Enthusiast Gaming Holdings Inc.
Q3 2022 Earnings Call Transcript

Published: 14 Nov 2022

[Operator:]

Good afternoon, and welcome to the Enthusiast Gaming Holdings Incorporated. Conference Call. All participants will be in a listen-only mode [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note this event is being recorded. I'd like now to turn the conference over to Mr. Eric Bernofsky, Chief Corporate Officer of the company. You may go ahead, sir.

[Eric Bernofsky:]

Thank you. Good afternoon, everyone, and thank you for joining Enthusiast Gaming’s third quarter 2022 financial operating results call. My name is Eric Bernofsky, Chief Corporate Officer of Enthusiast Gaming. With me today is our Chief Executive Officer, Adrian Montgomery; our Chief Financial Officer, Alex Macdonald; and joining us on his first quarterly conference call since becoming President is Bill Kara. We'll begin with commentary on the quarter from Adrian, Bill and Alex before opening the floor to questions. Before we begin, I’d like to remind everyone that today’s presentation contains forward-looking information that involves known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations. These statements should not be read as assurances of future performance or results. Such statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance or achievements to be materially different from those implied by such statements. A more complete discussion of the risks and uncertainties facing the company appear in the company’s management discussion and analysis for the three month period ending September 30, 2022, which are available under the company’s profiles on SEDAR and EDGAR, as well as on the company’s website, enthusiastgaming.com. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this presentation. The company disclaims any intention or obligation, except to the extent required by law, to update and revise any forward-looking statements as a result of new information, future events, or for any other reason. Now with great pleasure, I would like to turn the call over to Adrian Montgomery, CEO of Enthusiast Gaming. Adrian?

[Adrian Montgomery:]

Thank you, Eric. Good afternoon, and welcome to our third quarter 2022 financial and operating results conference call. I'm pleased to share with you the details of another strong and record quarter, proving the continued strength of our diversified business model and despite the macroeconomic headwinds we are on the cusp of reaching profitability. On today's call, I want to reiterate why our business model and strategic plan is the right one and sets us up for sustained profitability in 2023. Just two years ago, after completing the acquisition of Omnia Media. Enthusiast gaming was largely a programmatic advertising revenue company with a gross profit of $4.1 million and a gross margin of 16.8% in Q3 of 2020. In just eight quarters, we have become an integrated media and entertainment company for gamers rooted in communities, content, creators and experiences. Our flywheel model has separated us from the pack. Our diversified model makes us less reliant than ever on the price fluctuations of programmatic ad units. Today, Enthusiast Gaming owns some of the largest fan communities in the world. We own the largest gaming platform on YouTube. We own and make our own games like Little Big Snake, Mope, Apes and EV.io. We create our own desktop apps with millions of users. We sell subscriptions across a number of our properties and we create our own content that we distribute on multiple platforms like Snap, Twitch and TikTok. We also post sold out events all over the world through our Pocket Gamer brand from London to Toronto to Seattle, Helsinki, Jordan and beyond. We are the company that some of the world's largest brands turn to execute their gaming and esports strategies, names like LEGO, State Farm, HBO, Netflix, Disney, the United States Navy, Amazon, RBC, Nintendo, DoorDash, Hasbro, Fidelity, Mattel, Procter & Gamble and more. As I said, we are on the cusp of sustainable profitability. We have ample liquidity to get there, and we are a dominant player in the gaming and esports world. Despite the macroeconomic pressures on advertising prices, we have grown our gross profit over the last eight quarters by more than 4 times to a record high of $16.6 million this quarter while nearly doubling gross margin in that same time frame to 32.7%. When you have a business with a 33% margin, you need much, much less scale to become profitable. How have we done this? We've been laser-focused on developing a diverse and sustainable model that could stand the test of time and build a leadership position within the gaming and esports entertainment industry. And so we have continued to focus on the following key strategic business priorities that have all pushed enthusiast gaming further and further away from being a lower yield, lower margin business focused on programmatic revenue and into that diversified media and entertainment company that again is on the cost of profitability. These strategic priorities are

