CD Projekt S.A. (CDR) Earnings Call Transcript & Summary

Good afternoon. My name is Adam Kicinski, and I will be your host during today's conference. We are meeting to discuss the first half of 2023 at CD PROJEKT Group. I'll run the presentation together with Piotr Nielubowicz. Michal Nowakowski will join us for the Q&A session. Before discussing earnings, let's quickly sum up key events that took place in recent months. At the beginning of June, media outlets from all over the world had their first head on experience with Phantom Liberty. We gave our visitors the opportunity to play the expansion on all platforms, that is PC, Xbox and PlayStation 5. More than 120 media representatives have since published their first impressions. We are very happy with those early reactions. Not long after that, at several Xbox FanFest events, we invited gamers to try out the expansion as well. Their opinions were closely aligned with the positive feedback from media. Both groups appreciated the huge amount of work that we had gone into the expansion, and are looking forward to its release. The release date was announced at the Xbox games showcase event. Phantom Liberty will launch on 26th of September 2023. At the same event, Keanu Reeves announced a new trailer for the expansion. The trailer has been viewed by nearly 13 million people on our social media channels. This confirms Phantom Liberty's position as one of the most anticipated releases of this year. This announcement went together with the launch of pre-order campaign. After 2 months, we are very happy with how it's going. But of course, most pre-orders come in during the final pre-release days. By the way, this is also a great opportunity to highlight that the base game reached an important milestone in July. Cyberpunk has passed the very positive score threshold on Steam. From over 550,000 reviews posted since the release, 80% of players have rated the game positive. [indiscernible] more, the recent average review score stands at almost 90%. This is a significant achievement that validates the hard work we have put into Cyberpunk over the last 3 years. Let's go back to the summary of the Phantom Liberty marketing campaign. We have also announced that Phantom Liberty Tour, a series of 8 community events taking place around the world in August and September. Participants can play the expansion at end contests and meet the development team. On top of that, last week, at the opening of gamescom, we showcased new ways to play, a video announcing new content coming in the expansion as well as in Update 2.0, the biggest part for the base game yet. We have prepared a number of new and overhauled features to help experience the game in the best possible way. Phantom Liberty has again generated great interest in our IP. We believe it's another positive signal showing anticipation for our upcoming release. Before moving on to our developers' involvement in ongoing projects, let me quickly wrap up the recent organizational changes at the studio. As we announced in July, by the end of January 2024, we will be parting ways with about 9% of our team. This decision is closely related to the ongoing internal RED 2.0 transformation. We need to adopt the scale and structure of the team to our current operational needs and development plans. Coming back to the current allocation of developers. At the end of July, the Phantom Liberty team working on the pre-release phase consisted of 300 people. That's fewer than at the end of 2022, but still it remains our biggest team. On the other hand, the Polaris team has grown to almost [ 250 ] developers by the end of July. Last but not least, I would like to make some comments regarding 2 other teams. As you can see, the red part of the chart is smaller. This is a result of changes in Sirius project that we announced in May. Concerning the green part, the Gwent team will gradually decrease in size until the end of this year. This is related to the GWENTFINITY project, which entrust the future of Gwent to the gaming community. Now let's move on to financial. Piotr, the floor is yours.

