NEXON Co., Ltd.

Maiko Ara - Head of Global IR Owen Mahoney - President and CEO Shiro Uemura - CFO

Han Joon Kim - Deutsche Bank

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 conditions, 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 earning-related IR documents. We assume no obligation to update or alter any forward-looking statement.

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.

Please note we may be using Japanese, English interpretation during the Q&A session. 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.

Thanks, Ara San and thank you all for joining us today. Before Uemura San reviews our third quarter results and fourth quarter outlook, I'd like to share a few highlights of the third quarter, our pipeline, our recent investments and the bigger picture of what's happening in the business today.

First, on the quarter, we delivered a great quarter with revenues ahead of our expectations. This was primarily driven by solid performances in Korea and China, especially in September.

In Korea, both MapleStory and Dungeon Fighter outperformed our expectations. Both titles had successful tier 1 content updates and events and MapleStory in particular did exceptionally well during the quarter.

In China, we introduced a National Day update for Dungeon Fighter on September 27th, which got off to a very strong start. As we mentioned last quarter, the timing of this year's National Day update was later than last year's third quarter on September 22nd and so we expected the financial impact from this update in Q3 to be limited.

But the early momentum of the update was really strong and its first few days' performance exceeded our expectations. In Japan, we launched two new titles in late September; a new PC online game, Tree of Savior, and a new mobile game, Hide and Fire.

Although the impact on our consolidated Q3 financials from these titles was limited, both of them had good starts and helped offset the declining browser game revenues there. We also announced the Japan service of Ghost in the Shell S.A.C.

Online, an existing PC online game that we developed internally based on a popular Japanese sci-fi anime, which is scheduled for commercial launch in late November. We are also going to bring more mobile games to Japan, including HIT and Dungeon Fighter 3 mobile in 2016 and onward.

As we move through the fourth quarter in Korea, we're seeing good early performance of our new mobile games launched in October, including Sangokushi Sousouden Online and MapleStoryM, in Korea. In October, we also completed the closed beta test for one of our highly anticipated mobile games, Dungeon Fighter: Spirit, which is the official service name for what we've been referring to as Dungeon Fighter 3D mobile.

At the upcoming G-Star Show in Korea, we're presenting a huge number of games, including 28 mobile titles and 7 PC online titles that we will be launching in upcoming months. As most of you know, G-Star is the largest game exhibition in Korea and it will run from November 17th through the 20th.

We're extremely excited to show these titles, some of which are highly anticipated inside the Company, including Dungeon Fighter: Spirit, Project Dynasty Warriors, Dark Avenger 3, LawBreakers, and Moonlight Blade. Shifting gears now, I want to talk about our initiative for strategic investment in emerging markets.

By way of background, about a year ago, we established a subsidiary in Taiwan. Following that, last month we formally entered the Thai market through the acquisition of a 49% equity stake in a leading Thai game publisher, iDCC.

We will acquire the remaining 51% stake upon Thai government approval. For those of you who don't know them, iDCC is a Thai game publisher with a successful portfolio of mobile games.

We've collaborated with them on mobile games, including HIT, and found them to be a great company, providing strong regional operational support for that game. This investment will enable us to provide enhanced user support and marketing activities for our mobile games in the region and accelerates our expansion in the rapidly growing Thai mobile game market which is expected to grow over 20% year-over-year in 2017 with the mobile sector expected to grow up to approximately 60% of the market or 2.2 billion in the U.S.

Thailand currently represents over 20% of the Southeast Asian game market. The final message I would like to leave you with is that this is a very exciting time for Nexon.

As you know, last quarter we were in the midst of a tough period, facing challenges with some of our key titles in Korea. Today we're at the beginning of a large wave of new games launching in Korea and around the world.

In Japan, that wave of games is resulting in some early successes, such as Tree of Savior on PC and Hide and Fire on mobile, with more to come. Meantime, China remains a huge and very stable market for Nexon.

This wave of launches is a result of two and a half years of labor and game development, publishing, and live operations, preparation, and deal making. And this points to a core strength of our business model.