[Bill Kara:]

Thanks, Adrian. First off, as this is my first quarterly conference call since being appointed President, I'd like to say hello to our shareholder, analysts and other stakeholders for joining today. Adrian is right. The NFL deal we announced in August and launched in September, called Tuesday night Gaming is truly an exciting and transformational moment for Enthusiast Gaming. For some background, the NFL put an RFP out in 2021, looking for a partner and big idea to help execute first-of-its-kind gaming strategy. After a long, almost 18-month process, from RFP to executing an agreement, the National Football League chose Enthusiast Gaming as its partner to launch Tuesday night gaming. It is an exciting, a new content platform for brands and agencies to connect with a younger audience through bespoke custom content, talent integrations, including owned moments, featured segments, social activations and more. It is important to recognize two points here. The NFL recognized that a path to a younger audience leads directly to gaming and esports. And second, the NFL chose Enthusiast Gaming as its partner to execute this crucial strategy. We want to be in business with the NFL full stop. We expect this multi--year partnership to be profitable on a stand-alone basis, but it has another equally powerful benefit. A large reason why we are on the cusp of profitability is that, as Adrian summarized in his remarks earlier, we created a direct sales and customer success function from scratch two years ago. And that this quarter contributed north of $10 million in revenue at a target 50% margin. Now, alongside the NFL, we have signed new direct sales with Hu, the Food and Drug Administration, Nickelodeon, Disney and Universal Pictures, with more to be announced in the near future. Continued growth in direct sales will underpin our sustained profitability, and the halo effect of being in the company of the National Football League is substantial. We signed a deal at the end of August, and it was important to launch in conjunction with the start of the football season, which meant we had little to no lead time to pre-sell, but we want it to be a good partner and demonstrate that we can move quickly. Already, we have done big deals, as I mentioned a moment ago. And because of the NFL, we are speaking to brands we have never spoken before, too. We are already locking up deals in Q1 2023, with close to $2 million. We have received inbound requests from two other major professional sports leagues, who have reached out to us, talked about doing something similar with them, which will allow our business to scale even further. Not only are we excited about the NFL deal, we showed the business case to our lender and described the opportunity. They were incredibly supportive, seeing how this enhances our path to sustained profitability and increase the size of our debt facility by an additional $10 million. Here are some early audience metrics for the NFL Tuesday Night Gaming show. Since the September launch, we've generated 3.9 million total views on YouTube, across the P&G channel, VOD content and live streams with an additional one point – sorry, cumulative 1.4 million total hours watched, 1.7 million organic impressions on Twitter and 8.5 million views on TikTok. One other example of an activation we launched in the quarter was the work that we did with Fidelity where we created the Fidelity Minecraft Safe Room Challenge. In order to create a meaningful connection with the next-generation of investors, Fidelity tapped into gaming to position the brand as a resource to help investors achieve success. A custom-made Minecraft map featured weekly challenges, if players were unable to complete them maybe taken to the Fidelity Safe Room, where they could find Fidelity tips and tools to help them complete the challenge. The program was supported and promoted by Luminosity talent and amplified through custom videos and social posts to maximize awareness and engagement. Again, another example of a high-margin flywheel activation that brings together different assets to create a custom solution for brands. Subsequent to the quarter, I'm excited, about some of the recent work we started with Netflix. Netflix recently launched a live show, live animated series named, The Deep tuned in to. And as Netflix came to us, for advice on talent and how to promote the series across our network of TikTok channels, giving viewers a glimpse into the animated series that is set to air on Netflix. We are thrilled to partner with Netflix. This new partnership provides a unique opportunity for Netflix to reach out to their non-subscribers on other platforms like Twitch. We are constantly striving to deliver new and quality content and experiences to our community of gamers and Esports fans across the world. And this partnership marks another powerful vote of confidence in our platform of Digital Media assets and our unique ability to reach Gen-Z audiences. It's just another unique example of the flywheel in action where sales, content and talent come together to deliver a bespoke solution to a client. And while on the topic of things subsequent to the quarter end, I'm particularly bullish on a few trends in the gaming industry that have a positive read-through for some of our fan communities in Q4. Last weekend, The League of Legends World Championship took place with record-high attendance. This demonstrates the continued strength of The League of Legends franchise, which bodes well for U.GG. Second, Electronic Arts transitioned late last month, it's long running successful franchise, The Sims to a free-to-play game, as owners of the largest fans -- Sims fans community, The Sims resource, we have seen a marked increase in activity, both in free and subscription offerings. Finally, World of Warcraft will be releasing its next expansion pack Dragonflight later this month. The latest expansion, the last expansion pack, Shadowlands saw engagement numbers rise on our site, Icy Veins and you're watching for a similar impact with the release of this next pack. I will now turn it back to Adrian, for additional remarks.

