CD Projekt S.A. (OTGLF) Q2 2022 Earnings Call Transcript

CD Projekt S.A. (OTCPK:OTGLF) Q2 2022 Earnings Conference Call September 7, 2022 12:00 PM ET

Company Participants

Michal Nowakowski – Senior Vice President of Business Development and Member of the Management Board

Adam Kiciński – President of the Board and Joint Chief Executive Officer

Piotr Nielubowicz – Chief Financial Officer

Conference Call Participants

Nick Dempsey – Barclays

Omar Sheikh – Morgan Stanley

Matti Littunen – Bernstein

Matthew Walker – Credit Suisse

Saim Saeed – Berenberg

George Brown – Deutsche Bank

Operator

Good afternoon, good evening, ladies and gentlemen. Thank you for standing by. Welcome, and thank you for joining CD Projekt Group H1 2022 Financial Results Investor Conference. Through our today-recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. [Operator Instructions]

It is my pleasure, and I would now like to turn the conference over to Mr. Adam Kiciński, President of Board and Joint CEO. Please go ahead, sir.

Adam Kiciński

Thank you very much. Good afternoon. Welcome to CD Projekt Group’s 2022 half-year call. I’ll start with a short recap of the highlights for the period, then I’ll move on to recent announcements. In the second part, Piotr Nielubowicz will cover the financials. Michal Nowakowski will join us for the Q&A session after the presentation. The webcast of the presentation as well as the audio feed are streamed live on our corporate Web site and our YouTube channel.

Let’s kick-off with a summary of the key production milestones. In Q1, two separate CD Projekt RED teams were already working on two AAA project. One team continued development of the expansion for Cyberpunk 2077, the other started pre-production of the next Witcher game. On top of that, we continued working on improving Cyberpunk. In February, we released Patch 1.5 along with the next-gen version of the game. The positive response we received proved that we are heading in the right direction. Following the next-gen patch, we continued working on the 1.6 update, which came out yesterday, more on that later on.

Back in March, we announced a strategic partnership with Epic Games, our future productions will now rely on Unreal Engine 5 and its potential next versions. We had also used this opportunity to announce work on the new Witcher saga game that I’ve already referred to. As production of the game began at the end of Q1, the corresponding development costs started being capitalized.

Now, let’s move on to the recent project announcements. We are super excited that CyberPunk: Edgerunners anime series is coming to Netflix on Tuesday, next week. We’ve produced it in collaboration with Trigger, the acclaimed Japanese anime study. CD Projekt was responsible for creating the series, while Trigger adopted it to anime format. The first impressions of those who had the opportunity to watch the series during the recent [indiscernible] were very encouraging. We believe the series will broaden the interest in the Cyberpunk world and bring new players to the game. Indeed, this format provides a perfect match for the Cyberpunk universe.

Now, let’s move to slide four, and focus on Patch 1.6, called, the Edgerunners Update. It brings anticipated feature to the game, new weapons, wardrobe, [cyberware] [Ph] customization, and the Edgerunners content, to name just a few. With this new update, we also rolled out a set of modding tools to Cyberpunk, called REDmod. Thanks to this, it’s finally possible to modify practically every system and any aspect of the game, so it opens countless possibilities. Another thing we added is a performance mode allowing users of Xbox Series S to play the game at 60 FPS. This has been one of the most highly requested features by our community, and we are very happy to introduce it.

Moving forward, we decided to focus our attention and resources on the new-gen versions of Cyberpunk so we can further develop and upgrade the game on PC, Stadia, PlayStation 5, and Xbox Series X and S. Of course, the game will continue to operate on previous-gen consoles and we’ll keep providing technical support.

Let’s move to slide five, and recap [basic thoughts] [Ph] of yesterday’s announced expansion. We decided to develop one major expansion to Cyberpunk 2077, titled Phantom Liberty. To provide the best possible experience and great new features, the expansion will come to next-gens and PC only. The release is planned for the next year.

Now, let’s move to slide six, presenting the current allocation of our developers. As you can see, the largest team is working on Phantom Liberty, and the second-largest is on the new Witcher game. You can also see that the share of developers working on The Molasses Flood project has grown significantly since the end of 2021. At the same time, the GWENT team was adjusted to the scope of the game operations. And a small portion of the team continues to work on the next-gen version of the Witcher 3.