Thank you, Adam. Let's start with our consolidated profit and loss account on Slide 10. Unlike last year, when we launched Cyberpunk next-gen edition in Q1, the first half of 2023 saw no comparable sales events. This year, our focus has been on preparing for the Phantom Liberty expansion launch, as mentioned by Adam a moment ago. While we've been working on this new release, our existing RED products generated PLN 244 million in revenue. Together with PLN 85 million from GOG, this resulted in PLN 325 million in consolidated sales revenue, that's 86% of last year's figure. In contrast to the group sales, our cost of sales increased slightly, primarily from increased depreciation due to the completion and release of The Witcher 3 next-gen edition in Q4 last year. Moving on to operating costs. Our selling expenses decreased by PLN 5 million to PLN 85 million. This was mainly driven by a decrease in Cyberpunk servicing costs. At the same time, preparation and execution of the Phantom Liberty release campaign resulted in the Cyberpunk IP-related publishing expenses, reaching nearly PLN 30 million, which accounted for a substantial part of our selling expenses. As regards to administrative expenses, the increase is related mainly to the introduction of our new incentive programs in Q2, which replaced program introduced in 2020. Some of the new entitlements directly replace the old ones, which produced increased costs on the new ground state. All in all, during the first half of 2023, noncash expenses related to our incentive programs exceeded PLN 10 million. Moving further to other operating income and expenses, the positive loss of PLN 25 million comes mostly from the [ base ] of the impairment adjustments related to the Sirius project in the amount of nearly PLN 19 million as discussed during the meeting dedicated to Q1 results. The second positive driver for the operating income, which did not exist before, was nearly PLN 8 million effect on applying the innovative employee tax release. This regulation allows us to use the R&D tax relief budget originally intended to lower our corporate income tax to offset a portion of the personal income tax, which we are obliged to remit to tax authorities. Introduction of this mechanism makes it easier for us to benefit from the R&D relief and our status as an R&D center. And another supportive driver is visible in the financial operations category. The reported [indiscernible] loss of nearly PLN 22 million came mostly from the interest on bank deposits and T-bonds. Our income tax for the period consisted of 3 parts: currently account tax paid locally, withholding tax paid abroad and changes in deferred tax. As in regards to the calculation of deferred taxation, it was increased by nearly PLN 8 million as a result of utilizing the R&D tax relief budget on innovative employee relief as Adam mentioned a moment ago. All in all, our net profit for the first half of 2023 reached PLN 91 million. Let's now move on to the next slide, #11, our consolidated balance sheet. Over the first half of 2023, our balance of expenditures and development projects driven by Cyberpunk, Phantom Liberty, Polaris and Sirius projects increased by PLN 120 million. This figure represents the balance of new expenditures and development projects for the period PLN 148 million plus previously mentioned, the PLN 19 million impairment adjustments related to project Sirius and less the amount we've recognized as costs for the period, PLN 43 million. At the same time, among current assets, our trade receivables decreased by nearly PLN 82 million, which is [indiscernible] after the preceding [indiscernible] Q4 period. And last but not least, the total value of cash deposits and treasury bonds including the 3 asset items marked with an asterisk, is summed up under the table and totaled PLN 931 million as of the end of June 2023. I will walk you through our main cash flow drivers in a moment. Let's move on to the second part on the balance sheet, Slide 12. Our equity stayed flat as the 2022 dividend paid in June this year was offset mainly by the profits of the current reporting period. Our liabilities, [indiscernible] trade liabilities decreased since the end of 2022. The mechanism here is similar to what we experienced with trade receivables. During the first half of 2023, we also observed a significant decrease in provisions. This was mainly driven by the payout of 2022 bonuses in 2023 and change in our remuneration strategy. The change implemented in 2023 shifted most of the profit-dependent bonuses to base salaries and new incentive programs instituted this year. As a result, we set aside significantly lower provisions for 2023 results-related bonuses. Now please move on to the next slide, #13. CD PROJEKT RED's expenditures on research that development and service have released claims presented quarterly since 2021. As you can see, the development work has been in full swing during the past 3 quarters. Although our main focus right now is on the upcoming release of Phantom Liberty, other projects we have in development are also progressing with each passing quarter. And now our simplified cash flow on Slide 14. Cash-wise, the PLN 91 million in net book profit for the period was supported by nearly PLN 50 million in depreciation and amortization for the period. At the same time, when talking about cash expenses, non-receivables impairment allowance adjustment in the amount of PLN 19 million [indiscernible]. The already mentioned decrease in our receivables are similar in size to the combined decreasing liabilities and provisions, all of which are represented by the next 2 bars. During H1, we also financed nearly PLN 163 million in expenditures on development projects, the core of our business. To top it off, we shared PLN 100 million with our shareholders in the form of a dividend. Altogether, our financial reserves capped in cash and deposits and T-bonds decreased by PLN 160 million over the first half of 2023. That's all as far as H1 2023 results are concerned. I'm looking forward to our Q3 earnings call when I will talk you through the results of the Phantom Liberty launch quarter. Over to you, Adam.

Thanks, Piotr. We are now 27 days away from the launch of Phantom Liberty. As I've already mentioned, we are entering the most intense phase of the marketing and PR campaign. On top of that, in the next weeks, we'll be sending review copies to journalists around the world, enabling them to publish their impressions and reviews before the release. We are very excited, and we eagerly await the moment gamers can finally experience the game. That's all from us. Now we'll proceed with the Q&A session. Thank you.

[Operator Instructions] Our first question comes from Nick Dempsey of Barclays.

