Lamborghini car and the dashboard would look the same and you can look for that in the YouTube videos. So we paid attention to even a very small detail. And so it was a perfect match, and I think we were able to win users' appreciation for all the attentions that we've paid to the details. So it is with these large brands and popular brands that we are able to launch such collaboration. And this is thanks to the strong and IP franchise that we have. And in so doing, we are really moving our gamer base, the user base. And because we do not overlook the details in terms of execution of that collaboration. And I think that is why we are able to further grow our performance. So for collaborations, if we look at any point in time, we have a full upcoming year of pipeline in terms of the brands and companies that we will be collaborating with, the details of which I cannot disclose. Because the key impact of collaboration is when we unveil it, it really creates a big impact and it really resonates with our user base. So having that unveiling is very important. But I can tell you that you can look forward to the collaborations that are upcoming, because I assure you they are very appealing.

[Interpreted] Next question.

[Interpreted] The following question will be presented by Hee-Seok Lim from Mirae Asset Securities.

[Interpreted] Yes, I have several questions. First one is, one thing that I would like to gain understanding about the result of the second CBT test for Dark and Darker Mobile, and what was the reason you changed to Canada for upcoming release, the soft launch release? And second, regarding the New Jeans refund and in-game cash compensation, what is the impact of that? And third, for the Tango Gameworks strategic integration, you are using acqui-hire, Acquisition Plus Hiring. What's the difference with your past approach?

[Interpreted] The second CBT test for Dark and Darker Mobile just ended in the morning of today. So we internally would have to go through a process to look into the results of that CBT test. But I can tell you that, more people participated in the CBT test than what we had originally expected. So as of now, I can tell you that, it's been quite positive in that sense. Now, Dark and Darker Mobile, we will be servicing this game title globally. And so we're thinking about how we can effectively monetize on the game without undermining the game ability and the game characteristics of the game and still be able to go closer to the gamers with a very strong appeal. And so we decided that Canada would be the right place as a testbed for us to test different monetization approaches. And that is why we selected to do a soft launch in Canada.

[Interpreted] Regarding your question about the refund and the compensation that was given for the New Jeans collaboration, you know from July 3rd to August 2nd, people could -- paying users could choose to either receive a refund or be compensated. And depending on which method that they choose, the accounting treatment will be different. If a paying user requested for a refund, then the item will be recovered and there will be a refund of the G-COIN. And that amount would, of course, have to be deducted from our revenue. So, yes, there were some cancellations of the purchases that was booked in the second quarter. But what's quite interesting is that people who canceled the purchase actually came back and repurchased the item again. Maybe it's because it's a conjecture since there was an opportunity for them to receive a refund. Maybe they weren't able to or they didn't draw the character that they wished to draw and they were leveraging this refund opportunity to gain another opportunity to get the characters that they wished. But anyhow, there's been almost all of the repurchases regarding the amount of refund that had been made. In terms of the compensation, what this entailed was giving out free of charge G-COIN's to the gamers, but what's also interesting is that all of the G-COIN's have already been mostly used up. It has been all been used to make a purchase and often so, from the company's perspective, we were initially, yes, having some concerns about the potential financial impact that may arise from the compensation and refund regarding this New Jeans collaboration. But maybe it's because of the appeal of the content. Maybe it was so appealing. Maybe that was the reason. But we've seen almost everyone make repurchases. Lastly, on your question about Tango Gameworks, and the reason why we decided to do an acqui-hire model, there could be many different ways for one to acquire a studio, a outright acquisition of a studio, or acquisition plus hiring of a development team. And each of the methodologies may have their strengths and their weaknesses, plus and minuses. But this does not signal a shift in our strategy or our mission. Our mission is to able to -- is to have studios who have creative and also who have the competitiveness. It's just about the methodology through which we achieve that mission. So the methodology may differ depending on the situation, especially for Tango Gameworks. The studio actually closed down as of May, so there was no way for us to do an outright acquisition. We wanted to inherit the entire development team, and acqui-hire was therefore the most optimal way for us to do that. So we will select the most appropriate methodologies depending on the situation and depending on the most optimal way that we see fit.

Well, thank you very much. This brings us to the end of the second quarter and first half earnings presentation for KRAFTON for year 2024. We greatly thank you for all of your interest and your support. Thank you. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]