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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, everyone, and welcome to NEXON's 2019 First Quarter Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Ms. Maiko Ara, Head of Investor Relations. Please go ahead, ma'am.
Hello, everyone, and welcome. 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 operation and financial condition such as revenues attributable to our key titles, growth prospects including with respect to online game 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 and are 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 owner 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.
Thank you, Ara-san. And thank you all very much for joining us today. I'm very pleased to report that we've had an outstanding start to 2019. Our top 2 franchises, Dungeon&Fighter and MapleStory, are stronger than they have ever been. Revenues, operating income and net income all exceeded the high end of our expectations, representing a record-breaking quarter and beating the extraordinarily high comps of Q1 a year ago. On a constant-currency basis, our business grew year-over-year in all regions, reflecting solid execution worldwide, particularly in China and Korea. We are seeing enormous stability and longevity in our core franchises, especially in NEXON's wholly owned intellectual property. We're extremely fortunate to have an amazing team that is uniquely successful at growing online games in virtual worlds over a long period of time. And we're off to a solid start on several new projects. Let me share with you some of the highlights of a great Q1 that also set us up well for Q2 and beyond.
Last quarter, we said the China Dungeon&Fighter's Lunar New Year update had started well.
Strength of the Lunar New Year sales continued into the back half of the quarter and sales in March were strong, exceeding our expectations. As a result of these, Dungeon&Fighter's Q1 local currency basis gross revenues was as high as last year in the first quarter, which was especially noteworthy given the very high comps in 2018 Q1. China Dungeon&Fighter has yet again proved itself to be in great shape. Our Korea business was remarkably strong across various titles in the first quarter. Revenue for the PC version of MapleStory first launched 15 years ago, grew 69% year-over-year, exceeding the high expectations baked into our guidance. This is on top of 34% year-over-year growth in Q4 2018 and 129% year-over-year growth the quarter before that. MapleStory now has delivered its fifth quarter in a row of very strong double-digit or even triple-digit year-over-year growth.
Moreover, we expect the momentum to continue from Q1 and its revenue to grow year-over-year yet again in the second quarter. As a side note, the mobile version of MapleStory in Korea also recorded double-digit or triple-digit year-over-year growth for its fifth consecutive quarter, just like the PC version. FIFA Online also -- FIFA Online 4 also had an excellent start to the year, driven by successful Lunar New Year sales and March sales promotions. Combined PC and mobile revenues were nearly up to the level of the original FIFA Online 3 in Q1 2017 after the successful service transition last year from FIFA Online 3 to FIFA Online 4. Q1 also saw the resurgence of some of NEXON's other most enduring franchises. KartRider, NEXON's casual racing game, has experienced a major resurgence. Originally introduced 15 years ago in 2004, over the game's lifetime, fully 1/2 of the Korean population has played the game, and globally, the registered user base has exceeded 380 million. In Q1 of this year, the game grew over 3x year-over-year and is now ranked fifth among Korean PC online games with a 4% market share in Korean PC cafés. While not as large as Dungeon&Fighter, MapleStory and FIFA Online, KartRider is a great example of NEXON's ability to generate long-lived and resurgent performance in an existing online game, long after the original launch. This is what we mean by forever franchises, which we can revive and bring to a continually expanding base of fans.
Now moving to new games. In March, we launched a mobile version of Crazy Arcade BnB, a title we originally launched 18 years ago on PC. In Korea, it generated over 5 million downloads in just 4 days. Globally combined, it has exceeded 10 million downloads. What's even more interesting is the launch of the mobile version, which had a positive impact on both new users and active users on the original PC version. This is a theme we've now observed on several mobile titles, such as MapleStory M in Korea. The launch of the mobile version of our popular franchises benefits rather than cannibalizes our PC game. We think this bodes well for the future as we introduce more mobile versions of popular PC IP, such as Dungeon&Fighter 2D Mobile and Mabinogi Mobile. We'll announce more in upcoming quarters. In April, we started the Japan service of MapleStory M, and it's off to a great start. The game exceeded 1 million downloads in a week and appears to be resonating as well with our players in Japan as it has in Korea and other regions. We're particularly excited about it given the long-term solid performance of its service in Korea and globally. As mentioned previously, we've been applying AI tools to our live and newly launched games to augment the great work by our live operations teams. We've already seen positive impact of these tools in retention and monetization, so we plan to continue our investment in this area.