Speaking of which, moving to slide seven, I can confirm that this game is on track to launch in fourth quarter this year, stay tuned.

Now, let’s move to slide eight. I am happy to invite you all to the presentation of the CD Projekt Strategy Update. The event will take place in October, with details to be provided in upcoming weeks. We are eager to share our long-term vision and business outlook; can’t wait.

Now, it’s time for the financials. Piotr, the floor is yours.

Piotr Nielubowicz

Thank you, Adam. Now, I’ll guide you through our results for the first-half of 2022. So, let’s start with slide 10, consolidated profit and loss account. In total, our sales revenue reached PLN 378 million, which is 20% lower than for the first-half of 2021. As you may remember in H1 2021, we were adjusting our sales and cost provisions created after the release of Cyberpunk. As a result, in the first-half of 2021, nearly PLN 40 million in sales provisions were sold, and slightly over PLN 40 million in cost provisions were created. This led to an increase in our costs as well as revenues we posted last year.

It’s also worth mentioning that the reference period immediately followed the release of Cyberpunk, when the high post-release curve in sales of the game could still be observed. And this year, during H1, our revenues from sales of products supported by the release of the next-gen edition of Cyberpunk reached nearly PLN 286 million. Revenues from sales of goods for resale and materials mainly represent GOG business. The total figure here decreased by 9%. The main measurable reasons for that are, first, revenue booked by GOG on the PC version of Cyberpunk was naturally lower than last year as the next-gen update most influenced our console sales. And last year, we were still in the post-release curve.

Second, this year, the digital store recorded lower revenues from new releases from external partners as some of the new releases planned for H1 were postponed. And third, suspension of sales to Russia and Belarus added a bit on top of the above. At the same time and the supplies both to CD Projekt RED and GOG, where the bulk of sales is denominated in U.S. dollars, converting our revenues to Polish zloty benefited from the increased exchange of the U.S. dollar versus the zloty. Costs of products and services sold amounted to PLN 37 million. As mentioned a minute ago, the high figure reported for H1 2021 included adjustments of cost provisions in the amount of over PLN 40 million.

Apart from that, both this and last year, most of the reported amount comes from amortization of past expenditure on development of Cyberpunk. However, this year unlike last year, we no longer have amortization of initial GWENT development activities which had already been fully amortize by the end of 2021.

Cost of goods for resale and material sold came mostly from GOG, and decreased in line with sales or even a bit more. All in all, our gross profit on sales exceeded PLN 276 million.

Moving to the operating cost, in 2022, our selling expenses decreased to PLN 101 million which is nearly PLN 30 million than a year ago. The amount reported for H1 2021 was largely influenced by our involvement in servicing Cyberpunk, which as we indicated previously was expected to decrease this year.

And this indeed happened, from nearly PLN 48 million the last year down to PLN 15 million this year. The selling expenses line also includes over PLN 27 million in expenses allocated with broadly — associated with broadly speaking our Cyberpunk publishing activity mainly as a consequence of the next-gen release campaign. Next slide, in H1 2022 we also saved an administrative expense. The decrease was driven by two main factors. First, expenses related to the evaluation of the stock-based consensus program which declined due to the change in our estimates regarding the likelihood of meeting the results of the program which happened at the end of 2021.

And second, we can observe a decrease in early first phase research expenses related to our future products. That occurs as we progress to more advanced phases and further expenses are capitalized and expenditures on the development projects. Moving further, although our total sales revenue decreased by 20% versus last year our EBIT actually grew by 12%. This result was primarily driven by [indiscernible]. However, GOG also posted close to PLN 2 million in EBIT profit unlike last year when the result of this segment was negative by nearly PLN 5 million.

This significant improvement was made possible by reorganization and optimization of cost pro forma GOG in recent months. This year, the balance of financial activities was more favorable to us mainly due to the recent increase in interest rates allowing us to add PLN 6 million to the total result. At the same time, same as in Q1 the reported income tax for the period and the effective tax rate were higher than what we had observed in previous years.