We have a robust and very consistent base of revenues from our significant IP base. Our new games give us layers of optionality into new revenue streams that we are looking to make as large and consistent as our existing games.

While not all of these new games will be a hit, we've had some strong early wins and we believe more will come throughout 2017. Around the world, the entertainment business is changing as millions of consumers shift to spending their leisure time online and on mobile devices.

Nexon is in an excellent position to capitalize on this trend in Asia and throughout the globe. With that, I'll turn it over to Uemura San to run through the third quarter results and fourth quarter outlook.

Thanks, Owen. First, I would like to explain a disclosure for the change we have implemented this quarter, which affects our Q3 results and Q4 outlook.

Since our IPO, we have disclosed constant currency revenues in addition to as reported revenues in order to help you all understand our business, results the impact of change in foreign exchange rates. Using the local functional currency for respective Nexon Group entities' locations, the constant currency basis amounts were calculated using the average FX rates for the comparable fiscal quarter in the prior year and applied to the current fiscal quarter.

However, given the significant movement in the Chinese Yuan, we no longer believe this is the most accurate presentation of constant currency results for China. This is because our constant currency revenue recognition mechanism in China is complex.

This quarter is a good example of why we needed to make this change. Our old constant currency methodology shows China down in Q3 year-over-year when in fact it was up.

We are making this change in order to be more accurate and to more fully reflect that complexity. Specifically, Neople, the Korean entity that developed Dungeon Fighter for China, records its revenues in South Korean won.

The constant currency figures we have previously reported shows what Neople revenues would have been had the Korean Won versus JPY exchange rate not changed from last year's same fiscal quarter. As most of you know, in China, we licensed Dungeon Fighter IP to Tencent.

In exchange, we received part of Tencent's Chinese Yuan revenues as royalty and we will receive this revenues in U.S. dollars.

As a result, our as reported revenues for Dungeon Fighter in China are affected by both the Chinese Yuan versus U.S. dollar and U.S.

dollar versus Korean Won FX rate. While we have previously chosen not to introduce this added level of complexity to our constant currency calculations, we now believe this presentation gives a more accurate view of the actual performance of the business in local markets without any impact of all currency fluctuations and therefore have made this policy change.

Going forward, we will use this method to calculate constant currency in China. For this quarter, for the sake of consistency and comparability, we have provided both the previous constant currency calculations, namely old constant currency and our constant currency calculations, namely new constant currency.

Please be aware all constant currency numbers report in this presentation are based on the new constant currency basis. Now let's move on to the Q3 data.

Revenues were JPY44.3 billion, down 11% year-over-year on an as reported basis and up 4% year-over-year on a constant currency basis. Operating income was JPY16.3 billion and net income was JPY7.6 billion.

Third quarter revenues exceeded our outlook, primarily due to the strong performance of our PC online game business in China and Korea. Operating income also exceeded our outlook.

This was primarily due to the revenue outperformance particularly in China with higher margin as well as lower than planned costs including marketing cost. Net income was below our outlook, mainly due to FX loss on our U.S.

dollar denominated cash deposits and accounts receivable due to the appreciation of the Korean Won against the U.S. dollar and the Japanese Yen appreciation against the U.S.

dollar. Turning to our performance by platform, third quarter PC online game revenues were JPY34.5 billion, down 13% year-over-year on an as reported basis and up 4% year-over-year on a constant currency basis.

Please refer to the investor presentation for our selective performance metrics for PC online games. Mobile revenues were JPY9.8 billion, down 5% year-over-year on an as reported basis and up 5% year-over-year on a constant currency basis.

As a reminder, about 80% of our mobile revenues are from net [ph] games. Continuing on with third quarter regional highlights, revenues from the China business were JPY17.4 billion, down 14% year-over-year on an as reported basis and up 7% year-over-year on a constant currency basis.

As Owen mentioned, we conducted large scale updates for Dungeon Fighter in the third quarter, the summer update in July and the National Day update in September. Both of these were well received by users.

