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Transcript : CD Projekt S.A., Q3 2022 Earnings Call, Nov 28, 2022

28/11/2022 | 18:00

Presentation Operator Message
Operator (Operator)

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the CD Projekt Group Q3 2022 Financial Results Investors Conference. [Operator Instructions]

I would now like to turn the conference over to Adam Kicinski, President of the Board and Joint CEO. Please go ahead.

Presenter Speech
Adam Kicinski (Executives)

Good afternoon. My name is Adam Kicinski, and I'll be your host during today's conference dedicated to the CD Projekt Group's financial results for the third quarter of 2022.

I'll run this presentation together with Piotr Nielubowicz, Michal Nowakowski, who will join us for the Q&A session.

All right, let's get started down from the short summary of the past months. In the Cyberpunk franchise, 2 important events took place in September. On the sixth, we released Patch 1.6 and EDGERUNNERS update bringing another batch of substantial updates to Cyberpunk 2077. This was followed a week later by our first Anime series, CYBERPUNK: EDGERUNNERS aired on Netflix, a co-creation between ourselves and the Japanese studio Trigger.

The update featured multiple improvements to the game, many of which had been directly requested by the company. It also contains [indiscernible] to Cyberpunk EDGERUNNERS, encouraging anime fans as well as gamers to immerse themselves in the dystopian world of Cyberpunk.

Our goal was to establish transmedia synergy between these 2 formats, and it worked well.

Now let's move on to Slide 3. High scores on review sites, favorable impressions from key media outlets and a great deal of positive feedback from the company, all of this greatly exceeded our expectations. In its first week, CYBERPUNK: EDGERUNNERS keep the top 10 most watched non-English shows on Netflix and remained on at least for nearly a month. The popularity of the anime generated fresh interest in the game. For 4 weeks in a row, over 1 million gamers, both new and returning explored night city each day. Once more, the share of recent positive reviews of the game on stream exceeded 90%. It's an incredible result that once again proves we have a great game on our hands.

Now let's move to the next slide. In the past 2 years, we worked hard to introduce the necessary changes to the company's operations and to prepare internally for the big public review of our future plans. In our strategy update presented on the fourth of October, we confirmed the key directions in which we want to expand our business focused on the long-term product outlook. Speaking of which, let's move to the next slide.

In the second half of October, we disclosed that Canis Majoris, one of the projects originally announced during the strategy update would be a remake of the first Witcher game. This project will be developed by an external studio, Fool's Theory. A company run in big part by experience [indiscernible] to the [indiscernible] web developers, of course, will also be involved. Still on the subject of The Witcher, December 14, we'll see the launch of the Next-Gen update for the Witcher 3 Wild Hunt.

This will feature multiple visual performance and technical enhancements over the original, including performance and ray-tracing modes on consoles and new camera option available when playing the game, cross-progression and photo mode, which was highly requested by the community. The update will also offer a variety of community created molds and additional content inspired by The Witcher Netflix series.

As for our current operations and development, let's move on to Slide 7. As you can see, our focus remains unchanged. We are concentrating on the final stage of the development of Phantom Liberty and expansion for Cyberpunk 2077 scheduled for the next year. Right now, almost 350 developers are working on that project.

At the same time, we have strengthened the Polaris and Sirius teams. The former has grown to more than 150 while the latter accounted for around 60 developers at the end of October.

Now let's get back to the strategy outlook. Our ambitious plans for the next years to come are strongly linked to the recent announcement that we are opening a new studio base on 2 hubs, 1 in Boston and 1 in Vancouver. The goal behind this is to expand our development capabilities by tapping into the Northern American talent. This brings me to the last slide of my part of the presentation.

Attracting highly skilled employees and effectively motivating those who we already have on board is crucial for us to succeed in the long run. That's why during the upcoming extraordinary general meeting, we want to put to the vote a new incentive program for the years 2023, 2027, replacing the existing one. We expect this change to boost our position as an employer of choice in the highly competitive global gaming industry. It will also contribute to the long-term value of our company which is aligned with the interest of our shareholders.

If you have any questions in this matter, do not hesitate to contact us. Now it's time for financials. Piotr, the floor -- the floor is yours.

Presenter Speech
Piotr Nielubowicz (Executives)

Thank you, Adam. Now let's start into our 2022 Q3 results. Let's start with Slide 10, consolidated profit and loss account. Although due to seasonality, Q3 is usually the weakest quarter of the year. This year, so far, it was the strongest one for us.

