Earnings Transcript for NEXOF - Q4 Fiscal Year 2022

Operator: Good day, everyone, and welcome to NEXON's Fourth Quarter and Full Year 2022 Earnings Conference Call. [Operator Instructions]. At this time, I would like to turn the call over to Takanori Kawai, Team Leader of Investor Relations.

Takanori Kawai: Hello, everyone, and welcome to NEXON's earnings conference call. Thank you for joining us today. With me are Owen Mahoney, President and CEO of NEXON; and Shiro Uemura, CFO. Today's call will contain forward-looking statements, including statements about our results of operations and financial condition such as revenues attributable to our key titles, growth prospects, including with respect to the online games industry, our ability to compete effectively, adapt to new technologies and address new technical challenges, our use of intellectual property and other statements that are not historical facts. These statements represent our predictions, projections and expectations about future events, which we believe are reasonable or based on reasonable assumptions. However, numerous risks and uncertainties could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Information on some of these risks and uncertainties can be found in our earnings-related IR documents. We assume no obligation to update or alter any forward-looking statements. Please note, net income refers to net income attributable to owners of the parent as stated in NEXON's consolidated financial results. Furthermore, this conference call is intended to provide investors and analysts with financial and operational information about NEXON, not to solicit or recommend any sale or purchase of stock or other securities of NEXON. A recording of this conference call will be available on our Investor Relations website, www.ir.nexon.co.jp/en/ following this call. Unauthorized recording of this conference call is not permitted. I'd now like to turn the call over to Owen.

Owen Mahoney: Thank you, Kawai-san, and welcome everyone. I'd like to start today's call by setting context. Like most companies in our business, at NEXON, we regularly do comprehensive reviews of other companies that we might want to buy. Recently we've been challenged to find potential targets that have not expressed serious concerns about the future. Private and public game companies have each been telling us a very similar story, largely around four themes. First, the global economy is in bad shape and that is impacting consumer spending. Second, competition, especially from highly-funded AAA games, has been even more fierce than usual. Third, the end of COVID and return to work has eliminated the surge in players and play time we saw during the pandemic. Fourth, for many companies in the mobile space, the IDFA changes from Apple have destroyed their unit economics and their hope to generate any material profit. This all sounds pretty bleak. And certainly, the gloom we've been hearing in games is even worse in the broader consumer media and tech space where even the most respected companies are slashing ad spending and laying off tech workers by the tens of thousands. In sharp contrast to that gloomy operating environment, NEXON's performance has never been better and is getting even stronger. NEXON achieved its best ever revenue year in 2022. We just completed an outstanding Q4 where we grew our top-line 36% on a constant currency basis. That brought us to 19% growth for the year on a constant currency basis. And that great performance extends to Q1 of 2023. As Uemura-san will detail for you, our guidance calls for revenue growth of 19% to 28% growth on a constant currency basis. Performance of all of our largest live games has been excellent. Now we're launching a number of major new Virtual Worlds in 2023. In a moment, we will give you details of our performance by franchise and by region. Before doing so, we think it's worth pausing to underline a key point to help investors. That is, NEXON's business, the business of deeply immersive Virtual Worlds, is so different from other game companies as to constitute a wholly different entertainment industry category altogether. Virtual Worlds is different in almost every way; different in how we operate our business on a day-to-day basis, the kind of people we hire, what metrics we use to gauge our success, what technology investments we make, how we communicate our business performance internally and to outsiders, and perhaps most importantly, the mindset of our management and operating teams. The sharp contrast of our performance to other companies that we are usually grouped together with, presents an opportunity to reconsider and reframe what investors think they know about Virtual Worlds companies like NEXON. In this call, Uemura-san and I will endeavor to explain what we mean by this difference, so you can better analyze our performance and our future. I'll start by summarizing the highlights of the quarter and the year. Q4 2022 marked the highest Q4 revenue in NEXON's history and 2022 marked the highest annual revenue in NEXON's 28-year history. Fourth quarter revenue grew 49% year-over-year to JPY81.1 billion and included a year-over-year increase in operating profit of more than 200%. For the full year 2022, NEXON delivered a 29% increase in year-over-year revenue to JPY353.7 billion and a 13% year-over-year increase in operating profit. In the full course of 2022, NEXON delivered strong results in key franchises. FIFA ONLINE 4 delivered record high annual revenue. We're extremely pleased with the result, especially since we think the core product, the performance of our live game team and our live ops tech stack backing the game are working so well together. World Cup clearly provided a boost for 2022, although we should note we'll have a tough comp in 2023 for this product as there will be no World Cup. Meantime, following a drop we experienced back in 2021, MapleStory in Korea continued its growth trajectory that began in Q2 of 2022. Both revenue and MAUs increased year-over-year. Also in Korea, the mobile version of D&F, which we introduced in March 2022, has continued to perform well. In Q4, the game also won Game of the Year from the Korean Association of Game Industry known as K-Games. The live operations team celebrated this achievement by lowering monetization in the game. Why would they do this? Because they understand that in a well-run Virtual World, building long-term engagement year-over-year -- engagement over years and decades is more important than near-term monetization. In China, after significant preparation work by the live development team, the PC version of Dungeon&Fighter showed very strong performance. And overall, our business in China grew by 55% year-over-year. Importantly, the game saw a meaningful increase in active users in Q4. The Lunar New Year update released this January is proving to be very popular, and our China business is tracking toward double-digit year-over-year growth in Q1. It's too early to project how this trend will continue across the full year, but we are pleased with the recent results we're seeing in China. I will pause here to note that the rebound in both MapleStory in Korea and Dungeon&Fighter in China reflect our experience over and over again. Live Virtual Worlds fluctuate up and down in the near-term, but when managed well, can show steady growth over years and decades. Second, and as important, NEXON has a portfolio of such robust Virtual Worlds. So when one goes down, the others very often make-up for the difference. This inherent stability to our portfolio enables us to make thoughtful investments in the community of each game over time. Next, I want to provide an update on new Virtual Worlds in development for release in 2023. In mid-January, KartRider