[Adrian Montgomery:]

Thank you, Bill. Now that we've discussed the quarter, I do want to reiterate, that the search for a new CEO continues and remains a top priority of the company. Immediately following the AGM in July of this year, the Board struck a committee of Independent Directors and hired a fabulous firm, Russell Reynolds, an LA-based Executive Search Firm with the mandate being run by the head of their CEO practice based in California. We have an excellent list of candidates. And we're confident we'll have a new CEO shortly, who will take this business to the next-level and carry the momentum, we have established. In closing, I do want to reiterate, that we do not need to raise additional capital on our road to profitability. We have substantial liquidity to achieve sustainable profitability in 2023 and with close to $21 million on the balance sheet, by virtue of the increased facility and untapped line of credit with our lender. Additionally, we also seized an opportunity in the quarter, to sell a small cluster of Legacy Fan communities, which were not profitable for a sale multiple of 4.5 times revenue. Think about that in the context of our current valuation. We sold a small cluster of money-losing communities, representing almost half of 1% of our revenue for close to CAD7 million. The combination of these two moves bolstered the balance sheet and gave management and the Board unanimous confidence to proceed with our NFL partnership, which we expect will further drive the business towards increased profitability in 2023 and beyond. I will now turn the call over to our CFO, Alex Macdonald, for further commentary on our financial results. Alex?

[Alex Macdonald:]

Thank you, Adrian. Certainly, it was a dynamic quarter, our third quarter of 2022, which I'll speak to shortly. But briefly, here are my usual notes. I note that our results are presented in Canadian dollars. I note that the significant majority of our revenues and expenses are measured in US dollars and are translated into Canadian dollars for presentation in our financial statements. The exchange rate between the US dollar and our presentation currency of the Canadian dollar should be monitored and considered when analyzing our forecasting results. And I note that our business is affected by seasonal trends in digital advertising, with sequential increases each quarter throughout the year, driven by increasing ad prices and demand, which peaks in Q4. This seasonality is isolated to our media and content revenue streams. And now back to the quarter. Q3 revenue was CAD 50.6 million, up 17% from Q3 2021 revenue of CAD 43.3 million. Q3 revenue by source was as follows

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes with Robert Young with Canaccord Genuity. Please go ahead.

[Robert Young:]

Hey good evening. I just wanted to dig a little more into the seasonality for the next couple of quarters. Q4, as you noted, typically stronger Q1, a little bit of weaker sequentially. If you could just talk about, what you see given maybe some heightened headwinds. I think you said in the prepared remarks that, you've seen a larger impact from the macro later in the Q3. And so, how does that trending into Q4 and then Q1?