In total, our sales revenue reached PLN 245 million, which is 70% higher than for the third quarter of 2021. The Cyberpunk game was the main contributor to the GOG revenues. As you know, since its release, we've dedicated a lot of efforts into patching and updating it. In February this year, we released the Next-Gen update. And as Adam mentioned just now, in September, we released another significant one called the EDGERUNNERS update. It brought further enhancements and improvements to the game but also additional content related to the anime, that was to be released 1 week later. And so it happens on the 13th of September, CYBERPUNK: EDGERUNNERS anime premiers on Netflix. Those events were supported by marketing and PR communication. All this resulted in a significant number of gamers playing the game, both returning and new comers.

As far as the anime is concerned, in Q3, we also recognized full revenues and costs related to. This resulted in increased sales of products as well as increased cost of products and services out line item which, together with amortization of our already released games, which nearly PLN 49 million in Q3 this year. Although in the anime itself, we enjoyed lower profitability than we usually see on CD Projekt games. The gross profit on sales amounted to PLN 166 million, 82% above Q3 last year.

Our selling cost, PLN 54 million, slightly decreased versus last year, along with the change of the structure. We experienced a decrease of costs dedicated to servicing Cyberpunk 2077 and an increase of marketing and PR costs related to the franchise.

Next slide, we also saved our administrative expenses. Although most cost categories were on the rise this year, the decrease versus the comparative period was driven by 2 main factors: first, expenses related to the valuation of the stock-based incentive program which declined due to the change in our estimates regarding the likelihood of meeting the results goes of this previous program, a change which we communicated in our 2021 annual report. Second, our [indiscernible] research expenses related to future products also decreased as we progressed our projects to more advanced phases and further expenses are capitalized as expenditures on development.

Moving further, decreasing operating costs and the growth of our sales revenue allowed us to increase the EBIT position. In Q3 this year, it was over 6x higher than in Q3 2021. This result was primarily driven by [indiscernible]. However, GOG also posted over PLN 2 million in EBIT profit unlike last year when the result of the segment was negative. This year, the balance of financial income less financial cost was also more favorable to us than last year, mainly due to the recent increase of interest -- in interest rates.

All in all, our net profit for the third quarter of 2022 reached PLN 99 million, which is again 6x more than a year ago. What is also worth mentioning is that our net profitability for this quarter reached 40%, and for CD Projekt RED alone, it even exceeded 47%.

Let's now move to the next slide, #11. As I would also like to share with you that the last quarter was our best third quarter ever, both in terms of sales revenue and net profit and both for the whole group and for CD Projekt RED alone, the chart speaks for itself.

Let's now move on to the next slide, #12, our consolidated balance sheet. In Q3 of 2022, our balance of expenditures and development projects increased by PLN 50 million. This figure represents the balance of new expenditures and development projects for the period, nearly PLN 65 million, plus the amount we've recognized as costs for the period in the amount of PLN 49 million, which also includes the already mentioned onetime amortization of our expenditures related to CYBERPUNK: EDGERUNNERS. As usual, I will come back to expenditures on our new developments in a moment.

Another noticeable increase amongst noncurrent assets is presented in the other financial assets line, which mostly includes part of the treasury bonds we acquired in order to diversify our cash position. At the same time, looking at current assets, our trade receivables increased by PLN 84 million which is 2.3x the balance as of the end of June. The growth was mainly caused by the high revenues we accounted for in Q3 this year. The total value of cash deposits and treasury bonds included in the 3 items marked with an asterisk, is summed up under the table and totals PLN 1.95 billion as of the end of September 2022. This means that our financial reserves decreased by PLN 82 million during the last quarter.

Taking into account the increase of trade receivables by PLN 84 million and the fact of paying a dividend in the amount of PLN 101 million. This is a very solid result. I will give you more details on that in the cash flow presentation.

Let's move on to the next part of the balance sheet, Slide 13. As of the end of September, our group's equity had a value of nearly PLN 2 billion and grew by PLN 95 million, driven by our profit for the period. Another noticeable change amongst the liability section involves the liabilities themselves, which decreased by PLN 82 million. This was mainly caused by the July distribution of the already mentioned dividend, which was approved by the general meeting before the end of June and was recognized among our liabilities as of the end of the second quarter. As regards to provisions, this line item grew by PLN 19 million, mainly in relation to provisions for team bonuses set based on this quarter's results.