Shiro Uemura: Thank you, Owen. Now, I'll review our Q4 and FY 2022 full year results. For additional details, please see the Q4 2022 Investor Presentation available on our IR website. We achieved record-breaking fourth quarter revenue of JPY81.1 billion, up 49% year-over-year on an as-reported basis and up 36% year-over-year on a constant currency basis. Our performance continued to be driven by the growth of multiple major titles as well as contributions from new titles, HIT2 and Dungeon&Fighter Mobile. Overall, our top-line performance was within the range of our outlook. Dungeon&Fighter in China and FIFA ONLINE 4 exceeded our expectations, while revenues from our mobile business in Korea were lower than planned. By region, revenues from China, North America and Europe exceeded our outlook, while revenues from the Rest of World came in at the high end of our expectations. Revenues from Japan were within the expected range and revenues from Korea were at the low end of our outlook. Looking at the total company performance by platforms, PC revenues exceeded our outlook, while mobile revenues were lower than expected. Operating income was up 269% year-over-year and within our outlook at JPY11 billion. Net loss was JPY7.9 billion, which was below our outlook. This was mainly due to an FX loss of JPY25 billion related to the appreciation of the Korean won and Japanese yen against the U.S. dollar and its corresponding impact on U.S. dollar-denominated cash deposits. Let's move on to results by region. Revenues from our Korea business were at the low end of our outlook. On a year-over-year basis, revenues increased by 62% on an as-reported basis and by 50% on a constant currency basis, coming in at JPY51 billion, representing record-breaking fourth quarter revenues in Korea. FIFA ONLINE 4's PC and mobile combined revenues exceeded our outlook, driven by successful World Cup-related events and sales promotions. MAUs, paying users and ARPPU all increased year-over-year. As a result, its revenues grew significantly and marked record-breaking fourth quarter revenues. MapleStory's MAU and revenue increased year-over-year driven by the well-received Winter update. Dungeon&Fighter's revenue grew by 65% year-over-year, which exceeded our expectations and achieved record-breaking fourth quarter revenue driven by well-received update. For Sudden Attack, revenue decreased year-over-year due to the challenging comps with last Q4 when it grew 124% year-over-year. All in, PC revenues in Korea increased by 61% year-over-year. As for the mobile business, revenues from HIT2 and Dungeon&Fighter Mobile were lower than expected. HIT2's revenue was below our outlook as the impact from the update introduced during the quarter was lower than expected. We are preparing multiple major updates that we anticipate will help maintain high user engagement in 2023. For Dungeon&Fighter Mobile, the user community was excited about the news that the game was selected as the Best Game of the Year at the Korean Game Awards in November. Given this positive event, we decided to focus on keeping the good momentum and canceled the planned item sales, and instead, offered large scale rewards to players. As a result, while the revenue was below our outlook, the number of active users increased quarter-over-quarter. On a year-over-year basis, mobile revenues in Korea increased by 63%. Contributions from HIT2 and Dungeon&Fighter Mobile as well as growth of FIFA ONLINE 4 M and FIFA MOBILE, were partially offset by revenue decreases in Blue Archive, V4, The Kingdom of the Winds

