NC Corporation (A036570) Earnings Call Transcript & Summary

Good morning, and good evening. Thank you all for joining this conference call. And now we will begin the conference of the Fiscal Year 2019 Fourth Quarter Earnings Results by NCSOFT. This conference will start with a presentation followed by a divisional Q&A session. [Operator Instructions] Now we shall commence the presentation by NCSOFT.

Good morning. This is Yoon Jae-Soo, the CFO of NCSOFT. I would like to first thank everyone for taking time out of your busy schedule to participate on this earnings conference call for the fourth quarter of 2019. Let me begin my presentation with the fourth quarter earnings highlights. Fourth quarter sales was KRW 533.8 billion, an increase of 34% Q-o-Q and Y-o-Y, driven by the successful launch of the Lineage 2M, though a major title was launched, the solid revenue from existing games such as Lineage M and PC-based Lineage I also continued. Operating profit recorded KRW 141.2 billion, up by 9% Q-o-Q and 25% Y-o-Y due to the growth in the top line, even though the new title launch increased cost. Pretax income was KRW 97.8 billion, a decline of 36% Q-o-Q and 8% Y-o-Y because of an increase in nonoperating expenses, such as the impact of the stronger Korean won. Net income dropped 52% Q-o-Q and 20% Y-o-Y to KRW 54.2 billion. 2019 full year sales totaled KRW 1.7012 trillion, representing a 1% decrease Y-o-Y. While operating profit and net income was KRW 479 billion and KRW 359.3 billion, respectively, lower by 22% and 15% each versus the previous year. Next, let me break down sales by title. Fourth quarter mobile game sales totaled KRW 362.9 billion, a jump of 7% Q-o-Q and 63% Y-o-Y. Lineage 2M was successfully launched and Lineage M recorded Q-o-Q growth even after the launch of Lineage 2M. Lineage 2M, which was launched on November 27, opened the doors to new possibilities for mobile MMO games with its differentiated technology. The user-friendly game operation and abundantly rich content, which transcend all barriers between platforms, have taken the title to #1 in mobile game sales in Korea. Without disrupting the user traffic of any of the existing titles, Lineage 2M continues to show positive momentum in terms of user matrix, such as DAU and PCU, which is exceptional for a mobile game. Thus, we expect to surpass expectation levels throughout 2020. Lineage M posted a Q-o-Q increase in both traffic sales after the fourth episode update in November. Today, we are releasing a large-scale update that will enable an upgrade of the fairy class, the most-popular class within Lineage M. Approaching the third anniversary of the title in 2020, our goal is to continue the said performance of this game. The 5 PC online games represented KRW 116.6 billion, down 7% Q-o-Q, but up 3% Y-o-Y. Lineage M remains strong at KRW 51.4 billion for the third consecutive quarter since the remaster update. Lineage I sales has exceeded KRW 50 billion, which is the result of taking solid user traffic following the remaster update and adding the effects of the 21st-anniversary promotion. Lineage II sales were KRW 27.8 billion, up 21% Q-o-Q and 34% Y-o-Y. Following the large-scale update in August, the peak concurrent user numbers have more than doubled, showing that the player base has broadened. This has led to revenue growing for the second consecutive quarter. Aion, Blade & Soul and Guild Wars 2 each posted KRW 8.1 billion, KRW 18 billion and KRW 11.3 billion in sales, representing a Q-o-Q decrease of 39%, 16% and 25%, respectively. Royalty revenue was KRW 44.3 billion, similar to that of the previous quarter. To break down the full year 2019 performance for each of the games, 2019 total mobile game sales was KRW 998.8 billion, an increase of 9% Y-o-Y and representing 59% of total sales. The 5 PC online games ended at KRW 456.2 billion, a decrease of 4% Y-o-Y. Lineage I sales grew by 16% versus the previous year to KRW 174.1 billion. Even in Lineage I's 21st year, we continue to pursue new ideas and changes, which has led to a meaningful result of going back to positive growth in 3 years. Lineage II revenue was up by 46% Y-o-Y at KRW 93.6 billion, reaching the highest sales since 2011. Aion, Guild Wars 2, Blade & Soul each ended at KRW 46 billion, KRW 58.7 billion and KRW 83.9 billion, respectively, which is a decrease of 27%, 27% and 30% Y-o-Y. Aion, Guild Wars 2 and Blade & Soul have experienced weaker sales versus the previous year, but as we have successfully achieved a rebound in Lineage I and Lineage II, we will continue our efforts to create changes in these games also. Royalty revenue totaled KRW 197.5 billion, a decline of 30% Y-o-Y. The main drivers were the decrease in Lineage M Taiwan and Lineage II-based mobile games sales. Now let me talk about costs. Fourth quarter operating expenses totaled KRW 392.7 billion, an increase of 46% Q-o-Q. Labor cost was KRW 159.9 billion, up 46% Q-o-Q due to special businesses paid and advanced recognition of incentives related to the successful launch of Lineage 2M. Variable cost was KRW 116.2 billion, up by 59% quarter-on-quarter because of an increase in distribution fees related to the growth in mobile game revenue. And marketing was KRW 41.3 billion, up 81% Q-o-Q due to the large new-game launch and various updates and events conducted during the quarter. To move on to full year 2019 expenses. Labor cost was KRW 555.1 billion, up 3% Y-o-Y. Variable cost posted KRW 331.9 billion, an increase of 8% Y-o-Y, reflecting the increase in distribution fees as mobile game revenue continues to grow. Marketing totaled KRW 107.3 billion, higher 84% Y-o-Y due to mobile game launches in Korea and overseas and more advertisements for each game. Depreciation was KRW 52 billion, up by 88% Y-o-Y due to the accounting treatment changes from lease assets. And others was KRW 176 billion, 3% higher Y-o-Y without any special factors to mention. This brings me to the end of the presentation on fourth quarter earnings. In 2019, the company was able to reconfirm the strong demand for MMOs through Lineage 2M. It also was able to create another healthy revenue stream in addition to Lineage M. Based on the stable profit generation of Lineage M and Lineage 2M, we are preparing our new games with a renewed confidence. We will continue to fuel our growth with new games, such as Blade & Soul II and Aion 2. This year, Lineage 2M will also be going overseas. We will continue to exert our best efforts to repeat the success of creating a mobile MMORPG market in Korea and other markets. The company disclosed its shareholder return policy of paying 30% of net income for the next 3 years in cash dividends. In 2020, we will strive to deliver better performance to Lineage 2M in Korea and overseas and new title launches. We look forward to your interest and support. Thank you.

