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Edited Transcript of 036570.KS earnings conference call or presentation 2-Aug-19 12:00am GMT

Q2 2019 NCSOFT Corp Earnings Call

Seoul Aug 3, 2019 (Thomson StreetEvents) -- Edited Transcript of NCSoft Corp earnings conference call or presentation Friday, August 2, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Jae-Soo Yoon

Ncsoft Corporation - CFO

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Conference Call Participants

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* Dong Hwan Oh

Samsung Securities Co. Ltd., Research Division - Analyst

* Jae-min Ahn

NH Investment & Securities Co., Ltd., Research Division - Internet and Media Analyst

* Minuh Cha

Goldman Sachs Group Inc., Research Division - Analyst

* Moonjong Lee

Shinhan Investment Corp., Research Division - Economist and Analyst

* Stanley Yang

JP Morgan Chase & Co, Research Division - Analyst

* Taewon Kim

UBS Investment Bank, Research Division - Director and Research Analyst of Internet and Gaming

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Presentation

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Jae-Soo Yoon, Ncsoft Corporation - CFO [1]

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[Interpreted] 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 second quarter 2019.

Let me begin my presentation with the second quarter earnings highlights.

Second quarter sales was KRW 410.8 billion, an increase of 15% versus the previous quarter, driven by robust sales in PC and mobile games.

Operating profit recorded KRW 129.4 billion, up by 53% quarter-on-quarter due to solid top line performance and the absence of one-off labor costs, which were included in the first quarter.

Pretax income grew 50% quarter-on-quarter to KRW 147.1 billion, while net income rose 56% to KRW 116.9 billion.

Next, let me break down second quarter sales by game. Mobile game sales totaled KRW 223.8 billion, an increase of 13% quarter-on-quarter and 7% year-on-year. Lineage M, which is now 2 years into its launch, was able to achieve a year-over-year growth, which is particularly meaningful. Carrying on the trends of the first quarter, Lineage M continues to maintain its best traffic level since 2018. Leveraging its substantial traffic volume, we engage in new and unprecedented attempts to strengthen the value of the game and make it more entertaining. Considering the high user numbers and strong series of updates planned, we believe revenues will maintain sound in the second half of 2019.

The sales of the 5 PC online games represented KRW 120.7 billion, growing 28% versus the previous quarter.

Lineage I posted KRW 50.1 billion, jumping 142% quarter-on-quarter, fueled by the remaster update and the revamped monetization scheme. User metrics more than doubled following remaster and continue to remain at strong levels to date. In the second half, we expect stable revenues from various updates and continuous management of operations.

Lineage II sales was KRW 21.2 billion, down 2% quarter-on-quarter, but up 59% year-on-year. Lineage II first half total revenue is KRW 42.8 billion, representing a 55% increase versus the previous year. This year will be 16 years since the launch of Lineage II. The fact that a game in its 16th year is achieving 55% Y-o-Y growth is extremely encouraging for us. Lineage II is preparing large-scale updates in the second half, which should extend the growth momentum of the first half.

Aion sales was KRW 12.4 billion, up 1% quarter-on-quarter, while Blade & Soul and Guild Wars 2 each declined 9% and 3% to KRW 21.2 billion and KRW 15.9 billion, respectively.

Lastly, royalty revenue was KRW 51.6 billion, a decline of 10% quarter-on-quarter because of less revenue from Blade & Soul IP-based mobile games and Lineage in Taiwan.

Now let me talk about expenses. Second quarter operating cost was KRW 281.4 billion, up by 1% from the first quarter. Labor cost was KRW 125.9 billion, down 12% quarter-on-quarter due to the absence of management and employee bonuses and one-off expenses related to certain overseas subsidiaries that were restructured. Variable cost was KRW 77.2 billion, an increase of 18% quarter-on-quarter due to growing distribution fees, driven by the growth in mobile game revenue. And marketing was KRW 24.2 billion, an increase of 28% versus the first quarter, coming from the launch of Lineage in Japan.

In the first half of 2019, we were able to achieve significant performance across our key titles. In its second year, Lineage M is still able to maintain its top traffic levels, while Lineage I has been -- has seen users more than double after the remaster update. Lineage II has also been able to achieve sizable year-on-year growth due to new species and new server updates. The company will not be complacent about our leading position and continues to take on new challenges and try new attempts, which we believe is the secret to the long-running nature of our games.