Owen Mahoney: Thanks, Uemura-san. To summarize our thoughts, in the face of a very difficult global economy, NEXON has never been stronger or its future brighter. We grew 49% year-over-year in Q4 and we expect to grow 28% to 38% year-over-year in Q1. NEXON teams around the world are clearly firing on all cylinders. But as happy as we are by our results, we think there's an additional factor at work that is vital for investors to understand. The business of NEXON is commonly misclassified as games, as if making casual games or single-player RPGs is similar to making and marketing online Virtual Worlds. It's not. We operate a different category of the entertainment business altogether. This legacy misclassification is a trap for analysts. But since so many market participants use legacy mental models, there is a significant opportunity for the analysts who uses an updated set of tools. So what do we mean by the category of Virtual Worlds? First, we obsess about the time spent in a game over what a user pays us in an individual month. Second, we focus on assembling a community of dedicated players over near-term monetization. We'd rather miss our quarterly revenue forecast for the game than hurt the economy -- excuse me, hurt the community. We have made this decision many times in the past and it has served our shareholders extremely well. Third, over a period of years, a successful Virtual World will have ups and downs over the short-term, but we will see through those near-term fluctuations to achieve our objective of growing a community of players who are highly engaged. Fourth, player lifetime in a Virtual World is indefinite, spanning years, and in some cases, decades. In our world, a whale is not someone who spends a lot of money in the near-term, it is someone who is highly engaged and has a large and active network of friends in their chosen Virtual World. Finally, a concentrated portfolio of well-run Virtual Worlds may double revenues in the period of a few years without launching a single new game. Very few people understand this. Now why do we take this approach? We see ourselves as investors, not as traders. As investors, we look for compounding growth over the long-term. Our objective is to make NEXON a strong, resilient business. So what does this mean for you the analyst or investor? Our view is that it's best to start over and recognize we're talking about an entirely different industry, one that has similarities to the game business, but is in fact operating from a different set of principles. One example of where to start over is the game lifecycle fallacy, where a game starts, grows and then dies in a relatively predictable pattern. That pattern does not apply to a well-run Virtual World. A second useless analytical fallacy is the focus on timing of product launches to predict revenue. Again, this matters a lot in the games business, but is of very limited use in Virtual Worlds. So what should you do instead? Here's how we think of NEXON in the coming couple of years. Our base of live Virtual Worlds has proven again and again to be very solid. Within any quarter, some will be up and some will be down year-over-year, but we believe our portfolio is anti-fragile and serves as a stable base of revenue and profit in the coming years. On top of that base, we then have 8 major projects in the pipeline over the next 18 months. If one hits, we're looking at another year of strong double-digit growth. If two hit, we're a whole different company. We don't know the exact timing of most of these launches, but that doesn't affect your investment decision much because the impact of whatever month they launch will be dwarfed by the performance in following quarters and years. Net, we see our business as an asymmetric opportunity with limited risk to the downside and much opportunity to the upside. We have in fact designed it that way. We expect you to come to your own conclusion on how to forecast the NEXON business, but it's important for you to see the business through our eyes so you can make more informed decisions. Thank you very much for your time. With that, Uemura-san and I would be happy to take your questions.