And finally let me update you on our latest progress on Dungeon&Fighter 2D Mobile. In China, together with our partner, Tencent, we started open registration for its next closed beta test on Tencent's WeChat game, QQ Game and MyApp platform in March. This test, which will begin soon, follows up on the one we held in January. We'll keep you posted on further progress. During Q2 and Q3, we will be making further announcements about launches and new products around the world.
I'd like to close by complementing and thanking the thousands of NEXON employees around the world. Their incredible work on games like Dungeon&Fighter, MapleStory, FIFA Online and KartRider is truly the gold standard for making massive franchises grow year-after-year. And a stable base of revenue and operating income from these forever franchises enables us to introduce exciting games on mobile, PC and other platforms to a rapidly growing total addressable market of gamers in an increasingly converged world. Our world-class teams, our IP and innovative and growing AI technology stats and projects underway in the West, including those from Embark Studios set us up well for success throughout the rest of 2019 and well beyond. We have ambitious plans for the future, and we're excited to share those plans with you in coming quarters. With that, I'll turn the call over to Uemura-san to discuss the Q1 results and Q2 outlook.
Thank you, Owen. Now let's move on to the Q1 results. For additional details, please see the Q1 2019 investor presentation available on our IR website. We're pleased to report that revenues exceeded our expectations for the quarter. Q1 revenues were JPY 93.1 billion, up 3% year-over-year on an as-reported basis and up 7% year-over-year on a constant-currency basis. The revenue outperformance was primarily driven by stronger-than-expected performances of China Dungeon&Fighter, MapleStory and FIFA Online 4 in Korea as well as the new mobile game, Lyn, which we launched in Q1. Consequently, both PC and mobile revenues exceeded our outlook. Operating income was JPY 52.6 billion, exceeded our outlook driven by the revenue outperformance, while recording a JPY 2.9 billion impairment loss, primarily on prepaid royalties. Net income was JPY 53.4 billion, which exceeded our outlook, primarily driven by the operating income outperformance as well as JPY 6.3 billion FX gain, mainly on our U.S. dollar denominated cash deposits related to the depreciation of the Korean won against the U.S. dollar during Q1. Revenues from our China business in Q1 exceeded our expectations, driven by Dungeon&Fighter's stronger than expected Lunar New Year package sales and item sales in March. The unfavorable FX rate caused Q1 China revenue to decrease year-over-year. However, on a constant-currency basis, revenues were flat year-over-year. Q1 Dungeon&Fighter's revenue exceeded our expectation driven by the outperformance in March. At local currency basis, revenue was roughly flat year-over-year even compared to the high base set in Q1 2018 when it marked quarterly revenue at a record high since we began service in the region. For Dungeon&Fighter in Q1, we introduced the Lunar New Year update on January 21, which continued until April 4. It consisted of limited time off for Dungeon and Avatar Package sales. We also introduced the level cap release on January 21. Revenues, ARPU, MAUs and paying users for Dungeon&Fighter all increased quarter-over-quarter due to typical seasonality. MAU slightly decreased year-over-year. Paying users also decreased year-over-year, mainly due to the high comps with last year's Q1, as we had expected. Meanwhile, ARPU increased year-over-year driven by the strong sales of Lunar New Year Avatar Package. ARPU increased while paying users decreased, resulting in local currency basis revenue being roughly flat year-over-year. Revenue from Korea in Q1 exceeded our expectations, primarily driven by stronger-than-expected performances of MapleStory, FIFA Online 4 and the new mobile game, Lyn, which started service on March 14. As a result both PC and mobile revenues in Korea exceeded our outlook. MapleStory's revenue in the latter half of the quarter exceeded our expectations, primarily driven by the successful contents update and Lunar New Year sales