Now please move on to the next slide, #14. So the prior RED expenditures on research, development and service of released games are presented quarterly for 2021 and 2022 to illustrate the changes happening during recent quarters. The yellow part represents our total cost of servicing our released games, mainly Cyberpunk and GWENT. Although we continue to support Cyberpunk and the EDGERUNNERS update was released just now, the team is progressively moving on to new projects. So this allocation continues to decrease.

A similar situation can be observed with early phase research work represented by the green slice, which is actually barely visible in Q2 and Q3 2022. At the same time, to share -- at the same time, the share of the teams developing new projects is on the increase. This is represented by the blue part. Unlike last quarter, this time, we had no extraordinary onetime bookings related to cooperation with our external partners. Main projects included in the blue part, this past quarter were Cyberpunk, Phantom Liberty, Polaris, Sirius, Witcher 3 Next-Gen edition and final expenditures related to CYBERPUNK: EDGERUNNERS.

And now our simplified cash flow on Slide 15. Cash wise, the PLN 99 million in net book profit for the period was supported by nearly PLN 52 million in depreciation and amortization for the period and PLN 18 million increase in liabilities and provisions, not including the dividend liabilities. The main outgoing cash drivers were the already mentioned payout of the 2021 dividend in July in the amount of PLN 101 million.

Actual expenditures on development projects in cash terms, PLN 56 million, increase in prepayments and deferred costs by PLN 13 million, mainly driven by new distribution contracts concerning future game co-releases signed by GOG and last but not least, PLN 84 million increase in trade receivables that should be collected in Q4. Altogether, our financial reserves kept in cash bank deposits and T-bonds decreased over the last quarter by PLN 82 million. As I already mentioned, taking into account the increase of trade receivables by PLN 84 million and the dividend payout of PLN 101 million, this is a very solid result.

That's all for me for now. Thank you for your attention. We can now proceed to the Q&A session.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions] The first question is from the line of Omar Sheikh with Morgan Stanley.

Question
Omar Sheikh (Analysts)

I've got 3 questions, if I may. First of all, on Cyberpunk sales in the quarter, I know you don't normally give an absolute number for units. But if you could maybe just tell us whether you thought this quarter's sales or the quarter you just reported was the biggest so far for Cyberpunk, excluding the launch quarter, obviously? That would help us understand where the number is coming from?

And then secondly, on Phantom Liberty. You haven't yet given us a date for which part of 2023 you're planning to launch in or which quarter you're sort of currently targeting? I wonder if you could just give us an update on that?

And then finally, the Witcher Next-Gen, could you just give a sense of -- give us a sense of what the marketing campaign will look like? If you benchmarked it against previous expansion marketing campaigns, how should we sort of think about it? Is it going to be along the lines of Blood and Wine or is it going to be more in line with some of the major game releases?

Answer
Piotr Nielubowicz (Executives)

So I'll start with the first one. Definitely, this year, this was the best quarter of sales for Cyberpunk. I cannot tell you by hard how this Q3 result differentiates from the last year's Q4, which is also very good. But looking at the data I have in front of me for this year only. This quarter was the best one for Cyberpunk game.

Answer
Michal Nowakowski (Executives)

Okay. For the second question, it's me, Michal Nowakowski. We are unfortunately not disclosing the specific quarter for the launch of the Phantom Liberty yet. So I'll have to ask you for a little bit more patience here. We'll talk about it when we're ready.

I'll actually take the third question as well. I think the question was whether the market campaign level is going to be comparable to what it was with Blood and Wine? I'd say it's very difficult. It's not really -- to compare one to the other. It's not apples to apples. The market circumstances have changed, the installed bases are different. So I don't think we're really able to super specifically hone in on what that number might be.

But of course, it would not be the size of the marketing campaign of the full game launch, and it will be adequate to the -- the expectations we have with the expansion. It's a big expansion. So yes, there will be marketing support, but I would not draw a simple equal sign between the Blood and Wine campaign and what we're going to prepare for the Phantom Liberty.

Question and Answer Operator Message
Operator (Operator)

The next question is from the line of George Brown with Deutsche Bank.

Question
George Brown (Analysts)

I have 2, if I may. Firstly, just thinking about the trend in Cyberpunk sales. You've obviously seen a big spike in sales with the recent update on the Netflix series this quarter. Has that since normalized back to the trends level before the release of EDGERUNNERS or has it remained higher?

And then secondly, is there any guidance in terms of the developer headcount you will need to reach, in order to execute upon the strategy you announced recently, with a significant step-up in release activity? Does headcount need to double or even triple from the current level for this to happen? Or is this the wrong way to think about things?