Takanori Kawai: Thank you, Owen. Next, we would like to open up the lines to live Q&A. Q&A session will be conducted with Japanese-English or English-Japanese consecutive interpretation. Please be noted that interpretation will come between your questions and our answers. Please hold for interpretation before you hear our answers. Our answers will also be followed by interpretation. So please hold until the interpretation finishes before moving on to the next question. For those of you who have more than one question, we will take your questions one-by-one. Now we'd be happy to take your questions.

Operator: [Operator Instructions]. The first question is from Mr. Nagao from BofA Securities Japan Research.

Yoshitaka Nagao: I have several questions. So I would like to pose you the first question, which is on China situation. I would like you to add more color to the situation in China, especially around China Dungeon&Fighter. You mentioned that you are seeing an increase in the number of active users, which means that you have once again built a solid revenue base of China Dungeon&Fighter. And having said that, in your materials, you stated that you are emphasizing the stability of the community and operate accordingly. So when you look at the situation in China in 2023, especially around Dungeon&Fighter, do you think that FY '23 will be the year for investments or do you think you will be able to gain revenue from Dungeon&Fighter more than ever before or do you think year 2023 will be both, i.e., investment and generating revenue? So can you give me the full picture of what will happen in FY 2023?

Owen Mahoney: I will answer about the details of China Dungeon&Fighter. As I have mentioned in my previous briefing, we believe that we have bottomed out in Q1 of 2022. And then afterwards, we were able to see the steady improvement of this title throughout the last fiscal year. And under the new leadership, in particular, we emphasize communications with the players and increase the frequency in which we have dialogues with the users. And as a matter of fact, Korean developers actually directly got in touch with Chinese users, so we were able to understand what are the needs and wants of the users in China. And we had implemented those feedbacks into the improvement we made in the games. And I will give you some particulars of what kind of improvements we made. Firstly, for example, we included mechanism, which will enable the players to grow more easily than before. And secondly, we made the game more action oriented. And with those two endeavors as examples, drove our steady improvement of this title in 2022. And that improvement became very conspicuous in Q4 of 2022. And fortunately, we are seeing the continuation of such momentum in Q1 of 2023. Now, talking about the outlook for FY 2023; I mentioned that we were able to see the gradual growth of this game in Q1 of 2022 and therefore, when you try to compare the result of FY '22 Q1 vis-a-vis that of FY '23 Q1, the hurdle is not that high. And so we will continue growing this fiscal year, but please do not apply the growth rate that we are seeing in Q1 for the rest of the quarters of FY 2023. We gradually made improvements in Q1 of '22, and that momentum further increased throughout Q2 to Q4 Therefore, the comp between the sequential quarters will be very high. And as Owen mentioned in his remarks, we as a company emphasizes longevity. Therefore, we do not just look at the short-term revenue or growth. And so going forward, as far as China Dungeon&Fighter is concerned, we are going to work on the steady operation of this title.

Yoshitaka Nagao: My next question is once again on China. I know that you were able to get the regulatory approval of MapleStory M. And this title is very popular in Korea, whereas I do not think that is necessarily the case in China. Having said that, I have three questions. Firstly, on will be the launch timing? And secondly, how much marketing investment you plan to make? Thirdly, what is the expectations of the management towards this game in China?

Shiro Uemura: It is indeed true that we were able to get the approval of MapleStory M in China. But as far as the launch timing or what kind of marketing investment we will be making, we do not have any definitive information that we can share with you today. Talking about the expectations towards this game in China, needless to say, we do not think that China users will be in the same magnitude as that of the ones we have in Korea. But having said that, we still do have some amount of plans surrounding Maplestory in China as well. As you know, we already have MapleStory PC version in China. And China itself is such a big market. So the management does believe that we can expect to some extent the success of MapleStory M in China as well. But again, once we know the details of the launch and other matters that you have mentioned, we will disclose that as soon as those details are finalized.