The increase was mainly caused by withholding taxes paid abroad by our international licensees. Having received confirmations of withholding tax payments this year in accordance with existing treaties concerning double taxation, we deducted from our local corporate tax liabilities as much as was allowed. Obviously, the local R&D tax and IP Box tax regime which allow for preferential local taxation, give us less capacity to deduct foreign withholding taxes.

The excess withholding tax, which we could not deduct locally, was recorded in our P&L statement. The total amount of such excess in H1 this year reached nearly PLN 25 million. This amount is related mainly to licensees royalties collected after the release of Cyberpunk. For which, the corresponding tax payment confirmations were delivered to us this year. All in all, our net profit for the first-half of 2022 reached PLN 140 million. The absolute figure increased by 8% versus the comparative period. But what is worth mentioning, however, is that our net profitability grew from 22% to 30 year-on-year — to 30% year-on-year. And for [indiscernible] alone, it even exceeded 38%, which means that for each PLN 100 in sales revenue, PLN 38.4 remained with us as the net profit after taxation.

Let’s now move off to the next slide number 11, our consolidated balance sheet. In H1 of ’22, our balance of expenditures on development projects increased significantly by nearly PLN 84 million. This figure represents the balance of new expenditures in development projects for the period of PLN 121 million less amortization of past projects in the amount of nearly PLN 37 million. I would come back to expenditures on new developments in a moment.

Another noticeable increase among non-current asset is presented in the shares and in non-consolidated subsidiaries zloty. The increase by PLN 28 million was driven by our capital contribution to Spokko as well as increased valuation of previously acquired U.S. shares in the slot as a consequence of the U.S. dollar getting stronger versus zloty this year. At the same time, looking at current assets, our receivables decreased by PLN 122 million, mainly due to a natural cycle after Q4, a decrease in tax receivables and a decrease in prepayments for the development projects. The total value of cash deposits and T-bonds included in the three items marked an asterisk is summed up under the table and totals PLN 1,178 billion as of the end of June 2022. This means that our financial reserves grew by PLN 24 million during the first six months of this year.

Let’s move on to the second part of the balance sheet, slide 12. As of the end of H1, our Group’s equity had a value of nearly PLN 1,903 billion and grew by nearly PLN 9 million. The main counterbalance in drivers should be mentioned here. Two main counterbalancing drivers; first, an increase in real, an increase related to our profit for the period and second a decrease related PLN 101 million dividend for 2021 approved by the general meeting just before the end of June and not a change affecting the liability section at the end of June 2022, involve the liabilities themselves, which increased by nearly PLN 92 million.

And again, this was related mainly to recognition of our liability to pay out PLN 101 million dividends approved by the general meeting before the end of June and paid out in July. As regards provisions, we no longer have any pass through these sales provisions, and our cost provisions decreased by nearly PLN 49 million in the first-half of 2022. Those related to team bonuses decreased by nearly PLN 23 million due to 2021 bonuses being paid out in Q2 of this year, while [indiscernible] provisions decreased naturally by PLN 26 million over the first-half of 2022.

Now please move on to the next slide number 13. To the product routes, expenditures and research, development and service are released games are presented quarterly for 2021 and 2022 to illustrate the changes happening at the studio after the release of Cyberpunk. The yellow parts represent our total cost of servicing our East games mainly Cyberpunk and Gwent. Although, we continue to support Cyberpunk and Patch 1.6, was released yesterday. The team is progressively moving on to new projects and so this allocation continues to decrease.

A similar situation can be observed with early phase research work represented by the green slides, which is actually fairly visible in Q2 2022. At the same time, the share of the team developing new projects is on the increase. This is represented by the blue part development phase of new projects. And this time since the development part is bigger than usual we have three shades of blue to present it in more detail. The dark blue part at the top shows the amount related to outsourcing class of the next generation version of The Witcher 3, we booked last quarter. The medium shade of blue corresponds to outsourcing expenses related to Cyberpunk genres, mainly due to a shift in its status from prepayments for development projects to capitalized development projects. As the anime series has now been delivered by our partner animations to the trigger. In both cases, we are talking about kind of one-time events related to finalizing works on projects handled by our outsource partners. And finally, the blue part at the bottom represents our typical development activity and is growing scope.