promotions. KPIs, including MAUs, ARPU and paying users, increased and revenue grew by 69% year-over-year. FIFA Online 4 and FIFA Online 4M's revenues exceeded our outlook driven by stronger-than-expected sales in March with successful introduction of high-level players, package sales and promotions. FIFA Online 4's revenue increased significantly compared to last Q1 when it was negatively impacted by the service transition and has come very close to reaching the scale of 2017 Q1 FIFA Online 3 in its first service year. PC revenues increased year-over-year, primarily driven by increases in MapleStory, FIFA Online 4 and KartRider. Mobile revenues decreased year-over-year. The increase in FIFA Online 4M and contributions from multiple new mobile games, which became -- or which began, rather, services in Q1, including Spiritwish, Lyn and Crazy Arcade BnB M were more than offset primarily by deceleration of OVERHIT and AxE. PC revenues increased, while mobile revenues decreased year-over-year, resulting in a year-over-year increase in our Korea business for Q1. Revenues from our Japan business in Q1 were below our outlook due to lower-than-expected contribution from FAITH, we started service in Q4 2018. And meanwhile, revenues increased year-over-year driven by contribution from FAITH, Dynasty Warriors: Unleashed and OVERHIT, which launched in 2018 as well as Dark Avenger X which started service on February 13. These were partially offset by the year-over-year decline in mobile browser games, HIT and HIDE AND FIRE.
Revenues from North America in Q1 were in the range of our outlook. While Choices, DomiNations and MapleStory PC decreased, revenues were up year-over-year driven by contributions from MapleStory M, Darkness Rises and MapleStory 2, all of which launched in 2018 as well as mobile game AxE, which began service on February 21.
Revenues from Europe and others in Q1 exceeded our outlook, driven by stronger-than-expected contributions from MapleStory in Taiwan and Hong Kong. Revenues were up year-over-year, primarily driven by contributions from MapleStory M, Darkness Rises and Moonlight Blade, all of which launched in 2018 as well as AxE, which began service on February 21 and Crazy Arcade BnB M, which began service on March 21. Now turning to our Q2 2019 outlook. In Q2 2019, we expect the Chinese yuan and Korean won, major currencies in our business, to depreciate against the Japanese yen and negatively impact the as-reported basis performances in China and Korea. For Q2 2019, we expect revenues in the range of JPY 52.1 billion to JPY 56.7 billion, representing a 9% to 19% increase year-over-year on an as-reported basis and a 12% to 22% increase year-over-year on a constant-currency basis. By region, we expect revenues to decrease or to slightly increase year-over-year in China and increase in all other regions. We expect our operating income to be in the range of JPY 12.6 billion to JPY 16.3 billion, representing a 21% decrease to 2% increase year-over-year on an as-reported basis. I will be discussing the details shortly.
We expect the net income to be in the range of JPY 14.6 billion to JPY 17.8 billion, representing a 55% to 45% decrease year-over-year on an as-reported basis. In Q2 2018, we recorded an FX gain of JPY 15.5 billion. We do not expect such a gain in Q2 2019, which is the primary reason we expect a decrease in our net income. Excluding the impact of the FX gain, we expect our net income to decrease 13% or to increase 6% year-over-year.
In China, we introduced the Labor Day update to our key PC online game Dungeon&Fighter on April 23. It's off to a good start and has been going well. We are also scheduled to introduce the 11th anniversary update in June. MAUs in April were up year-over-year, while the number of paying users decreased compared to the high base in Q2 2018. ARPPU increased year-over-year. Reflecting these factors, we expect Dungeon&Fighter's local currency basis revenue in Q2 to be roughly flat year-over-year, even compared to the high base set in Q2 2018. Overall, we expect revenues from our China business in the range of JPY 21.4 billion to JPY 23.6 billion, representing an 8% decrease to 2% increase year-over-year on an as-reported basis and a 5% decrease to 5% increase year-over-year on a constant-currency basis.