The National Day update we introduced on September 27th had the theme of Tales of King Arthur. And it had a particularly strong start which led to the outperformance against our outlook.

Factors contributing to solid performance included strong item packet sales in time for the National Day update driven by the popularity of a new character, Demonic Lancer, which we introduced in June. MAUs for Dungeon Fighter increased quarter-over-quarter in line with typical seasonality in the third quarter.

On the other hand, the number of paying users slightly decreased quarter-over-quarter. This is due to the difficult comparison with the second quarter with high base of paying users that is driven by February effect from update including the eighth anniversary update.

On a year-over-year basis, MAUs decreased while paying users increased. The slight decrease in MAUs was primarily due to a timing issue of the National Day update which we introduced later than last year's third quarter.

However, thanks to the increased base of paying users which grew significantly in the fourth quarter of last year and have stayed on that level paying users were higher in this year's third quarter compared to last year. ARPPU for Dungeon Fighter increased quarter-over-quarter in line with fixed growth seasonality and decreased slightly year-over-year.

The year-over-year decrease was primarily due to more light users with lower ARPPU who became paying users for the first time since the fourth quarter of last year. Revenues from the Korean business were JPY18.3 billion, down 9% year-over-year on an as reported basis and up 4% year-over-year on a constant currency basis.

PC online game revenues were JPY13.8 billion, down 10% year-over-year on an as reported basis and up 2% year-over-year on a constant currency basis. Mobile game revenues were JPY4.5 billion, down 5% year-over-year on an as reported basis and up 9% year-over-year on a constant currency basis.

Revenues exceeded our outlook primarily due to the strong performance of key PC online titles, MapleStory and Dungeon Fighter. MapleStory performed exceptionally well due to the successful large scale update we conducted in July, events held during the quarter and item packet sales in time for the Korean Thanksgiving holiday.

Dungeon Fighter also performed very well due to the successful summer update and the 11th anniversary update introduced during the quarter as well as item packet sales in time for the Korean Thanksgiving holiday. We expected third quarter PC online revenues to decrease year-over-year, even on a constant currency basis, due to FIFA Online 3 and Sudden Attack.

However, this was more than offset by the strong performance of MapleStory and Dungeon Fighter. As a result, we had a little growth in PC online revenue on a constant currency basis.

As for new titles, we launched multiple mobile games during the third quarter, including an internally developed title, Master of Eternity, and a published new title, Chaos Chronicle. Revenues from our Japan business were JPY3.7 billion, a 25% decrease versus a year ago.

Mobile revenues were JPY2.7 billion, a 29% decrease year-over-year and a 12% decrease quarter-over-quarter. Revenues decreased sequentially for both native games and browser games.

PC online revenues were JPY1.1 billion, down 13% year-over-year and up 24% sequentially. As for new titles, we started the official service of the PC online game, Tree of Savior, in late September.

In mobile games, we started launching new titles on a monthly basis, including Hide and Fire, Fantasy War Tactics, and Chaos Chronicle. Hide and Fire, launched in late September, is a third person shooter game, which is a unique genre in Japan's mobile game market.

Revenues in North America were JPY2.1 billion, a 5% increase versus a year ago on an as reported basis and a 24% increase on a constant currency basis. The year-over-year revenue growth was primarily due to the good start of the PC online game, Riders of Icarus, which was released into an open beta test in late July, as well as a mobile game, HIT which was launched in early July.

Our revenues in Europe and other regions were JPY2.7 billion, a 14% increase versus a year ago on an as reported basis and a 32% increase on a constant currency basis. The main factor driving the year-over-year growth in revenues was the strong performance of the mobile game, HIT, which was launched in early July.

It performed very well in Asian countries such as Taiwan, Hong Kong, Macau, Thailand, and Vietnam included in the other component of Europe and other regions. Now turning to our Q4 2016 outlook, for the fourth quarter of 2016, we expect revenues in the range of JPY39.3 billion to JPY42.2 billion, representing a 14% to 8% decrease year-over-year on an as reported basis.