And now our simplified cash flow on slide 14. Cash wise, the PLN 140 million in net book profit for the period was supported by over 43 years out in depreciation and amortization for the period and nearly PLN 73 million decrease in receivables over the first-half of 2022. The main outgoing cash drivers not included directly in the P&L statements were nearly PLN 43 million, decreasing liabilities in product and provisions actual expenditures on development projects in cash terms nearly PLN 90 million, purchases of intangible and tangible assets at over PLN 25 million, increasing prepayments and deferred costs by nearly PLN 20 million, mainly driven by new distribution contracts concerning future games releases, signed by GOG and actually among others. This position includes a contract with a new important partner of GOG Sega, and it covers a wide catalogue of Sega games, some of which are already available on GOG.

And last outgoing cash driver is a capital contribution to the Spokko Company, which is excluded from consolidation. The contribution allowed Spokko to pay back its loans to CD Projekt, and the net effect of these two types of transactions amounted to PLN 17.5 million. Altogether, our financial reserves increased by PLN 24 million, reaching PLN 1.178 billion in cash from deposits and T-bonds as of the end of June, 2022. The increase was generated during the first quarter mainly thanks to the collection of our receivables for the preceding fourth quarter and for the February next-gen digital release of Cyberpunk.

In Q2, we paid out our annual team bonuses for 2021, and incurred over two-thirds of the increased expenditures on development projects for the first-half of the year.

This is all from me for now. Thank you for your attention. We can now proceed with the Q&A session.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] We have the first question from Nick Dempsey from Barclays. Please go ahead.

Nick Dempsey

Yes, good afternoon, guys. I’ve got two questions. So, first of all, when I’m just focusing on the sales of products lines, you saw in the first quarter PLN 174 million, second quarter PLN 112 million. So, when I’m thinking about that line in particular for the second-half, am I right in thinking that you normally have seasonally lower Q3, and there’s not really any other factors that would move that number up, and then in Q4, the only factor that could change it is the Witcher 3 next-gen update. Am I missing anything other than those factors when I’m thinking about how to model Q3 and Q4 sales of products? That’s my first question.

And then just on the second one, slide six, it looks as though, as of 31 of July, there was really only a very small team working on the next-gen version of the Witcher 3. Have you stepped the up since then or is it just that it was more or less complete when you picked it up from Saber? And are you still very confident of releasing that in Q4 of this year?

Piotr Nielubowicz

Okay, so start with the first one, question about sales of products. Yes, typically Q3 is the lower season of the year for us, and typically Q4 is the high season of the year for us. As far as the Q3 is concerned, the main customer-oriented event on our side are the release of the new 1.6 patch and also the premier of the Cyberpunk: Edgerunners series on Netflix. Obviously, they do not directly drive sales [in the meaning] [Ph] for the premier of new game, but we believe it will [indiscernible] and we dedicate a lot of communication out to those situations — to those events, the Edgerunners series and Edgerunners update for Cyberpunk. And the main event for us for Q4 will — would be the Wither 3 next-gen release, which as Adam confirmed, is planned to happen by the end of the year, in Q4.

Adam Kiciński

So, answering the second, the team is proper, because when we take over the project it was not ready, of course. But the remaining works were very highly specialized technical work. So, there is a group of professionals proper for the tasks and they are finishing their works. And yes, as we said, we are on track to release the game in Q4.

Nick Dempsey

Okay, thank you, that’s great.

Adam Kiciński

Thank you.

Operator

The next question is from Omar Sheikh from Morgan Stanley. Please go ahead.

Omar Sheikh

Good evening, everyone. I’ve got a couple of questions as well. Maybe, first of all, on the next Witcher game, could you just update us on where you are in the development of that game? How far through it are you? And do you still anticipate it will take, broadly, three to four years to develop? And also, is that game all being developed on Unreal, just that would be helpful as well? And that’s the first question. And then secondly, I guess on the Cyberpunk expansion for next year, again, a similar question, I suppose, where are you in the development of that, how is that going, how is the game — how is the expansion currently looking in terms of development process, and are you broadly targeting just at some point before the end of the year or can you be a bit more specific? Thanks.