Operator: We will take the next question from Mr. Seyon Park from Morgan Stanley.

Seyon Park: I have two questions. One is on FIFA and the other is on KartRider

Shiro Uemura: So thank you very much for your question. Allow me to answer your first question on FIFA Online 4. And as you mentioned, it is very true that we are finding a very good performance at this moment. And that is why for the past quarters, we have always been able to mark record high. And certainly, we do believe the World Cup did have a good effect to that. And of course, we had been preparing ourselves to make sure we'd be able to materialize the momentum. But then what is really crucial is something that we already mentioned in operating Dungeon&Fighter. In other words, we believe it is crucial that we always have communication with the users so that we'd be able to invigorate the community. And at the same time, we need to make sure we have good seasonal updates that matches the needs of the users. And I think that is very crucial in operating PC online games. So again, it's really about daily operations and to make sure we have the good content update on appropriate manner. And theoretically, that is what is supposed to give you a long-term growth. And on top of that, we now have the tailwind of the World Cup, and that is why we're seeing this very good performance. And on top of that, we did really well on the marketing promotion. So all of these multiple factors is what created this very good performance of FIFA and we're still seeing the good momentum continue to today. But with that said, we cannot deny that 2022 was a particular year where we were able to enjoy the contribution from the World Cup itself. And so in 2023, we do not want to be that bullish. We would not be surprised if we started to see the numbers start to turn off from what we have been seeing. So that's something that I'll be able to comment. And also when it comes to operations in other countries that's not something that I would be able to comment because that's not something that we'd be doing.

Owen Mahoney: Seyon, this is Owen. I just want to add to what Uemura San said, and then also answer your second question about KartRider

Seyon Park: Yeah, thank you for the color, Owen, Uemura San and looking forward to playing the game as well.

Owen Mahoney: Great. Look forward to seeing you online.

Operator: So the next question is from Ms. Yamamura from Citigroup Global Markets Japan.

Junko Yamamura: Thank you very much for your presentation. And I want to refer back to what Owen has mentioned a few minutes ago about Virtual World. And I have one follow-up question around that. I fully agree that your business is based on making constant improvement and to build a long-term community. And I remember you mentioning using the analogy vis-a-vis the theme park. And I fully agree with you that Virtual World is akin to theme park. But when you look at the real tangible physical entertainment world, you have to understand that we only have one body. And if people tend to go more towards the Virtual World, the tendency of people is such that we be feed back to the entertainment that is being provided in the real world. And I think that, that has been this issue that digital entertainment industry has been facing so far -- and you've talked about the probability of coming out with 10 million virtual cities. And once those 10 million virtual cities are being built, one by one, the later you come into the game and the hurdle, I believe, will get higher because as I mentioned before, we only have one body. So there will be a limitation in the number of virtual cities or virtual communities that you as an individual can belong to. And I think it all boils down to the balance that you have mentioned. So I want to know how you plan to embrace the players in your Virtual World? And how do you plan to strike the good balance? So can you give me some tangible ideas about what kind of strategy you plan to pursue in growing your Virtual World?