On a constant currency basis, we expect revenues in the range of JPY45.6 billion to JPY48.9 billion, representing a flat to 7% increase year-over-year. We expect operating income to be in the range of JPY8.2 billion to JPY10.3 billion.

We expect net income to be in the range of JPY7.7 billion to JPY9.5 billion yen. For the fourth quarter, we expect the major currencies in our business, including the Korean Won and the Chinese Yuan, to depreciate against Japanese Yen by 12% and 19% respectively year-over-year.

As you are all aware, depreciation of these currencies against the Japanese yen would have a negative impact on our revenues, operating income and net income. As a reminder, we expect JPY1 move against the U.S.

dollar would have an impact of JPY0.34 billion on our revenue and JPY0.1 billion on our operating income. For simplicity, FOREX sensitivity is calculated based on the assumption that Korean Won and Chinese Yuan move similarly against Japanese Yen when there is an exchange rate movement in U.S.

dollar and Japanese yen. In China, for fourth quarter revenues, we expect 20% plus low teens percent decrease year-over-year on an as reported basis and a low single-digit percent decrease to high single-digit percent increase year-over-year on a constant currency basis.

We are scheduled to introduce a tier 1 update, winter update to our key PC online game, Dungeon Fighter, in December. As you know, the timing of National Day update for the Dungeon Fighter in this year's third quarter was later than that in last year's third quarter.

Therefore, we expect the contribution from the update to be mostly in the fourth quarter. Our fourth quarter China outlook reflects the October performance of the game, including the contribution from the update as well as the most recent trend of the game.

In Korea, for fourth quarter revenues, we expect a low teens percent to high single-digit percent decrease year-over-year on an as reported basis and a low single-digit percent decrease to high single-digit percent increase year-over-year on a constant currency basis. As for PC online game, we expect some titles including Sudden Attack, to decrease year-over-year.

Meanwhile we expect this to be more than offset by a year-over-year increase from titles including MapleStory and Dungeon Fighter and expect Korea revenues to slightly increase on a constant currency basis. As for new mobile games, we launched Sangokushi Sousouden Online and MapleStoryM launched in October, which are both off to good starts.

We also conducted the closed beta test for Dungeon Fighter: Spirit in October. While we expect contributions from some of these new mobile games, we expect fourth quarter mobile revenues to slightly decrease year-over-year even on a constant currency basis, due to the difficult comparison with last year's fourth quarter when HIT was just launched and performed exceptionally well.

In Japan, for fourth quarter revenues, we expect low single-digit percent decrease to high single-digit percent increase year-over-year on an as reported basis. While we expect mobile browser game revenues to decrease year-over-year, we expect revenues to be largely flat year-over-year, driven by the third quarter contribution from mobile game, Hide and Fire, and PC online game, Tree of Savior, both of which were launched in third quarter.

On the mobile side, we are scheduled to launch a new action RPG, Dungeon Striker G, in November. For PC online, Ghost in the Shell S.A.C.

Online, a game [ph] based on the popular anime IP, Ghost in the Shell S.A.C., was released into open beta test in early November. We are scheduled to start the commercial service of the game in late November.

In North America, for fourth quarter revenues, we expect a high teen to high single-digit percent decrease year-over-year on an as reported basis, and a low single-digit percent decrease to high single-digit percent increase year-over-year on a constant currency basis. In Europe and other regions, for fourth quarter revenues, we expect a low single-digit percent decrease to high single-digit percent increase year-over-year on an as reported basis, and a low teens percent to 20% plus increase on a constant currency basis.

In the fourth quarter, we expect our operating income to be in the range of JPY8.2 billion to JPY10.3 billion, showing a 21% decrease to flat year-over-year. We expect Q4 revenues to decrease year-over-year due to significant depreciation of the Korean Won and Chinese Yuan against the Japanese Yen.

Also, we expect year-over-year increase of HR costs driven by increased headcount primarily in Korea. On the other hand, we expect this to be offset by lower variable costs, including royalty cost associated with third party licensed games and we believe one-off impairment loss we recorded last year in the fourth quarter.