Adam Kiciński

Hi, Omar. So, answering the first question, we are in pre-production phase, as I said. So, this is the first phase of development. And as for now, we have a needed team and we are in line with the plan. But commenting the total time of the project, I can’t comment the total time of the project. But as for now, we are where we should be, and the game is being developed on Unreal Engine, as we said. On expansion, of course, the situation is very different. The expansion is the last project developed on our own technology. And, well, we are where we should be at this stage. This is very advanced stage, so the bulk of our development team are engaged in the project. And I can’t comment anything about days. We keep saying that this will be next year, and, well, it will be the time to — for the further announcements.

Omar Sheikh

Okay, thanks. And just one follow-up, if I could, on the Witcher, you referred to a new Witcher saga. So, are you now talking about multiple new games? So, just maybe if you could elaborate a little bit on what you mean by that?

Adam Kiciński

Sure. We said that there will be new saga, but, of course, now we are pre-producing the first game of this saga, but we have in mind more than one. So, like the first saga were three games, so, now we are thinking about more than one game. But we are in pre-production of the first game from the second Witcher saga.

Omar Sheikh

Got it. Okay, thank you very much.

Adam Kiciński

Thank you.

Operator

The next question is from Matti Littunen from Bernstein. Please go ahead.

Matti Littunen

Hello, good evening. Just on the parallel development beginning, just to check if I am reading the charts correctly, that capitalized parallel development on those two products started in Q2, and is — are we talking about a Witcher game and another AAA project? And if so, you had a statement in the press release about revisiting a world which is an integral part of CD Projekt history, just checking was that statement referring to the new Witcher saga game that you were mentioned or another game? Then, now that we’ve got the Phantom Liberty trailer out and the next year’s release date, could you give us an update on if there is one on — what the plan is for any subsequent sort of major expansion DLCs for Cyberpunk? Is it too early to say, or could we maybe — should we expect the similar couple of expansions as we got for Witcher 3? Thank you.

Piotr Nielubowicz

I will take the first question about capitalization. No, actually the capitalization started early; one project at the end of 2021, beginning 2022, and the second one in Q1, 2022. And I’m talking about two projects, since one is the next Witcher production, but we also work together with The Molasses Flood on their project, and it’s also part of the capitalized expenses.

Adam Kiciński

And to add one more thing, referring to parallel development in CD Projekt RED, I meant development of expansion, which from the production perspective is fully AAA development. And together with this, parallelly, we started development of the next Witcher game.

Matti Littunen

Got it, very helpful, thanks.

Michal Nowakowski

Hi, and this is Michal. On your question on the further expansions for Cyberpunk, we decided to develop one major expansion for Cyberpunk, which is going to take advantage of all the capabilities of the new-gen consoles. And having said that, we are totally fully committed to developing the Cyberpunk IP further, so beyond the — this particular Cyberpunk expansion, which is expansion we’ve put a lot of effort and time into building this franchise, and we definitely want to continue to build up on the what was built right now with new stories, new experiences, new content, basically, not just the videogame format. And I’ll leave it here. So, in terms of expansions, so there’s just going to be one major expansion, however there’s going to be new stuff in the future.

Matti Littunen

Got it, thank you.

Michal Nowakowski

Welcome.

Operator

The next question is from Matthew Walker from Credit Suisse. Please go ahead.

Matthew Walker

Thanks a lot, thanks for taking the questions. Just two questions, please. The first is, when we’re thinking about the potential sales from the Cyberpunk expansion, should we be using the sales from the Witcher 3 expansions as a guide, is that the best thing to do or is there another sort of methodology that you would recommend? And the second question is just, I think, in the past, when you’ve talked about industry consolidation you’ve always said that you want to remain independent to sort of run your own franchise, and essentially make sure that you fully exploit Cyberpunk. Is that still the case; is that still your thinking?

Michal Nowakowski

Okay, I’ll take the first one, so the question is about the potential sales of the expansion. So, we’ve never been big about leading on the actual sales. I guess what I can say is we believe we have a great expansion on our hands, and we have really ambitious goals. However, in this case, it’s important to remember that there is — that we’re targeting the next-gen and the PC fan base, so the next-gen — new-gen consoles’ owners and the PC owners, so that that’s an important factor to keep in mind. And I think that’s pretty much as far as we want to go. Important thing to maybe remember is that we’re also looking at like a long-term sales to what adding this expansion is also going to do for the sales of the base game, any potential complete editions, and so on, look back in the Witcher 3 history, when we’ve done similar moves, and that’s probably going to give the idea. Again, I cannot really specifically comment on the actual numbers, even in terms of percentage and things like that.