I've got 2 questions. The first one, when I'm looking at Slide 13 and looking at the development expenditure new product line, for Q2, that looks almost identical to Q1. When I'm looking at Slide 14 and I look at expenditure on development projects, I've got PLN 163 million versus, I think it was PLN 71 million at Q1. So there's more of a over PLN 90 million in Q2. Can you just explain to me what the gap is between those 2 things because that's going to be helpful for me trying to model that for the full year? And second question, when we're thinking about tempting the model Phantom Liberty unit sales, we're thinking about an attach rate versus Cyberpunk unit sales. One consideration is that Phantom Liberty is not available on PS4 and Xbox 1. Can you give us any indication how of unit sales that you achieved is somewhere just over 20 million, roughly what kind of proportion might have been purchased on PS4 and Xbox 1.

Piotr Nielubowicz here. I'll take the first question. So the difference between the 2 slides is based on the fact that Slide #14 present our cash flows. So the money actually outgoing from the company on development of our games while the previous Slide #13 presents a book expenses we booked during the period. The major difference between the 2 in respect of the first half of this year, is that within this period, we've paid out balances for 2022, which was onetime cash operation, visible in the cash flow slide. And at the same time, cost wise, it was applied on the previous quarters of 2022, therefore, was not visible in the first half of '23. And at the same time, as you may have heard starting this year, we've implemented new [indiscernible] according to the philosophy of remuneration people we've shifted some or most -- actually, most of the bonuses to base salaries and incentive programs implemented this year. Therefore, this year, book-wise, we have much less reserves for bonuses, profit-related bonuses than we used to have in previous years.

Okay. So just to understand, if I'm trying to continue that going forward is the kind of just under PLN 75 million or something close to the PLN 90 million, a sensible number. Does the PLN 90 million includes some kind of one-offs related to bonuses that I shouldn't be rolling forward?

Yes and no. Bonuses are kind of one-off paid -- were that kind of one-off paid the following year for the results of the previous year. However, as I said, we've shifted the bonus to base salaries and month-to-month costs will be proportionately higher and they will not be booked onetime or quarterly, it will be booked month by month. In some average way of transforming obviously, because each year is different.

Our next question comes from Matthew Walker of Credit Suisse.

Actually, there was a second question, which we haven't answered yet.

Matthew? Matthew Walker from Credit Suisse. Are you there?

Yes, I am.

Okay. Please go ahead.

Shall I go ahead? Okay. Yes. Firstly, when you talked about pre-orders, you said most pre-orders, I think, will come in the final period before the launch. I was just trying to think about what you're expecting for the split in units between Q3 and Q4, given that you're launching quite late in the third quarter. And then if you remember back when you launched the original Cyberpunk, some issues around console. Obviously, as Nick said, you're not sort of doing this on old consoles, but are you happy that you've got the balance right between the coding working really well on both PC and next-gen consoles? And then final question is, what impact do you think the Phantom Liberty launch is going to have on the impact of the base game because obviously, I guess you're going to have some bundles with the base game.

