Paradox Interactive AB (publ) (PDX) Earnings Call Transcript & Summary

Hello, and welcome to the last report for 2022, the Q4 and Full End Year Report. With me, Fred Wester, and...

Alexander Bricca.

Good to have you with us. So we're going to walk you through a couple of the things that happened in the quarter. That's my name by the way, if you click, my name is going to show on the screen.

Let's see if it's connected. Now we are live with the presentation as well.

There we go. That's me.

All right.

So we're going to walk you through the most important events of Q4 and we're going to walk you -- I'm going to do that. And then Alex will take you through the numbers as well with a few comments maybe from me if I have anything to add there. So we're looking back at a good year. And by no means perfect, but we have a great lineup, strong sales. And we can't really deny that the weak Swedish kroner has helped us a bit with some FX tailwinds with -- but we've also done some organizational changes, leading to lower cost of goods. And the most important, maybe not most importantly, but important for the EBIT and the profit margin is that we had very low write-downs, almost no write-offs at all -- write-downs at all on games. So we've done -- throughout the year, we've had progress. We've been working with organizational realignment and to, first and foremost, strengthen quality of the releases. Also to get better cost control, mostly on the marketing side, but throughout the whole organization. And we've also on the development side worked a lot to get the release cadence up so we can get more content out there for our players. Obviously, quarter 4 was dominated by the release of Victoria 3 that has done -- in our opinion, it's done really well. Some mixed reviews. But we have to remember that Victoria is also the smallest of our Grand Strategy franchises. So all in all, it's a good release with a fairly happy community, I would say.

Yes, for sure.

And going through again, I come back. Victoria 3 is big picture here on the left and we also released during the quarter one of the DLCs for Crusader Kings III and Northern Lords on console, Airport Simulator on mobile and a couple of different things on the simulation and city building side with Cities: Skylines, Surviving the Aftermath, and Prison Architect. It's worth mentioning that Cities: Skylines did a bit better than expected in Q4 as well, really helping the results. And we also released the title, the space colony builders, Stardeus through Paradox Arc in this quarter. When it comes to community, we've always said that we have 5 million active users. And now we are happy to say it's 5 million to 6 million users, right? So it's a bit above 5 million. We don't dare say 6 million yet, because we want to see a strict trend line where we know we can say for sure that we're going to be over 6 million, but we're approaching 6 million monthly active users on a steady basis, which is a healthy gross -- growth on the player side. Obviously, the core focus on the marketing and sales side is to engage our community more and work more together with our players and make sure that we meet the people in the channels where they want to communicate. So it's more forward-leaning community engagement activities to be expected in the future as well. After the end of the quarter, we -- as you know, we announced Age of Wonders 4. That was a really positive announcement as well, met by a lot of praise from the fans so far, is going to be released in May 2, which is next quarter from now. We went into early access with Surviving the Abyss from Paradox Arc and we announced First Contact, a new DLC for Stellaris. And with that, Alex, I leave the word to you.

Thank you very much. As always, let's dig into the numbers. Record revenues in the fourth and last quarter, SEK 580 million compared to SEK 391 million fourth quarter 2021. So that's a healthy 49% increase. It's the first time that we are above SEK 0.5 billion in one quarter. Last record was Q3 2020.

Crusader Kings?

Yes, when we released CK 3. So this is the first time we are above a -- SEK 0.5 billion and it's with a good margin. So very good. As always, it's what we released in the quarter that drives our revenue. And in Q4 '22, it was mainly Victoria 3 that made the big difference. We said -- I think we went out with a press release after a month and said that we had already sold in 0.5 million units of the base game. So quite successful. And as you mentioned, Fred, Cities: Skylines was a big contributor in the fourth quarter as well. Financial District, the DLC they released did some CCPs, some content creator packs, 1 or 2 radio stations as well. So...

We should be talking to the audience of Financial Districts right here.

Yes.

We shall.