[Alex Macdonald:]

Rob, how are you? This is Alex. Certainly, there -- so the typical seasonality, as we know, would be increasing ad prices and demand peaking in Q4. I have -- I still remain fully confident that prices will continue to rise. Most of that seasonality is still ahead of us, the Black Friday weekend, Cyber Monday, leading into the holiday season and the flushing of the annual budgets that occurs in the back end of December. That will still cause an increase per my judgment. The question will be how much of an increase will we see this year? Will it be a little muted in comparison to a normal year, similar to, yes, how we saw a muted seasonality in the back half of Q3 because these types of patterns also exist within quarters. I think that what this quarter is showing though, is we are seeing an example of the P&L and the business model being stress tested and the gross profit is holding up strong. I would, once a stronger seasonality, we still derive gross profit from the programmatic channels. However, they are much lower margin. So there is some insulation there and gross profits is more and more fueled by the higher margins with streams, which are less affected. It remains to be seen though. The big movements are still ahead of us in the quarter and the results remain to be seen.

[Robert Young:]

Okay. And is there an argument for tightening macro leading the average ad buyer to save a little more ammunition for Q4? Like are they taking it to Q3 budget so that they have more to deploy in Q4 because that's such an important period?

[Adrian Montgomery:]

Yeah. This is Adrian. Anecdotally, I would agree with you. And we saw some shift on the direct side even from Q3 to Q4. So I would agree with you. There's obviously big, big events in Q4. Think about Hollywood studios, think about, as Alex said, Black Friday and Cyber Monday. And so that is an encouraging trend, I think, for us quarter-over-quarter.

[Robert Young:]

Okay. And then I want to ask the same seasonality question around your expectation of breaking through EBITDA profitability. I'm not sure if that's still possible in Q4. But I was curious if you still expect it to improve in Q4 and then weaken a bit in Q1?

[Adrian Montgomery:]

We have a shot at EBITDA profitability in Q4 despite macroeconomic pressure. And it's because we're really growing our higher-margin diversified revenue stream. So certainly, the world has changed from an external perspective, we still do have a shot at it, and that bolsters our confidence. I think that we expect to have substantial sustainable profitability in 2023 as well. So we really, in many ways, remain on track for that. And I think it's a result of the business that we've built since the purchase of Omnia Media. And again, being able to double gross margin in only eight quarters has us on that cusp of profitability.

[Robert Young:]

Okay. Thanks for taking the questions. I'll pass it on.

[Adrian Montgomery:]

Thanks, Rob

[Operator:]

Thank you. The next question comes with Scott Buck with H.C. Wainwright. You may go ahead.

[Scott Buck:]

Hi, good afternoon, guys. Thanks for taking my questions. First one for me, I'm just curious if you could give us a little color on who the incremental subscriber is and how you grow that business from a $15 million run rate business to a $30 million or $50 million run rate business?

[Bill Kara:]

Hi, there. This is Bill. I'll take this call. I think the biggest growth that we've had has largely been organic on our subscription base. And going forward, it's going to be a continuation of how to optimize that organic growth, but also layering it on to it a user acquisition strategy that's typically found in other gaming companies. So we have a lot of area of expansion that hasn't been tapped into. User acquisition is a major one. And of course, continued organic optimization is going to get us there as well, but primarily through user acquisition and that will be a major effort of our teams in 2023.

[Scott Buck:]

Great. That's helpful. And my second question, curious as you look across the business, whether it's any other potential divestitures that you're looking at?

[Adrian Montgomery:]

Not at the present time.

[Scott Buck:]

Okay. Thanks. And just one more quick one. Should the macro environment continued to deteriorate what kind of leverage do you have on the OpEx side to help offset that?

[Adrian Montgomery:]

Well, we've -- we have a number of levers on the OpEx side. And I think that really, our commencement of cost-cutting initiatives started really in Q1, the back part of Q1 and Q2 of this year and we've made substantial reductions, as you can see, without affecting the gross profit line. So, certainly, there have been some headcount reduction. Certainly, we've eliminated a number of positions in an advantageous way through the sale of our editorial sites. And then really -- and Bill has done a tremendous job with this. We've really started to get aggressive on our tech costs, our engineering costs. And so we are very, very focused on the cost line. As Alex said, OpEx went down almost $1 million quarter-over-quarter, while at the same time, margin grew substantially. So costs are going down. They're going to continue to go down. We expect sequential margin improvement. But really no stone is being left unturned on the cost side. And we're benefiting from the fact that we got out in front of this starting in March of 2022.