In the second half, the hugely anticipated Lineage 2M will be launched. We are confident that Lineage 2M will once again change the landscape of the mobile game market with its shared scale, differentiated content and top-quality graphics.

Other large-scale titles, such as Aion 2 and Blade & Soul 2, are also progressing smoothly. From the beginning, these games are being developed to ensure that they perform well, not only in Korea but also in the overseas market.

We look forward to your continuous interest and support. Thank you.

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Questions and Answers

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Operator [1]

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

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Minuh Cha, Goldman Sachs Group Inc., Research Division - Analyst [2]

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[Interpreted] The first question I would like to ask you is about Lineage I. If you look at the quarter performance, it has rebounded significantly due to the remaster update. And I do believe that the market is very interested about whether this is sustainable going forward. So for the third quarter, what is your revenue outlook for the game? And why do you believe it will be so? The second question that I would like to ask you is about your second half outlook for the other key games that you have.

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Jae-Soo Yoon, Ncsoft Corporation - CFO [3]

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[Interpreted] So to address the Lineage I first. If we look at this current situation since the update has taken place, we have seen very solid numbers taking place in terms of the overall user traffic numbers. In the second half, we also have other updates that are being planned right now. So as a result, we do believe that we will be able to maintain the current traffic numbers and also revenue numbers.

And for the other key titles, which would be Lineage M in 2019, we do believe that for the full year that we will be able to maintain the current strong revenue that we have been able to see.

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Operator [4]

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[Interpreted] The next question will be provided by Stanley Yang from JPMorgan.

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Stanley Yang, JP Morgan Chase & Co, Research Division - Analyst [5]

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[Interpreted] There are 2 questions that I would like to ask you. First, if we look at L2M, you did say that this is something that would be launched in the second half of the year. But could you be a bit more specific about the details surrounding that launch schedule? And for example, when are you planning to start the overall preregistration? In addition to that, for this game at the management level, what is the expected or target level of revenue that you are looking at? For example, if you would compare it to Lineage I or maybe to Lineage 2 Revolution, what number would you be expecting? The second question that I would like to ask you is about your labor cost. It seems to be down now. Is this a trend that you think will continue throughout the year? So would the current level be what we should be expecting going forward? And in addition to that, there was a restructuring that took place at NCWest. So are there going to be further restructuring? And as a result of that, would there be a downward overall stabilization of your labor cost?

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Jae-Soo Yoon, Ncsoft Corporation - CFO [6]

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[Interpreted] For Lineage 2M, right now, internally, the plan is to launch within the fourth quarter. And as a result of that right now, at the business level, there are various scheduling that is taking place. So if there are no additional issues on the development side or on the launch preparation side, we do think that the overall plan should be going ahead as we have laid it out. We do believe that in the not-too-far future, from the business side, you would be able to see more details about our game trends and also our marketing activities.

And to talk about management's expectations about Lineage 2M, of course, the overall level that we would be expecting would be similar to what we have from Lineage M. However, if you compare the Lineage II IP to the Lineage I IP, Lineage II to appeal to a much broader base on the global side. So as a result of that, we do believe that for this game, our expectations is not only success in Korea, but the plan would be to launch at a very timely manner in the global market as well, with no large gap between the launches. So as a result of that, the overall level of achievement or performance that we would be expecting would be on par to Lineage M or more.

And lastly, talk about labor cost. Into the second half of this year and the first half of next year, there are various projects that will be actually reaching the production level. So as a result of that, we do think that the overall development cost will trend to a higher level during that period of time versus what it is at the current time. In addition to that, for NCWest, we are going through a process in trying to improve the efficiency of that overall operation, but we do not expect any significant decrease in labor cost from that entity.

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Operator [7]

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[Interpreted] The next question will be provided by Jae-min Ahn from NH Investment and Securities.