Answer
Michal Nowakowski (Executives)

It's Michal Nowakowski. I'll take the first one and then pass on to Adam, I think. So when it comes to the trend of the sales of CYBERPUNK pre EDGERUNNERS, right now, I can confirm that the sales level we are seeing right now is higher than prior to the EDGERUNNERS' launch and straight after the EDGERUNNERS has launched. So we see that the stable bar has raised to a level higher than what it was pre-EDGERUNNERS' launch.

Answer
Adam Kicinski (Executives)

And I'll take the second one. Adam Kicinski speaking. So the final -- I mean, there is no final goal in terms of the size of the team. Our goal is to keep growing. And we'll see actually whether it will double size of the current team in the, I don't know, 5 or 10 years or -- I mean I don't want to close ourselves in those numbers. It highly depends on the average skill of new team members, especially in the new North American studio which we are going to open -- to start opening next year.

Even though the Vancouver is already existing and then growing, but I don't want to refer to any numbers, but we want to keep growing. I mean, this year, net, we've grown so far around PLN 100 million and will keep growing, and it will be according to our needs. We believe that for -- we have very good start with this team, which we already have to continue developing Polaris and then to jump to Orion next -- next year.

Question and Answer Operator Message
Operator (Operator)

The next question is from the line of Nick Dempsey with Barclays.

Question
Nick Dempsey (Analysts)

So first question, given that so many people have bought the Witcher 3 already, a huge success over many years, and those people get the Next-Gen update for free. Do you expect to get a notable step-up in revenue during Q4 around that launch or just a kind of a boost for the community of Witcher 3 rather than a step-up in revenue?

The second question, when do you expect to start ramping up the cash spend on the Boston studio? Will that initially be expensed in the P&L? Or will it be capitalized because it will -- from the beginning, be associated with a new yet to be released game?

And third question, just when we're thinking about Q4 versus Q3, historically, you've seen a seasonal boost in Q4 versus Q3. You saw the spike in September and now you've talked -- you've helpfully talked about that coming off but at a higher level. When we're thinking about balancing out those 2 quarters, should we still have a seasonal step up when we consider all of that?

Answer
Michal Nowakowski (Executives)

Okay. I'll start with the first one, Michal, here again. So first and foremost, we do not really provide the guidance when it comes to revenue for any of our launches really, and that is true also under Witcher 3 Next-Gen update. I may just make a comment that it's obviously, it's free of charge for people who previously owned the copy of the game. But obviously, if you never own the copy of the game, and I believe there are people like that still around -- they would obviously be needing to purchase the game, one way or another. So I would just like to add that little point. But we do not provide that guidance per se to any of the launches. So -- thank you.

Answer
Piotr Nielubowicz (Executives)

I'll take the second and the third question. When do we expect to start ramping up the Boston studio? Basically, after launching Cyberpunk Phantom Liberty, we will accelerate the works on the Orion project done by the new Boston studio.

And the second part of the question was whether we will be expensing the cost of this development into P&L or we'll be capitalizing them. So initial phases, research phases will be expensed directly into our P&L. And once we move to the actual development phase, it will be capitalized. So we will use the same formula as we used to use also on recent developments.

The third question was about the seasonal boost in Q4 and Q4 proportion versus Q3. And first of all, as you know, we are not guiding. Secondly, the Q4 is still up and running. Definitely, Q3 was our best -- this Q3 was our best Q3 in history. So the base for comparison with Q4 is definitely high. However, for this we have the Witcher 3 Next-Gen additions still in front of us, which will definitely support the sales and revenues we may expect from this quarter. So there is no precise answer I could give you, especially that we intend not to guide on future results.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions] The next question is from the line of Matthew Walker with Credit Suisse.

Question
Matthew Walker (Analysts)

I've just got 2, if that's okay. I think you've indicated that with Sirius and Canis Majoris, I think you've indicated that one of those will come after the Witcher 4 launch. The other one, which I think is Sirius, is that coming before Witcher 4 or afterwards? And how do you think about the size of that game?

And the second question is, Cyberpunk costs something like PLN 570 million to develop, what do you think the average cash flow development cost of the titles that you've outlined will be to help us model?

Answer
Adam Kicinski (Executives)

Adam speaking. I will take the first one. And starting from Sirius. We are not guiding anyhow, anything about design of this game. So we are not talking about the size or what type of game it is. We just said that -- the design is to be accessible for broader audience, and that's it.

And there is a very clear business purpose for that because we have to prepare ourselves in the right moment to communicate the product to games. As the product is very different from managing [indiscernible] released so far, we have to be sure that gamers first will understand properly what the game is about. So that's why we are not saying anything, that we are not describing what type of game and what kind of size of the game it is.