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

The first question that I would like to ask you is about your mobile game revenue. In the fourth quarter of last year, it seems to be that there was some change in -- changes in the accounting method or the accounting recognition that you have for sales, and as a result of that, there are some deferred revenues in this quarter. So as a result of that, it's difficult to do an apple-to-apple comparison with your past numbers. If we were to use your past number recognition and look at Lineage 2M and Lineage M, what would be the overall aspects and what would be the numbers from that standpoint? In addition to that, the second question that I would like to ask you is that in the beginning of your presentation, you had mentioned that for Lineage 2M, the overall traffic was very exceptional in terms of the fact that it was very strong and also showing an upward trajectory. If that is the situation then versus the fourth quarter sales numbers that we have seen, what is the first quarter like in terms of the performance for this game? We are now in the mid of February. So how do you see the trends evolving? The reason I ask you this question is that in the past for other games, it seems to be that in the first quarter, we've had a somewhat downward adjustment in your overall revenue numbers, but what are the trends for -- in the case of Lineage 2M?

So thank you for your question. Maybe if I can address the first question that you have asked. In terms of the change in the revenue recognition, as we have launched Lineage 2M and the overall contribution from our mobile game sales is increasing, we did believe it was the right time to readdress and maybe review the situation in terms of how we recognize our item sales from a user standpoint. So as a result, we have made the decision to make this change in the fourth quarter. In actuality, if you look at the impact of this change, the biggest impact was on Lineage 2M, so as mentioned before, as a result of that, around 20% of our revenue has been deferred to the next quarter. However, for the other games, including Lineage M, the impact is not that meaningful. It's more like a single-digit situation. So as a result of that, I can say that for Lineage 2M, the impact was the largest. But for the other game titles, it was not that large. And in addition to that, as we enter into the first quarter, this effect in itself, of course, will evaporate, so as a result, going forward, this impact will not be very large. And to move on to your second question, which I understand to be about the overall traffic and revenue trends that we see for Lineage 2M. I think that for Lineage 2M, particularly looking at the traffic numbers, we do see a lot of differences from Lineage M, and this is something that internally, we are also studying. For Lineage M, if we remember what the overall trend was in the beginning, it really took off. And then after that, in terms of the daily active users or the DAU numbers, we saw a decline, after which it stabilized. However, for Lineage 2M, what we're actually seeing is that from the first day of the launch to even today, the overall DAU numbers continues to consistently grow. We also see that same trend taking place in terms of the peak concurrent users, the numbers that we see. So it's overall continuously growing. Also in terms of the overall revenue trend, it would be the same situation for Lineage M as was that in the beginning. It took off. There was a decline, after which there was a stabilization. However, for Lineage 2M, it seems to be that the stabilization in itself is taking place at an extremely moderate place. And we do believe that this is because of the new users that are entering into the inflow. Their spending is contributing to offset the rent.

The following question will be presented by Oh Dong Hwan from Samsung Securities.