Okay. I'm probably going to take most of these questions. Kind of first, I actually wanted to go back because I think Nick asked one more question, which we haven't addressed, and we went immediately to the -- to these questions. So please allow me because there was a comment -- sorry, not a comment. There was a question about the pre-orders we would have expected had we launched for the Xbox 1 and PS4 of the previous generation of the consoles. So we never obviously modeled anything for the past consoles because as you may recall from the moment we have announced the expansion, we were targeting the next gen. So we don't really have any answer to that. And also, I'd like to add, we're not really guiding on attach rate or sales ahead of launch, we never -- that we're not going to do it here either. But one thing which brings an interesting case, I mean there is no such thing as a single standard for platforms or generations or PC versus consoles attach rates so there is nothing that we can say with 100% certainty that we've lost XYZ because we were not percentage-wise, it just doesn't work like this. So now jumping to the questions, which were asked just a second ago -- sorry, we need to -- I need to remind myself looking at them. The pre-orders, what are we expecting to put in units between Q3 and Q4, given that we're launching quite late in the quarter. So the expansion launch is sort of similar to the launch of a game, to be honest. And typically, the moment of the launch and the weeks -- the last weeks leading to that launch, the last week, 2 weeks, 1 week of pre-orders are like the most significant when it comes to the numbers. So obviously, Q4 has Christmas and lots of reasons for people to purchase gift and whatnot. So I would say that Q3 is going to be significant in terms of number of units just because it is a launch period. And I would not, however, want to go deep and suggest what is going to be exact split of units, but my guess would be Q3 is going to be significant for sure. Now the next question back on you on CP, there was issues around consoles. We're not launching the old console. So are we happy that we got the balance right for the [indiscernible] in the next gen PC. I'm not sure I follow exactly the question here. But if you're asking about the performance of the next gen, we have been actually showing the game publicly on the next-gen consoles to the public during the Phantom Liberty Tour. And we just came back from gamescom in Germany where the game was shown both on PC but also on the on the Xbox consoles and we had very positive feedback from both gamers and media. And you know, I mean, let's wait for the launch and talk then. But what we've seen so far, we're satisfied what happened. Now the impact of the P&L launch having the base game. Obviously, our bundles, we're not commenting on making statements about bundles or anything. The full focus is on the Phantom Liberty launch, which is just around the corner. And what impact it will have, I mean, typically, the launch of an expansion -- of a big expansion drives the launch -- sorry, drives the numbers of the base game as well. So yes, there will be an impact for sure with [indiscernible]. We're already seeing that to some extent in the pre-orders, which if you're tracking some of the [indiscernible] on the Steam, which are publicly available, a click away, you can see that yourself as well without, obviously, specific numbers, but those were not providing here. So we've been talking long, but I'm going to -- I think I'm done.

Our next question comes from Alexey Philippov of JPMorgan.

[indiscernible] my first question is that there is a the [indiscernible] in resources allocated to The Witcher IP in this quarter, is it mostly project Polaris as it seems and you are scaling down the project Sirius? So what's happening in there, please? And shall we assume that project Sirius is not on the table? That's my first question. Another question is on the transition to new engine. What is the update there? What is the strategy with developers that are now working on old engine, that is the biggest team of Phantom Liberty. And one more final question is, could you comment on the fact that the principal place of the business is relocated to Boston according to your management comments report.

Adam Kicinski, I'll take probably all 3. So there are more and more resources on Polaris. As you can see on the slide, it's 250-ish now and it will keep continuing. I mean we will move more and more people towards Polaris. Sirius is smaller, actually, Sirius is smaller than in the previous Q1 presentation, as we changed some fundamentals in terms of approaching this project as announced before. So this is about The Witcher -- resources allocated to The Witcher IP. Transition to new engine. We are transitioning. I mean we are happy that we made this decision. Of course, still in development. We are finishing the last big project on Unreal Engine, Phantom Liberty. Most of developers is already familiar with Unreal, And as I said, we are happy that we are transitioning. Of course, still, there are things to be done. But in this regard, as for now, we think it was by decision that we are shifting to graphics technology. And the third one, Piotr, you want to take the third one? Okay. So the floor is yours.

Right. So yes, [indiscernible] principal places business was relocated to Boston, but only for our Los Angeles company that so far was responsible for our North American marketing activities. We decided to use the same shelf, the same company, the same legal entity also to kick off, initiate the development studio that is to be located in Boston. So the principal place as to the product launch and [indiscernible] so there was no change. However, one of our [indiscernible] companies was relocated from Los Angeles to Boston.

Our next question comes from Ali Naqvi of HSBC.

If I could just refer to on Slide 8. The light blue portion, which currently -- which is your development teams working on the Cyberpunk expansion. When that -- when the game gets released, are they going to move on to Polaris? Or what is the sort of strategy there in terms of staff numbers? Or is this another opportunity to look at your development team and see if it's appropriate for the projects you have going on and that are live? And then could you just remind us what your policy is on updating us in terms of copy sold? Is it every iteration of 5 million or 10 million and when we might expect sort of an update on how Cyberpunk is sort of [indiscernible]. And final question, given the release of Phantom Liberty and the new 2.0 expansion, and this will hopefully address a lot of the issues that were solved -- issues that came out of the original release. How much does this go in terms of returning the lifetime value of the Cyberpunk franchise?

Thank you for the questions. I'll take the first one, Adam Kicinski. So after releasing Phantom Liberty, we'll transfer a big part of the team to Polaris, obviously. Some members, some remaining members will then focus on supporting other ongoing projects like Orion or Hadar and -- but bear in mind that we will also be supporting Phantom Liberty after launch for some time. That's obvious. And it's across the company, but including Phantom Liberty, as I said in my presentation, we are at the same time, parting ways with some team members. It's a gradual process, which will end in Q1 next year. Michal, you can take the second, right?