In Korea, we expect PC revenues to increase year-over-year, driven by key titles, including FIFA Online 4 and MapleStory. As in the case of Q1, we expect significant increase in FIFA Online 4's revenue versus last Q2 when it was negatively impacted by the service transition. Moreover, we expect MapleStory's momentum to continue from Q1 and its revenue to increase even compared to last Q2 when it grew by 61% year-over-year, driven by the successful 15th anniversary events and large-scale content update. We expect our mobile revenues in Korea to increase year-over-year. While we expect OVERHIT and AxE to decrease year-over-year, we expect to benefit from FIFA Online 4M, Lyn and the new MMORPG TRAHA, which we launched in April. Overall, we expect revenues of our Korea business to be in the range of JPY 18.0 billion to JPY 19.1 billion, representing a 16% to 23% increase year-over-year on an as-reported basis and a 20% to 27% increase year-over-year on a constant-currency basis, driven by both PC and mobile business. In Japan, we expect revenues to be in the range of JPY 4.3 billion to JPY 4.9 billion, representing a 32% to 48% increase year-over-year on an as-reported basis and 34% to 51% increase year-over-year on a constant-currency basis. While we expect OVERHIT and mobile browser games to decrease year-over-year, we expect to benefit from FAITH, Dynasty Warriors: Unleashed, DarkAvenger X and MapleStory M, which we launched in April.
In North America, we expect revenues to be in the range of JPY 3.5 billion to JPY 3.9 billion, representing a 7% to 21% increase year-over-year on an as-reported basis and a 6% to 20% increase year-over-year on a constant-currency basis, primarily driven by contributions from MapleStory M and AxE.
In Europe and other regions, we expect revenues to be in the range of JPY 4.9 billion to JPY 5.3 billion, representing an 84% to 98% increase year-over-year on an as-reported basis and an 87% to 102% increase year-over-year on a constant-currency basis, driven by contributions from MapleStory M, AxE and Moonlight Blade as well as OVERHIT, which we are scheduled to launch in Q2.
In Q2 2019, we expect the operating income to be in the range of JPY 12.6 billion to JPY 16.3 billion, representing a year-over-year decrease of 21% to increase of 2%. A favorable factor compared with Q2 2018 on the operating income is that revenue increased. Negative factors compared with Q2 2018 on the operating income are, first, increased variable costs, including PG fees associated with revenue increase primarily in mobile business as well as royalty costs in relation to increase in contributions from publishing titles, such as FIFA Online 4, TRAHA and Lyn. Second, increased HR costs due to an increased headcount and annual salary hike, primarily in Korea. Third, in Q2 2018, we recorded a JPY 2.7 billion gain on the step acquisition under other income in reference to the acquisition of additional shares of NAT Games and its consolidation. We expect other income to decrease as we do not expect such a gain in Q2 2019. Lastly, increased other expense due to an impairment loss.
In Q1 2019, we adopted IFRS 16 leases. Related to this adoption, we have capitalized items, such as office rent as right-of-use assets, which was formerly expensed. In Q2, we expect to record an impairment loss of approximately JPY 1.4 billion of these assets, which are assessed to have no value. The high-end of the range reflects the fact that we expect the impact of positive driver to be larger than that of negative drivers, resulting in a year-over-year operating income increase. Now we'd be happy to take your questions.
[Operator Instructions]
[Interpreted] This is Yamamura of Nomura Securities Company Limited. I have 2 questions. First question is around China business. You mentioned that in February you will not emphasize monetization and we do not expect ARPU to increase, therefore. And at the same time, I do understand that sales of March trended very well. And I guess, the following situation is not only true in China, but in other parts of the world as well, but ARPU increased very much. So I want to know what actually happened in March.