And coming back to the remake and when will come, yes, it will come after for Polaris, which is a consequence of how we think about this project. We think that remake will be based in big part on technologies from Polaris. So it will be developed, partially parallel to Polaris, but once Polaris is launched, everything for Polaris will be then in the final shape and it will be partially be produced in remake.

But we are not saying whether Sirius will be before Polaris or after. We just said that all those 3, which again will be the first games we are going to launch in our pipeline. But this is the only thing I can say as for now.

Answer
Piotr Nielubowicz (Executives)

The second question was about budgets or cash outflows for the titles we plan to develop. So we've not revealed any budgets for any of our future games, and that was always so prior to using them. Once we release a game, then we usually share the budgets, but we're definitely not in this position yet.

Having said that, we will develop a little bit games and all those products announcing this strategy update gradually. And at the same time, we still continue selling our historic titles. We will be releasing some new products like the Witcher Next-Gen addition or the Cyberpunk Phantom Liberty, which will also allow us to increase the cash inflowing to the company.

So we will use this daily incoming or monthly rather incoming cash to also finance the developments and the investments into new products.

Question and Answer Operator Message
Operator (Operator)

We have currently no other questions, and I hand it back to Adam.

Answer
Adam Kicinski (Executives)

Thank you. And we have 2 questions in the chat window. The first is when you -- when do you plan to publish the results/targets for the incentive program? Piotr, you can take it, right?

Answer
Piotr Nielubowicz (Executives)

Yes. So this question requires a bit broader answer. So -- the nature of the new program is different from our historic programs. It's divided into 2 parts. Part A, where shares will be sold at nominal value and which will therefore account for the bulk of the program's costs. There are no results goals at all. The scheme is based on the concept of deferred remuneration, payable insures after 3 years of employment. The aim of the program here is to promote retention.

And in Part B, 3-, 4- or 5-year goals will be set in due course for each stage separately throughout the program's 5 years duration. But what is also important, the exercise price for each stage within this program of Part B will be based on the stock price on the corresponding ground date. This means that in order for participants to benefit from the program it will be necessary for the subsidiary stock to gain value and also for the company to achieve its long-term goals.

Part B aimed at members of the Management Board and the other top managers is much more demanding in terms of requirements than Plan A. And as I said, the goals will be set year-by-year over the duration of the program. And given our policy to avoid guidance on future earnings, not to publicly reveal the internally planned release dates, we purposely -- purposely decided not to reveal our financial goals throughout the duration of the program.

Answer
Adam Kicinski (Executives)

The second question, do you think about opening more studios outside of Poland in the next year?

Well, let's open CD Projekt RED America first, and this is the plan for the next year. And it's very ambitious. So we have no plans for further -- for opening further studios. But of course, I mean we can think about things like this in the future, but no plan is for now for opening any other studios as CD Projekt RED North America.

And the third one is do you expect to enter pre-production size of Cyberpunk sequel in the next year?

And I can take it as well. Yes, after releasing Phantom Liberty, we will start working on the next Cyberpunk game. Of course, initially, it will be a conceptual phase which from the very formal perspective, it's not a pre-production because there are 2 perspectives. I mean our common language in development and then the formal language linked to how we allocate costs.

So -- Initial phases or from the very formal perspective, research phases and all costs are going directly into P&L once concepts are ready, we start development. This is very, very formal approach. I mean, how we make it in our books. And development starts from pre-production. So from a very formal perspective, pre-production probably won't start next year as this is the first part of development. But of course, we'll start working on the game in a conceptual phase next year.

Of course, in smaller team than it's now working on Phantom Liberty as some developers will join Polaris and will help in development of Polaris.

And the next question is, are you planning a second season of CYBERPUNK: EDGERUNNERS for Netflix?

Michal, I think you can take it.

Answer
Michal Nowakowski (Executives)

Yes, I can take it. So while we're not confirming any specific plans, second season of EDGERUNNERS or anything super specifically, we did say a number of times that we have an appetite for -- to do more in the transmedia so in the linear visual animation or live action. And those plans have not changed. So when we are ready, you may expect to see more announcements in that regard coming from us.

Answer
Adam Kicinski (Executives)

All right. As we have no more questions, I would like to thank you again for joining us today. If you have any follow-up questions, do not hesitate to contact our IR team directly by mail. Have a nice evening, and goodbye.

Question and Answer Operator Message
Operator (Operator)

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.

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