They probably are. And as Fred mentioned, a few DLC releases on some of our smaller games: Surviving the Aftermath, Prison Architect, Stardeus, we released and the new mobile game as well, Airport Simulator. As we have seen in many quarters in '22, we have had good benefits from the weakened SEK. So I think the dollar is up some 20-plus percent year-over-year, euro, not that much, but 8% I think, and British pound 5%. And these are our biggest currencies in terms of revenues. So of course, when these currencies goes up, our revenue goes up as well. Yes, top 5 contributors are not the 5 usual suspects, of course, because we have a new game, Victoria 3. And we hope that we will start to say 6 usual suspects in the future when we report revenues that Victoria 3 will establish itself as a long-term main revenue-generating title. Profit -- operating profit SEK 244 million compared to SEK 148 million the fourth quarter the year before. So that is up 65%. New record profit-wise as well. And that's the fourth quarter in a row that we break the profit record. Q1 was a record, Q2 new record, Q3 new and now finally Q4 fourth record.

Fantastic.

It is. And as we said, also record in terms of revenue. Profit of the financial items or profit before tax, SEK 244 million as well compared to SEK 147 million last year, and profit after tax SEK 194 million compared to SEK 116 million last year -- last year's Q4. Profit margin 42%. It's up compared to 38% last year's Q4. It's down a bit if you compare it to the quarters we have had earlier this year. We had, I think, 45%, 46% in Q1, Q2 and then fantastically 48% in Q3. And why are we down? Well, the most profitable thing we can do, we've said this many times, but that is to come out with the DLCs on our successful games. And Q3 was a great example of that when we had DLCs on all our top 5 games. And then we had 48% profit margin. When we release new game like we did in Q4, of course, the revenues becomes very high, but it comes with a lot of cost, especially amortization or development cost. So therefore, we don't see the same profitability even though we are successful with the game release. So why do we release new games? Well, 42%, it's not bad. It's a decent margin. But our goal with a game like Victoria 3 and with almost all our game -- new game releases is that some of them will establish themselves as a long-term game that can live on for 5, 6, 7, 8, 9 years and...

Yes. And why not 10 to 15 years?

Exactly. And when it do so it can just as we've seen with Stellaris, with Crusader Kings, with Beverly Hills, then they can start to turn out DLCs with very, very high profitability. So that's the target. What more equity through asset ratio is increasing, shows on our solid finances. Employees at the end of the period 656. We were at our peak when we ended Q3 in '21. So 5 quarters ago, I think we were at 742. Then we decreased with roughly 90. Back to, let's say, end of Q2, so half year ago. Since then, we have been very stable. I think we have increased with 2 or something like that. So I think that we are at a good level today. Let's move on. So this chart -- this shows 3 lines: revenue in green and our 3 main cost items in yellow, blue and red. The green shows very clearly what we have said. It's a record quarter, almost SEK 600 million in revenues. The costs, cost of goods sold, selling expenses and admin expenses, all in all, SEK 321 million compared to SEK 261 million Q4 2021. So it's up SEK 60 million and that is almost entirely driven by the release of Victoria 3 and especially the amortization of the development cost. But let's dig into a little bit more. Cost of goods sold, as you know, if you've listened to the streams before, this is the cost for our 9 internal development studios, cost for our external developments, royalties that we pay to external studios. We amortized license and brands when we have acquired studios and IPs. We amortize that every quarter. And this also contains the development cost that we have for our riskier projects, for example, that we run under our new games teams. And also some of the development costs that we have. We have some tech development in our publishing business which -- that is not really game development, but still technical development. This is all under COGS. And in Q4 '22, COGS was SEK 253 million compared to SEK 196 million Q4 of '21. So it's up significantly. And this is, as I said, it's amortization of Victoria 3. The amortization part of the COGS is SEK 119 million compared to SEK 60 million the same quarter a year before. So it's SEK 59 million up. So we have released Victoria 3. And as we have done with several other games released during the last years, we have this aggressive amortization method where we take 1/3 of the development cost in month 1 and another 1/3 spread out during month 2 to 6. So that means in Q4, we released a game in October. So then we took 1/3. And then November, December, we took another 2/5 of another 1/3. So if you add 1/3 with 2/5 of 1/3, that is, I've done the math before…

45%.