Yes, I can take the second. I'll try to take the third one as well, I think. So on the policies and I'm thinking of some copies. So we don't have any official policy, but we're trying to make them notable milestones basically. So the last one we have announced is -- was 30 million copies. I think it was September of fall and the autumn last year, 20 million copies of CP. And again, we're not -- I don't want to create here on the call a policy, which is going to -- which has been something we're going to have to religiously follow or something. But when there's going to be a notable milestone crossed, we're definitely going to update you. Now as for the third question, how does the 2.0 go in terms of retaining lifetime value of Cyberpunk franchise. So the whole idea of 2.0 comes from us listening and analyzing what the players wanted and we're big believers in that if you listen and have proper conversations with your fan base, that can only end up in good things happening to the franchise, also in a commercial way. So I guess it's my way of saying that we do believe it does definitely add up returning lifetime value to the Cyberpunk franchise, but it is -- I don't think to quantify it in any way. I think it's very intangible, but we are deeply convinced that it's something that is going to add up to the life cycle of the franchise in a long time and it's going to benefit for the players in that.

Thank you very much. As we don't have any further questions on the line, now we will move to questions from chat. Please go ahead. I would like to turn the call over to the host to take questions from the chat, please.

Yes. I'll read them and then I will be first and then [indiscernible], [indiscernible] is asking what part of deferred income is connected in Cyberpunk 2077 Phantom Liberty pre-orders? Piotr, that's for you.

Yes. So the current part of -- to the pre-order core segments deferred income was reported in the amount of approximately PLN 18.5 million as of the end of June, and it consists of around PLN 2 million of subsidies and PLN 16.5 million of sales relating to the future periods. Around 3/4 of the latter amount is attributable to pre-orders of Phantom Liberty just for the last 19 days of June, so from initiation of the pre-order campaign until the end of the reporting period. What needs to be taken also into consideration is that this amount reflects only the advances on royalties we got for PC pre-orders since none of the console platform is advancing royalties for console pre-order sales. So this amount you can -- we can receive and book therefore is attributable only to our PC Phantom Liberty pre-orders.

The second question from [indiscernible]. Can you comment on quality assurance process in Phantom Liberty? Have you completed it already? Can you comment whether the Q&A is carried out internally or externally? It's not completed as we are still in the final phases, it's already -- it's almost completed, of course. We are releasing Phantom Liberty digital only. So we are not producing any physical disks for it. So the final touches are still there, and it's carried out both internally and external. The next one, [indiscernible]. How far are your Hadar right now? Have you already created a framework for the universe. Michal, we can talk that one, but you can take it, right?

Actually, you start [indiscernible] because as much as we would love to, it's not the right time for us to go deeper into Hadar. So the work is progressing, the small team that is creating this framework, as you called it, as you put it, of the universe is working on it, but we don't have any comment in terms of how far, how deep, how much more pending. That's not something we're commenting here right now.

The next question from [indiscernible]. What number of Phantom Liberty cells may convince you to work on another [indiscernible] expansion. And what loan number may mean you may drop such idea as not worthy to pursue. I can -- Michal can take it, yes.

I mean it's -- yes, I can take it. So it's -- the decision has been actually made already, as we have announced for a long time ago, we're not going to make second or third expansion. This is the only expansion of the game. It has nothing to do with the numbers, how satisfied or not we are with sales or anything of the kind, it's technological decision to be [indiscernible]. This is the last time we're working on the RED Engine for the time being, at least. And in the foreseeable future, as you know, we are working on the Unreal Engine from Epic and this was one of the key reasons why we decided to [indiscernible]. This is the only one.

Thank you, Michal. And there is another question from [indiscernible]. Have you recently made any changes to work-from-home rules following layoffs and do you see that market is still driven by employees, not employers. So it's totally not connected with layoffs. Layoffs are the result of planning the future production and they are not connected with anything else. So not with work-from-home growth whatsoever. And about the market, well, in our case, market is not as other markets, I would say, generally, because we are fighting for top talent and we are always -- it's always competitive, but at the same time, we believe that great projects and great working conditions. We can provide or attractive enough to attract top talent. But I wouldn't say whether the market is driven by employees or employers in our case. All right. As we have no more questions, I'd 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. Goodbye.

Thank you. That concludes today's conference. You may now disconnect.