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Jae-min Ahn, NH Investment & Securities Co., Ltd., Research Division - Internet and Media Analyst [8]

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[Interpreted] One of the areas, I think, that we are interested in is that the company has just talked about its expectations for our revenue for Lineage 2M. And I personally believe that this is a game that will perform very well. However, from the investor side, I do believe that there is questions that people have about the overall Korean MMO market. Because if you look at the titles that have been launched recently into this market, they have not been performing well. So I think that, that leads to various questions about how large this market can actually grow in terms of the potential for growth. So as a result of that, could you elaborate a bit -- a bit more about your Lineage 2M revenue upside potential that you see? For example, Lineage M was a significant performance. However, on the upside of that, how far do you think this game has the potential to grow?

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Jae-Soo Yoon, Ncsoft Corporation - CFO [9]

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[Interpreted] So if we look at the numbers that we are able to measure, for example, when we do an update, what the revenue is as a result of that update. And also in terms of non-revenue indicators, such as user traffic or our overall activity levels, that is something that we are able to monitor. And in addition to that, if we look at other games that are launched by competitors, we're also able to see what the traffic metrics are from those games also. So of course, at the current time, we do believe that there are gamers right now that are very active that are enjoying the various games and are consuming them, but we also believe that there is a huge amount of potential demand that is out there in the market that are waiting on the sidelines for something new and exciting to appear. And we do believe that Lineage 2M in that area would be a game that can meet those expectations and satisfy that pent-up demand that we see within the market space. So as a result of that, we do think that once again, we will be able to show the market the potential that the Korea market would have in a similar manner to what we have seen to the Lineage M launch. So we think that Lineage 2M would be what's able to once again show the overall potential of the market to the investor base. However, that has been said, we do recognize that the Korea market as a whole does have its overall limitations. So for us to grow to the next phase in terms of our overall revenues, we do recognize that we need to add on more overseas revenue. So in that spirit, when developing Lineage 2M, we have put in mind the overall global or overseas user base and try to create a game to cater to that market accordingly. And we do believe that we have been able to achieve a product that would do so.

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Operator [10]

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[Interpreted] The next question will be provided by Dong Hwan Oh from Samsung Securities.

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Dong Hwan Oh, Samsung Securities Co. Ltd., Research Division - Analyst [11]

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[Interpreted] There are 2 questions that I would like to ask you. If you look at your competitors, I do believe that there are companies that are preparing console-based games or cloud platform games right now. So what is the company's preparations in this area? The second question that I would like to ask you is also about Guild Wars 2. If you look at the other IPs that you have right now, a lot of it has been converted to a mobile game platform. However, for Guild Wars 2, it seems that we have not been able to hear about that taking place. So is there something that is in the pipeline right now?

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Jae-Soo Yoon, Ncsoft Corporation - CFO [12]

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[Interpreted] To address your first question, on the topic of console games, I do believe that this is something that we touched upon during the previous conference call, that it's something that we have discussed and communicated through multiple opportunities in the past. But with the exception of the mobile games that we categorized, basically, for what we have called the legacy PC games in the past and any games that would follow under that category going forward, from the beginning will be designed to be able to be played on a console format or platform. So in addition to PC, it would be the PC plus console would be the basic default platform on which these games would be able to be enjoyed. And that is the fundamental standing point that we start from in terms of the overall development. On the cloud game side, I do not believe that there is something specific that we will be able to discuss with you. But internally, there are various attempts that we are trying out right now. And there's a lot of research that we're doing in this area.

And I think your second question is about the mobile version of Guild Wars 2. Right now at ArenaNet, I think that including a Guild Wars 2 mobile type of format, there are various considerations and various options that we are currently reviewing. And there are prototypes that are being built as a result of that. So as of now, it would be difficult to say, yes, we are going to have a mobile or maybe we're not going to have a mobile version of Guild Wars 2. Because, again, right now, we're in a phase in which we're exploring all of the options that would be available. For example, Guild Wars 2 mobile or maybe with the related resources, whether pursuing something of a different nature or different projects would be better. It is something that is still under review. So that is where we sit as of today.

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Operator [13]

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[Interpreted] The next question will be presented by Taewon Kim from UBS.