[Interpreted] Thank you very much for your question. Regarding the China situation, I understand that you're talking about Dungeon&Fighter. Regarding your ARPU, we did not say that we are not factoring in the potential of the increase of ARPU. And talking about what has happened in March and more in particular during Q1, we conducted level cap update and also conducted content update in line with the Lunar New Year. And we were able to see how we are performing around mid-February, and we succeeded in Lunar New Year's update, and toward the end of it, I thought that we will be settling down in terms of the momentum come March. But due to the level cap update success, the game was very activated and there were many in-game activities being conducted and enjoyed by the core users, in particular. So when you look at the situation that evolved from January to March, it was quite different from the pattern of our ordinary years. So we see some consistency in the group, and we were able to continue growing in March as well, thus leading to the increase of ARPU. And it is indeed true that ARPU increased, but given the fact that we have long history of operating PC online games, we know that there are different patterns of growth. One is ARPU driven growth, another may be the paying users growth driven the increase. So I believe that even though the figures trended better than we have expected, at the same time, we can say that it was within the range of our thinking as well.
[Interpreted] You said that usually, the pattern is that the business settles down regarding the momentum in March. But this Q1 wise, the momentum continued up until March and the popularity was sustained. And I want to know what is the reason behind that. Is it because the content was quite different than before? Or is it the difference of user behavior?
[Interpreted] It's not that the content was different from the ones that we have provided in the past. So we might be able to say that it was down to the user behavior. We can comment on one thing, which is the level cap update actually worked in activating the core users, which was followed by the increased activities of the middle users because they wanted to increase their level. And that is why we were able to enjoy many activities amongst the players in Q1, leading to the revenue.
[Interpreted] I have a second question, which is related to the comment that was initially made by Owen. You mentioned that the launch of mobile actually had a positive activation impact on PC as well. So can you elaborate more on this point? Are you saying that you were able to capture new users who originally started enjoying the game through the mobile version and then move onto PC or you were able to activate the dormant users? And I believe that the pattern might be quite different depending upon the nature of each title, but can you please further delve into the details?
[Interpreted] So as mentioned by Owen, it is our strategy to leverage fully on our own IP, and that is what we have conducted so far. And in terms of the IPs that were available for years, that there are players who love those titles and who feel at home and have good memory playing those games in the past. So when the title was moved from PC to mobile as well, some of the dormant players were reactivated or some of the players who left the game in the past have decided to come back and start enjoying the title once again because they really have fond memories of playing those games in the past. So they will restart playing the game on PC as well. And such an example is MapleStory. And as in the case of MapleStory, mobile users were actually stimulated to play on PC as well. And as you, Ms. Yamamura, mentioned, the pattern might be different from one title to another given the nature of the game itself. But through the example of MapleStory, we were able to confirm such a positive repercussion from mobile to PC as well. So upon launching the new mobile titles in the future, we're going to leverage on this lesson learned and try not to cannibalize on PC version of the game, so that both mobile as well as PC version can grow together in tandem.
Our next question comes from Han Joon Kim from Deutsche Bank.
I wanted to follow up on the question that was raised before, the point about how your mobile version kind of stimulates the PC one. But as we extend that thought into Dungeon&Fighter in China, this is the game where the PC version is quite active. And so when we launched the mobile version, it will be more natural to think that there's going to be some level of cannibalization, then naturally a surge in the PC version as well. So could you perhaps kind of give us an indication of any type of simulation work or any exercise you've done to think about the impact of what Dungeon&Fighter mobile in China will do to the PC version? [Interpreted]
[Interpreted] Thank you very much for your question. So when we have the mobile version of Dungeon&Fighter in China, are we going to see some cannibalization amongst the users or not? Well, to be frank, we will have to start to see what is going to be the result. And of course, we do expect there might be some level of cannibalization. But then what I was talking about earlier on was our experience, a very good experience in titles such as MapleStory. And so we want to make sure we'll be able to leverage on that learnings there, experience there, so that we'll be able to minimize any cannibalization with the PC users for Dungeon&Fighter in China. And so -- and also, I would also like to reemphasize that China Dungeon&Fighter, this is something that we've been having for 11 years, and so therefore it is not exactly a title that we'll be able to expect a massive growth from here. What we want to do is to make sure that we'll be able to expand this franchise with both PC version and mobile version.