I would like to ask about your new game launch pipeline that you have. I think that before you had mentioned that either Aion 2 or Blade & Soul II would be launched in the second half of this year. Is this comment still valid? And if so, when we talk about the second half, would it be closer to the third quarter or the fourth quarter?

So for the new game launch plans that we have. In the current time, if we look at what is determining the launch timing, rather than it being determined by the overall development situation that we have for these games, it's more of a strategic decision that the company will have to make in light of the overall market environment and also our internal conditions that we see. So as of yet, we have not made any decision on this standpoint. So it would be difficult to say when that specific timing would be. However, I think that it is safe to say that whatever game goes first, we are prepared to be able to launch when we see the time to be right.

The following question will be presented by Kim Sung Eun from Macquarie Securities.

I would like to ask a question about your Lineage II mobile fourth quarter revenues. It seems to be that the overall performance of your top line of this game is much higher than we see for other large-scale competitive titles within the market space. So the factor that I would like to ask is that in terms of who is driving these revenues, do you see that it's actually a lot of MMO users or MMO gamers coming on to your title, or do you actually see -- because this is more of a cross-platform game that existing or previous PC online game users are transferring over to Lineage 2M? So in actuality, where is the user base actually coming from?

So if we look at the overall situation, I think that basically, what we can say, it would be difficult to break it down between whether they were existing mobile game users or whether they are using the PURPLE platform because they were PC-based users. It's difficult to break it down in that manner. However, what we actually do see taking place is that, first and foremost, within our own existing base of mobile gamers and also PC-based online gamers, we have not seen any signs of cannibalization across all of our other games. What we expect is that for the new inflow that we see, it's mostly coming from the dormant users from our previous games. And also, we see a new generation or maybe younger generation in terms of the age of the gamers or the users that are flowing in. So these are fresh gamers. So as a result, that's one trend. And in addition to that, we also see people who had not been enjoying MMO games, that are also coming in and trying out our game. Based upon the market data available, we also believe that there are gamers that have been enjoying maybe a similar smaller-sized or medium-sized game and who have transitioned over to Lineage II mobile.

The following question will be presented by Sung Jong Hwa from eBest Investment Securities.

I have a couple of questions that I would like to ask you about the labor cost. If -- first, if we look at the fourth quarter, for Lineage 2M, you had mentioned that there were special bonuses and also the advanced recognition of incentives related to Lineage 2M. I think that what we were expecting is that with the launch taking place that there would be around KRW 10 billion in labor cost increases that we would recognize, but it seems to be a much larger number. So is this, in actuality, that you have paid the bonuses in advance related to this game? So that is the first part of the question. In addition to that, if we look at past precedent for Lineage M, after launching the game in the second quarter of 2017, it was extremely popular. So for the first bonuses or incentives that were paid related to that success, it came in the third quarter of 2017. So as a result, I do believe that we were expecting that the same would take place for Lineage 2M, and therefore, we were expecting that the bonuses would come for us in the first quarter. However, it seems to be that it actually took place in the fourth quarter. So is this an advanced payment of that bonus? And in addition to the KRW 10 billion or so bonuses related to the launch in itself, how much in actual performance-related incentives were paid? What would that number be? In addition, if we look at the first quarter labor cost expectations, do you believe that because you have made advanced payments in the fourth quarter that the first quarter labor cost will actually go down or will decline because of that situation? And lastly, because Lineage 2M is performing very well. I do believe that throughout the year, there could be other bonuses or incentives paid during the year. So if that is the situation, then what would be the company's policy for incentive payments per quarter throughout 2020?

So thank you for your questions. I think that you have had a long list of questions. But at the core of what you are trying to understand, I think, is the situation that is surrounding the overall incentive program that we have for Lineage 2M. So one thing that I think that there is a misunderstanding about is that we did not actually pay out these incentives in the fourth quarter. It was an advanced recognition. This means from an accounting standpoint of future expenses. If we look at how the overall performance year ends, it ends in March. So as a result of that, based upon the performance that we see taking place, there will be an accrual from an accounting standpoint of the incentives. And that is what we reflected in the fourth quarter. As of course -- because the overall performance of Lineage 2M in itself has boosted our performance, as a result, in the fourth quarter, there was a large amount that we have been able to recognize, and that was the majority of what has been included in the fourth quarter numbers. Again, this is something that we will continue to accrue up until the end of March. And because it is performance-based, we do think that in the first quarter, again, since our performance continues to be very robust, that labor costs will increase again. However, in terms of the level of increase, we don't think it will be as large as what we have seen in the fourth quarter. To move on to your question about what our annual or full year policy would be. I think that the overall bonus scheme that we're using for Lineage 2M actually is identical to the formula that we used for Lineage M, so I think that you can use that as past precedent to see how things play out. However, in terms of the actual amount, that would come at the end of the performance here. So as of now, we don't have a final number to share with you. But it is a continual accrual process.