[Scott Buck:]

Great. I appreciate the added color, guys. Thank you very much.

[Adrian Montgomery:]

Thank you.

[Operator:]

[Operator Instructions] The next question comes with Gianluca Tucci with Haywood Securities. Please go ahead.

[Gianluca Tucci:]

Hi, guys. Good afternoon. I just want to ask in terms of Q4, given that the World Cup is in Q4 for the first time. Over -- how your customers are positioned for that incremental ad spend? And how exposed is the company to capturing a portion of that incremental ad spend that's caused by the World Cup every four years?

[Alex Macdonald:]

Gianluca, how are you doing? This is Alex. I mean exposure is a good thing in that circumstance. And certainly, we have a number of places for us to capture it. To come to mind immediately, one is, you may recall, in April, we acquired FFS, Fantasy Football Scout. So we see a convergence between sports lifestyle and gaming and lifestyle and FFS was an entry point for us into that football or soccer world, and we do have partnerships with the Premier League and there are campaigns coming out of the EMEA region, which is a region we've established a sales team in at the beginning of this year. And not to mention, of course, our NFL partnership -- so we're fairly well positioned. Adrian often looks at markets and industries. You've spoken about the movie industry and other industries we've targeted. Sports is clearly something we're after as a next big driver for direct sales. And I think particularly on properties such as FFS and on NFL, we're likely going to be benefited in Q4 from that spend.

[Gianluca Tucci:]

Okay. That's great. Thanks. And I'm impressed by the continued gross margin uplift there. How much of that is caused by direct sales growth? And how much of it is other, I guess, optimization efforts that you guys are working on?

[A – Adrian Montgomery:]

A large part of it is direct sales growth. Effectively, direct sales is a 50% margin business that we created from scratch in 2020 and it's now turning over meaningful, meaningful volume and gross profit and continues to grow. And it's really the great outward example of how we stitch these assets together and make the whole greater than the sum of the parts, and it results in this high-margin vertical. So direct sales plays a substantial role as we've taken the business, again, away from that programmatic heavy business to this almost 33% margin integrated entertainment company. And again, -- when we create these campaigns through the direct sales channel, Bill talked about Fidelity, Investments, Netflix, Disney, Adidas, et cetera, et cetera, we're not just selling media, we're selling bespoke solutions that drive specific KPIs and ROI criteria of these sophisticated companies. So it is a huge part of the profitable growth of our business, and it's driving a lot of that margin. And again, other examples, subscription and the continued growth of subscription through number of subscribers added and pricing optimization has driven margin expansion as well. Our desktop app on U.GG, which now has over 1.2 million downloads and generates meaningful revenue on a weekly basis. That's another example of us branching it into products. The new game titles that we have through addicting games, the in-game advertising that we sell, the integrated sponsorships that involve those game titles increased subscription on the AG profile or platform, these are all levers. And then don't forget, Pocket Gamer. Look, we were growing this business substantially during COVID, and we lost that left hand, which was our live events business, it's now back in full force. Helsinki was a massive success for Pocket Gamer -- we're in Jordan in the Middle East. We're going to Saudi Arabia at the end of the month. London, which is our flagship event, highly profitable is coming in January. So that live event business is back in full force. Pocket Gamer is selling out all over the globe, and that's yet another lever to drive substantial margin improvement.

[Gianluca Tucci:]

Okay. That's great. So it sounds like you guys continue to expect gross profit growth to outpace overall sales growth. Is that fair to assume?

[Adrian Montgomery:]

Yes.

[Gianluca Tucci:]

Okay. Great. Thanks, guys.

[Operator:]

The next question comes with Drew Mcreynolds with RBC Capital Markets. Please go ahead.