We expect royalty costs to decrease year-over-year, primarily due to a lower contribution from the publishing title, HIT, which just launched in Korea last year in the fourth quarter, as well as lower royalty costs for DomiNations in relation to our acquisition of its developer, Big Huge Games, in the first quarter. As a reminder, since we follow international financial reporting standards, impairment loss is recorded as other expenses in the calculation of the consolidated income statement and thus has an impact on operating income.

Lastly, the share buyback program of up to JPY5.0 billion, which we announced on September 5th, was completed. We repurchased 3.2 million shares for JPY5 billion in the approximately two month period from September 8th to October 31st.

We'd like to remind you that the cancellation of these shares has been resolved by the Board of Directors. The details of the share buyback program are also available on our IR website in addition to Q3 investor presentation.

Having shared that context on our performance and our outlook, we'll be happy to take your questions.

Thank you, Uemura San. Next we would like to open up the lines to live Q&A.

Great, thank you very much and congratulations on a blowout quarter. I just wanted to get a better sense of your Q4 guidance, so from what I can read, I think we're looking at somewhere between JPY4 billion to JPY5 billion of -- sorry, JPY2 billion to JPY5 billion of quarter-over-quarter decline in the revenues.

But I think on the operating profit side, I think it was more like, if I'm reading this correctly, JPY3 billion to JPY6 billion. I think we basically see a bigger OP decline relative to the revenue decline sequentially, so can you just give us the context of the thought behind the 4Q guidance?

Thank you very much for your question, Han Joon. Please give us a moment while we translate.

Thank you very much for your question. I understand that your question pertains to the comparison of Q3 to Q4.

And mainly we will be impacted by the seasonality. As you know, generally speaking, Q3 is a very strong quarter whereas Q4 is the weaker season.

And also, on top of that, we will be seeing strong trends in publishing titles as well as mobile titles. Therefore, our royalty fee as well as PG fee will most probably rise.

And also, in the fourth quarter, we have multiple new title launches therefore, that will push up our marketing fee. Therefore, Q-on-Q-wise, we believe that there will be an increase in cost and that has been factored in.

Okay, great. I guess as a follow-up to that, if we can just have a -- if you guys have a guidance for actually marketing cost for 4Q?

Thank you very much for the question. Please give us a moment for translation.

Regarding the marketing cost, it will be on par with the marketing cost of Q4 of the previous year. As you know, we will be launching multiple titles in Q4, so we will be investing in the marketing area.

Understood, one last question if I may, I think we've been communicating that we have about 35 titles that we're going to showcase at G-Star next week and 35 is quite a bit. So if you can just help us think about what is the timeframe of launch for these 35 titles, are we releasing a sizable chunk of them over the next six months, over the next three months or is this really just the full breadth of what we have with undetermined dates, just if you can help us frame the idea behind showcasing so many titles, I think that would be very much appreciated?

Yes, Han Joon, this is Owen. So we have a lot of titles as you mentioned that we are launching.

And my -- I guess the way to think about it is, whenever you're showing titles at a major trade show, you want them to be near enough to launch that you feel that you can really talk about them publicly. So without giving specifics on each title and when we expect them to launch, what we see is that they're in a window where we're seeing them come out and they're going to be in the market in the foreseeable future and we feel confident enough that we can show them to the outside world.

Having said that, there are a lot and our publishing teams around the world have become very, very busy because our development teams that have been hard at work for the last two and a half years. We are looking at this wave of new titles.

I would just emphasize that, while we're talking about a lot of titles, our emphasis is really on providing quality titles and that we're not per se interested in launching a lot of titles. But what we're trying to do is make sure that they're good titles that last a long time and grow a long time.

So although we're planning on having a very big G-Star show this year, we don't want to leave the impression that we're all about the numbers. We're about the games.

Each of the games themselves are important to us.

Okay, great, so I'll be there as well. So I'm looking forward to that.

I look forward to seeing you there.

Sure.

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 [email protected] 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.