Yes. You're quick, 46%. So 46% of the entire Victoria 3 development costs up until release has been taken as cost in Q4. So therefore, amortization in COGS goes up. Another part of COGS is what Fred talked about, write-downs or write-offs due to game cancellations. We had 0 in Q4 of that compared to SEK 26 million in Q4 of '21. And this is now the fourth quarter in a row where we don't have any write-offs or write-downs on game development projects. We used to have this roughly 1.5% to 2% of the capitalized development was being written down every quarter due to game cancellations. But 1.5 years ago, we did a big kind of a cleanup project where we decided to cancel several game projects where we were not happy with the risk-reward ratio, you could say.

Yes. That's correct.

And we also changed the approach how to develop high-risk games, where we let our new games team run them. They invest much less at the beginning during the riskier phases of the game development. And during those phases, we don't capitalize. And clearly, this method has paid off because we have now for 4 quarters in a row, hadn't had one single write-down due to cancellation. This new games team still cancels quite a lot of games, I would say, in the same pace as we've done always. But it doesn't show up because we have already taken the test cost.

Yes. We take it as running costs basically.

Exactly. And the costs are also smaller because we invest much less at the beginning. So all that is good. What else is part of the COGS? Well, SEK 23 million is because we are -- every quarter, we are amortizing on our acquired businesses. So like Harebrained Schemes, Playrion, Prison Architect, the World of Darkness brands, everything we -- every quarter, we amortize…

SEK 23 million.

SEK 23 million we take as costs every quarter. It was SEK 20 million Q4 of '21. It has gone up, not because we have acquired more, but because the FX rate has gone up, so the amortization is slightly higher. What else is part of the COGS? Royalties is one. Royalty has gone up SEK 31 million in Q4 compared to SEK 60 million the same quarter a year before. And the revenue is up in this quarter because Cities: Skylines did a good quarter and there we pay royalties to the developer. And we have also had not huge, but still significant revenues from Across the Obelisk and Stardeus. These are 2 co-publishing deals, which means that we take the full revenue into our books, but then we share a significant royalty with the developer. So therefore, you can see the royalty going up in Q4 of '22 compared to the previous year. Also, then we have a part left on in COGS, which is non-capitalized development and tech costs from the publishing business. That part has gone up from SEK 66 million in Q4 '21 to SEK 87 million in Q4 '22. And this is what we have talked about, the increase comes from these new games teams game development. So when we develop high-risk projects, we take them as cost directly and that ends up as a higher COGS directly. Selling expenses, SEK 45 million compared to SEK 43 million a year before. Perhaps some of you have -- had expected this to be higher because we have released Victoria 3. We have had significant cost due to now marketing Victoria 3. But compared to a year ago, we have also done good efficiency activities within marketing and sales, so that we are seeing the fruits of now. Admin expenses -- and regarding selling expenses, I think it's worth pointing out, yes, we did market a new game, Victoria 3. But this is -- it's a game in the middle of our core. We know the players. We have the players to a large extent. So it's a very efficient marketing we can do. When we will release games that are completely new franchises, we won't be able to do that with the same efficiency. So we will need to spend some more money on the marketing when that day comes. Yes. Admin expenses is staying fairly flat, SEK 22 million, SEK 23 million. Let's move on. Revenues quarter-by-quarter and profit quarter-by-quarter, you can see here again that we are breaking the record is very clear here in terms of both the revenue and profit. You could also see, if you look towards the left of the chart, you can see that it's very choppy, especially in terms of profit. If you look to the right, it has been very steady for 4 quarters in a row. But I would want to point out that -- this steadiness is more of abnormity for Paradox. Our normality is more that the profit and revenue changes a lot from quarter-to-quarter because it's so tightly connected with what we release. And normally, we don't have a smooth release pace. We can have some quarters where we release a lot and then one quarter where we don't release pretty much anything. So I think you should expect going forward, still -- you should still expect volatile quarters.

Yes, you should expect like you've seen this graph to -- us to grow over time as well. So even if quarters go up and down, the long-term effect and the long-term idea is that we continue to grow and we see no end to that growth as we look at the moment. But we take it step-by-step.