Got it. Understood. One follow-up. In separate discussions that I've had with you guys, we've talked about how there is a tectonic shift in technology, where it may be prudent for us to spend more in R&D than what we have been today. So as we continue to talk about that with our current and potential-to-be shareholders, how should we be thinking about your increase in R&D or headcount and general investments into the coming quarters for 2019? [Interpreted]
Han Joon, this is Owen. I'd say in the immediate future, there wouldn't be a major change that should be factored in. I think we're constantly trying to -- I guess, the expression would be to sharpen the saw, meaning making our spending as efficient as we possibly can. That is a very important part of what we're doing, but at the same time we're always on the lookout for deploying capital in a way that's going to get us the right types of returns. But I would say that overall, as we've talked about before, we think there are major tectonic shifts going on in the video games industry right now that create the kinds of opportunities we haven't seen before. We've been talking about, for example, the convergence of PC and mobile. And that's one. The investments we've made in AI, as we said in our prepared remarks, have started to really bear fruit for us. So we're happy with that. We continue to look forward to those types of opportunities. [Interpreted] I would just add one other thing to that, which is, one of the things that makes us, I think, unique is that as we've shown again this quarter, our existing franchises, what we call our forever franchises are extraordinarily stable. And that goes to a lot of different things, including the incredible work of the teams around the world that have created incredible longevity of those franchises. And because we have that, that enables us to invest around the themes that we've talked about before. And if we think about it in terms of concentric circles, that's in the core, existing types of genre as one concentric circle out would be among stretch -- what we call stretch that you've heard us talk about before and then around frontier investments such as AI. And we continue to believe that that's the right way to think about our business and the investments that we should make. [Interpreted]
Our next question comes from Seyon Park from Morgan Stanley.
I have one question related to Dungeon&Fighter Mobile. The second CBT in a matter of, I guess, 4, 5 months. Maybe can you explain a little bit of background on having a second CBT this year. Is it to, I guess, improvise on some of the [ may ] issues that you have with the first CBT? Just kind of thinking whether it's custom or that you have many CBTs a year or whether the fact that the game could be near launch is one of the reasons behind it. Also, assuming that the second CBT goes well, should we expect the game to be launched relatively easily or would there be some kind of a regulatory queue which needs to be gone through for the game to be officially launched? [Interpreted]
[Interpreted] Thank you very much for your question. Regarding Dungeon&Fighter Mobile, it is indeed true that we have conducted a major CBT in January. And we are scheduled to conduct the second CBT, but we have not announced when we are going to conduct that second CBT. Along with Tencent, we do have high expectations to Dungeon&Fighter title. And since this is a very important title for us, it is not a rare case in which several CBTs are conducted vis-a-vis such a title. So given that backdrop, the current situation of Dungeon&Fighter Mobile is nothing special. And we will make sure that the lessons learned and the feedback that we get in the first CBT will be incorporated in our second CBT. And once the development is completed and we are very confident of the gain, we will launch it to the users.
[Operator Instructions] This concludes the question-and-answer session. Ms. Ara, at this time, I'd like to turn the conference back over to you for any additional or closing remarks.
Thank you. If there are no further questions, I would like to take this opportunity to thank you for your participation in this call. Please feel free to contact the NEXON IR team at investors@nexon.co.jp should you have any further questions. We appreciate your interest in NEXON and look forward to meeting you, whether it is here in Tokyo or in your corner of the world.
Thank you. That concludes today's conference. Thank you for your participation. You may now disconnect.