[Drew Mcreynolds:]

Yes. Thanks very much. Good evening. Just two for me. I guess, first, maybe for you, Alex, just on FX, what kind of dynamic there was in terms of gross margin in the quarter on that one? And then maybe one for you, Adrian, just bigger picture. Every company is obviously going to revisit some strategic initiatives or cost structure at this juncture, and it sounds like you're fully on top of that. Do you feel that you are constrained at all in terms of still continuing and tackling the real important strategic priorities for the company, given the uncertainty in the environment or are you pretty comfortable you can kind of trim costs, deal with a choppy macro environment, but still obviously invest where you want to invest. Thank you.

[Adrian Montgomery:]

I'll let Alex handle the FX first, and then I'll answer the second part, Drew. Go ahead.

[Alex Macdonald:]

Hey, Drew. So FX gave us, in particular in the gross property, it did give a small bump. I think the average FX rate Q3 over Q2 was up about $0.025. And you can imagine that multiplied over just north of $16 million, although there was an offsetting factor to that, and that's in the GBP. The GBP versus CAD declined. And this quarter, with Helsinki event, out of our steel media subsidiary, which has a functional currency of GBP in the books of GBP that we lost some FX on. So there's an offsetting. So it helps. I enjoy the rise in -- the strength in the US dollar. -- but there are offsetting factors. And in the end, it didn't have a huge net material impact because we also have a lot of expenses in US dollars. So not too material, but there was a little bit of a – a little bit of an impact there from those movements.

[Drew Mcreynolds:]

Okay. Got it.

[Adrian Montgomery:]

And then as it pertains to being constrained in the environment, I think we're very disciplined about what our growth drivers are, and our growth drivers are increased direct sales, increased subscription, increased growth through products and that's really where we've been focused on, and those teams are intact and those teams continue to deliver. We -- as I said earlier in the call, we started attacking the cost structure in February, March of this year with some outcome or redundancies and other headcount reductions that we made quite effectively early. We've gotten more and more aggressive in terms of cost reductions. And we're also in a situation where OpEx is going down, it will continue to be attacked. And margin is growing at the same time. And so really, we got out in front of this. We continue in this world to be very, very judicious about our spend. The teams that are driving the organic growth are intact and don't need expansion. And at the same time, we had a lender that was sufficiently impressed and supportive of the growth profile of the business to give us $10 million of additional debt financing. And I think one of the things particularly in this environment, Drew that the team deserves a lot of credit for was a very, very advantageous sale of some money losing web communities to the tune of almost CAD 7 million. And so the impact -- the cumulative impact of all of that, has put us in a position where we continue to grow where we need to grow. But again, we will continue to turn over every rock in the cost structure. The times warranted, and I think we got on top of it early, and we continue to stay on top of it.

[Drew Mcreynolds:]

Okay, that's great. Great context. Thanks again.

[Operator:]

Thank you. It seems we've got no further questions. So I will be handing back to the management for closing remarks.

[Eric Bernofsky:]

Thank you very much. Thank you very much, and thanks to everyone for coming in to this call. The team remains resolved as we stay very, very focused, very disciplined on our path to sustain profitability. The delta shrinking costs are going down. They will continue to go down. Margin is going up, and it will continue to go up. The delta is shrinking. We are very, very focused on the task at hand to build that sustainable profitable business, which we are on the doorstep of, and I would be remiss if in my last parting comments here, I wouldn't, again, to echo what Alex said, reveal who is entirely responsible for all that hard work and all those results, particularly in a very tough environment, and that is the hard-working enthusiasts that show up every day that give their all that obsess over this business, that share their passion and their love for all things gaming and eSports. And they truly are and you, Enthusiasts, who are listening on the call, you truly are responsible for our ability to continue to show resiliency in growth, particularly at a time like this. So hats off to all of you. Thank you for everything that you do. Thanks to our shareholders. Thanks to our analysts. Thanks to everyone, who is part of the Enthusiast Gaming story. And as always, we'll continue heads down to deliver for you. Thank you.

[Operator:]

Thank you. This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.