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Taewon Kim, UBS Investment Bank, Research Division - Director and Research Analyst of Internet and Gaming [14]

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[Interpreted] The question that I would like to ask you is about Lineage 2M overseas revenue and your expectations on this side. If we look at the markets such as Japan, Taiwan and also Southeast Asia, these are markets in which, in the past, MMORPGs have performed well overseas. However, in addition to that, do you think that L2M would be able to make more inroads into North America and also European markets, which have not been -- which has not been the case to date? Do you think that this is a possibility? And if so, why do you believe that would be so with Lineage 2M? What do you think would be the point of differentiation that would appeal to this market? And if you would be able to elaborate a bit about that, that would be appreciated.

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Jae-Soo Yoon, Ncsoft Corporation - CFO [15]

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[Interpreted] To address your question for Lineage 2M, we do think that we do have high expectations for North America and Europe and the [R E N]. Because of that, in terms of the priority in the overseas -- making inroads these overseas markets would be one of the top priorities that we would have in launching this game. It's not because we think that Lineage II in itself or other as a PC game was able to appeal largely to an existing North American and European base and, as a result of that, that we would be able to appeal to that base, but rather because we do think that for Lineage II mobile, that this is going to be a full 3D seamless open world. And it will also support very high-quality graphics. So as a result of that, we do think that this is going to be a very new experience for the users in North America and also Europe. And as a result of that, that it will appeal very well to them. And that is the point of differentiation that we do believe will appeal and lead to the results that we're hoping for.

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Operator [16]

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[Interpreted] The next question will be provided by Eric Cha from Goldman Sachs.

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Minuh Cha, Goldman Sachs Group Inc., Research Division - Analyst [17]

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[Interpreted] So I would like to ask some additional questions. First, if you look at the overall cash flow from the company, cash flow generation is very robust and strong. So in terms of shareholder return or any potential M&A, what would be the company's thoughts in those areas? And secondly, this is something that has come up a couple of times. But if you look at the depreciation during this quarter, it seems to have grown significantly. What would be the reason behind that?

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Jae-Soo Yoon, Ncsoft Corporation - CFO [18]

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[Interpreted] On the topic of shareholder return or M&A possibilities, I think that there is no change in our stance on these issues. So it would be what we have said before, it will continue to be valid and continue to stand as our position. So for dividends or maybe overall shareholder returns, this is something that we continue to discuss at the BOD level this time around, during our meetings. It is -- it was a topic of discussion. And we are planning and are committed to maintain the stance that we have had in terms of shareholder return. On the M&A side, we do have teams in both the U.S. and also in Korea that continue to explore various targets and search for targets. So I do think that there may be some news that we will have upcoming soon. But in terms of these targets and any progress there or we're able to make, we will make that information available once it comes.

And to move on to the question about why our depreciation has been increasing, it is because of the change in our accounting standards. Under IFRS, the way that we recognize our lease asset has changed. So what was initially done as lease fees that we have included of around KRW 3 billion each quarter is now accounted under our depreciation against the lease assets that we have. So the change in the accounting has led to the increase in our depreciation.

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Operator [19]

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[Interpreted] The next question will be provided by Moonjong Lee from Shinhan Investment.

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Moonjong Lee, Shinhan Investment Corp., Research Division - Economist and Analyst [20]

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[Interpreted] It might be a question that you will not be able to answer because it's a bit too early. But for Lineage 2M, you had mentioned before that the overseas launches will be taking place on an interval that would not be too wide to the Korean launch. How long or how many months would that actually represent? And in terms of your priority for markets overseas that you're looking at, in terms of the countries, what would be your priorities?

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Jae-Soo Yoon, Ncsoft Corporation - CFO [21]

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[Interpreted] So you asked only one question, but unfortunately, it's a question that I cannot give you a clear answer to, and it's not because I don't want to do so, but it's more because it's still a work in progress. So as a result of that, in terms of how many months the actual launch date would be spaced out between and in what countries we would prioritize. When I say it won't take too long, what I am trying to say is that it's not going to be something like 6 months or 1 month after the launch in Korea. And in addition to that, in terms of the sequence of countries, this is something that is still under review. So I would not be able to talk about that now.

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Operator [22]

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[Interpreted] Currently, there are no participants with questions. We will wait for a second until there is another question.

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Jae-Soo Yoon, Ncsoft Corporation - CFO [23]

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[Interpreted] So if you do have any follow-up questions, please do not hesitate to contact our IR team. And with this, we would like to wrap up with our conference call for the second quarter 2019. Thank you once again for your participation.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]