Adam Kiciński

And answering the second question, yes, definitely, yes, we haven’t changed our strategy. And we are focusing on building enduring franchises, we are focusing on bringing more and more content to our franchises, having, of course, AAA games in the center of our franchise flywheels.

Matthew Walker

Okay. I have a follow-up, have you — have any thoughts around how the cost of living crisis could impact the company going forward?

Piotr Nielubowicz

So, of course, the cost of living inflation impact wages, that — definitely. And it is not the only factor, but we see that wages are rising. Last year, that the average rise was 23%, this year, we are expecting the same trajectory, so similar trajectory. So, costs are rising. And on top of that, we have new factors like working from home, which is, on one hand, opportunity because we can hire people from around the world, but on the other hand, wages are more and more global, and we have to adjust to it.

Matthew Walker

I meant really impacting the consumer demand, so basically if inflation goes up, energy prices goes up, consumer has got less money. How do you see that impacting the sales of the games?

Michal Nowakowski

Hi, so it’s Michal. So, of course, we’re not fortunetellers, and the situation the world is in currently, on so many fronts, is rather unprecedented, I think we can agree on that. Having said that, previously, games were rather crisis-proof, but again nobody can, at present, tell what is going to happen. Having said that, we have not — with everything that’s happened so far we have not really seen any negative impact to our sales to be perfectly honest.

Matthew Walker

Okay, thank you very much.

Piotr Nielubowicz

And I’ll say one more thing that we are actually providing our customers, gamers with a fairly cheap entertainment considering that our games are potential sometimes hundreds of hours, and they pay, for Witcher 3, $40 or $20 on promotions. For Cyberpunk, prices is very attractive as well. So, they get a lot for a very decent price.

Matthew Walker

Yes, agreed. Thank you.

Adam Kiciński

Thank you.

Operator

The next question is from Saim Saeed from Berenberg. Please go ahead.

Saim Saeed

Hi there. Thanks for taking my question. Just a very quick on your playerbase and its split across different console types, could you provide an indication of what percentage is on next-gen consoles and PC?

Adam Kiciński

Could you repeat the question again? Sorry, I think we were — you were [indiscernible].

Saim Saeed

So, just in terms of your playerbase, do you have an idea of the split of the active playerbase that are on next-gen consoles and PC?

Michal Nowakowski

So, yes, I mean, we do have, of course, obviously, very good idea in terms of PC. In terms of consoles, that visibility is not as simple as with the PC. However, we do have insights into that too, yes.

Saim Saeed

And would you be willing to share that, would you say that the majority of console players have shifted on the next-gen or are they still on original — or are they playing it on an original — well, the previous generation of console?

Michal Nowakowski

No, we’re not really providing guidance on that kind of stuff. Some of that information is also console-specific — confidential, yes.

Saim Saeed

Okay, thank you.

Operator

The next question is from George Brown from Deutsche Bank. Please go ahead.

George Brown

Hi, thanks for taking my questions, I have two, if I may. So, firstly, in terms of the Cyberpunk expansion, what sort of price can we expect from this or will these details be shared at a later date? And then secondly, is there any potential for any future platform deals to bring Cyberpunk to Xbox Game Pass or PlayStation Now as sort of a subscription services as well? Thank you.

Michal Nowakowski

Hello again. So, I can take these two. So, the first one was about the price. So, we’re obviously not disclosing price at this moment in time. Of course, we’re going to reveal that at an appropriate moment. Having said that, we did mention this is the major expansion, it’s actually pretty sizable, and we’re happy with its quality. So, the price is going to be according to what we’re going to present to the players, basically. As for the second question, are there any potential deals in Xbox and PlayStation, well, we’ve done some deals in the past but, obviously, if there is any deal happening it’s — we cannot really talk about it in the future. And if anything is going to happen it’s going to be announced at an appropriate time. We don’t have anything on that matter to share here now.

George Brown

Okay, thank you.

Operator

There are no further questions from the call. Perhaps we have questions from the webcast. And I’ll hand over to [indiscernible].