Owen Mahoney: Sure. Thanks for your question. It's certainly a very, very interesting question, and we could probably spend several hours talking about that question alone. But if I understand the core of your question, I think what you're saying is we only have limited time in a day, and people tend to revert to their physical life in their entertainment life. Look, what I -- I don't think that, that has proven to be the challenge for the industry. The challenge for the industry is as an industry if you look -- and I say this as a consumer, as a game consumer, if a Virtual World is really entertaining and if someone -- if I've got lots of interesting things to do in that Virtual World, I will definitely play that game. And if the game is -- if that Virtual World is undifferentiated, it looks like everything else, it becomes uninteresting over time; I won't. And so much of what we do or what the industry does is create things that are very similar. And yet, what we find over and over again is when there's innovation, when there's new types of experiences when we bring a high-quality product to market, people immediately start gravitating in very, very large numbers. And through the history of the last 20 years, we've seen this over and over again across not just Virtual Worlds, but games. And so it's really -- and I could name Virtual World from NEXON, I could name games and Virtual Worlds from other companies over and over again where that has been the case. And then people get blown away. People get so surprised by how many people end up playing and how many hours they end up playing. So to us, it really comes down to a question of quality. And if we deliver a great online experience to customers, they will definitely play. Their playtime will be indefinite. They will keep coming back to that Virtual World for years and, in some cases, decades. And the management team -- we're all gamers and our personal experience has certainly borne this out. The experience of our kids has borne this out. We've seen this among our friends, and we think the industry has borne this out over and over again. So if that is gets to the crux of your question, I hope I'm understanding your question correctly. But what I would summarize is it's about meaningful differentiation and meaningful quality. And if we deliver those things well, we find that that online games especially Virtual Worlds are incredibly compelling form of entertainment.

Junko Yamamura: I understood it very well. Thank you very much.

Operator: We will take the next question from Mr. David Gibson from MST Financial Services Limited.

David Gibson: Well done on a great quarter and guidance. On the costs, I wanted to ask about, in particular, HR costs in 2023, your guidance for 1Q is up JPY6.3 billion year-on-year. Can you talk a little bit about the rest of the year and how you think the costs will grow? And will it be moderate -- more moderate growth versus last year's growth? That's my only question.

Shiro Uemura: So thank you for your question. So your question was around our cost, especially HR cost. Now I do believe the circumstance that we are experiencing this year versus last is a bit different because last year, it was the time when we wanted to make sure that we'd be able to strengthen the pipeline that we had in line. And so for that, we wanted to make sure we have good increase in the talent that'd be able to look after it. And so this was an investment to make sure we'd be able to have the right number of people to look after these pipeline. But then this year, we are better -- we are in like getting better prepared for the launch of these titles now. And so when it comes to like the increase on the HR side, it will not be on the magnitude that we did last year. It's not going to be as much. But then, of course, with that said, we will keep on adding appropriate number of people if we find it necessary. And also another part of the cost, which you didn't ask, but it's about marketing, we do believe we will be spending more for marketing this year because, again, any title, any large title that we have high expectation, we do believe we need to spend marketing appropriately to make sure we'd be able to secure future growth. And so that is why for marketing, we are going to expect a cost increase. But overall, when it comes to our overall cost, we do believe that in 2023, we will be able to secure the same level of margin that we secured back in 2022. But with that, we do believe we will be spending costs accordingly.

Owen Mahoney: This is Owen. Just to add on to what Uemura San. So maybe helpful for everybody to sort of remember how our P&L works. Remember, we have, as I mentioned before, for existing live Virtual World, we have a very strong base of revenues, very stable. We also have a very stable cost base for those live Virtual World. That doesn't change much. But then remember, we have several major new products, new live -- or new Virtual Worlds that we're launching, which are really about, of course, development spend and about live operations in preparation for those launches. And currently, until those launch, we generate no revenues against those costs. But we've got real major ones on the way. But as those Virtual Worlds launch, we generate revenues and those revenues flow through our P&L and end up after those costs that we've been incurring, they end up as operating profit. So it's sort of a special time right now because we have several major new Virtual Worlds in production getting ready for launch. So it's important to remember that when you think about the long-term cost and how we're investing against investing towards our future business.

Operator: This concludes the question-and-answer session. Mr. Kawai, at this time, I'd like to turn the conference back over to you for any additional or closing remarks.

Takanori Kawai: Thank you very much. And with that, we would like to end this conference call and allow us to take this opportunity to thank everyone for your participation. And if you have any further questions, please contact the IR team. You can contact us by e-mail, investors@nexon.co.jp. So thank you very much.

Operator: Thank you. That concludes today's conference. Thank you for your participation. You may now disconnect.