Yes. And I think you could see that if you move to the next chart, where we have lumped 4 quarters together. The trend -- you see a clear trend here. If you kind of take out the big peak in the mid -- in Q3, Q2, 2020 and if you would remove the drop in 1 year afterwards or Q2, Q3 '21, it is a fairly steady trend line trending upwards, both in terms of revenue and in terms of profit. So that is, of course, very good. We had 12-month revenue, SEK 1.973 billion. It's a bit annoying that we didn't reach SEK 2 billion, but…

We'll do it this year.

It's close. And the operating profit for 12 months is SEK 887 million. It's almost up 3x compared to the full year profit of last year. Cash flow, very strong cash from our operating activities, SEK 344 million. Great, not the record, but very strong. If we look at the cash flow from our last 4 quarters, so our last year, cash flow from operating activities, SEK 1.085 billion. And as always, we invest a lot of that cash flow into new game development. SEK 251 million was invested in game development in the fourth quarter. And looking at the full '22, we have invested SEK 807 million in game development. So quite a lot. So if we look at the full year '22, despite that we have invested SEK 800 million in game development and paying out SEK 106 million as dividends to the shareholders. So in total, more than SEK 900 million has gone out. We have still increased our cash position with SEK 137 million. So we have accumulated a substantial amount of cash and it's more than we need at the moment. So therefore, the Board has, as you have seen in the report, has proposed to the Annual Shareholders Meeting that we increase the dividend from SEK 1 per share to SEK 2 per share. I think this is the final slide before we have the questions. So total equity is steadily going up and it's -- how much is it? It's worth mentioning, I think it's almost all of this equity comes from our profit. SEK 60,000 of, I think it's SEK 2.3 billion, SEK 60,000 of that is -- comes from other things. The rest is profit, profit minus dividends. So I think we are in a very strong position balance sheet-wise. And if you look on the yellow bar, total noncurrent assets, SEK 2 billion, there the largest part is capitalized development. So this is games that are -- that we are waiting to announce and release.

Exciting.

Yes. Exciting for sure. That's it I think. Do we have...

Do we have couple of questions?

Yes.

We actually got a lot of questions. So thank you for sending those questions in and make sure to do it on time next time as well. So we can take some time to reply to them.

Yes. So let's see what we can manage to answer. The first one is for you, I think, Fred, with all the hype around generative artificial intelligence tools coming to the market, what long-term impact do you see for Paradox?

I have said it before in an interview that I've never seen anything that will impact our whole business and I'm not only talking Paradox. I'm talking about the computer games business as a whole as much as AI. And it's everything from how you develop [ cold ] to how you develop written content to how you develop graphics. That being said, I mean, at the moment, we're prototyping, we're testing new things. We're seeing how it's going to impact us. And that being said, I think in the future, we're probably going to be able to do things faster and smarter with the help of AI. I'm not thinking, first and foremost that AI is replacing anything that we're doing at the moment or people that we have employed at the moment. It's -- but it's going -- for sure, going to be a great tool for us to use. So we're looking forward to digging deeper into what AI can offer. And I think, like I say, it's a groundbreaking change that is about to happen to the whole industry. And it's super exciting to see.

Very exciting. Good.

Next question, how impacted is Paradox's business during global recessions as the one that has been predicted this year?

Well, it's difficult to say. Of course, I think a global recession hits everyone. So we need to be prepared and mindful and have respect for that going forward as well, of course. But if we look historically, we can clearly say what impacts our financials more than anything is the content we release. If we manage to release X DLCs or X plus 1 DLCs, that difference makes much more impact than any financial sentiment on a global scale, I think. We also know that our players are very loyal. They spend quite a lot of time in the games. So if you split up the DLCs that we release in a year on your favorite game, the cost per hour of entertainment is very low regardless with -- regardless what you compare it with.

Yes, it's true.

So we think we are in a strong position. What else can be said about the recession? Well, it's -- we are in a strong position financially. We have a good cash flow, no real debt on the balance sheet. So this also puts us in a position where we can act opportunistically if good opportunities come up. We have, for a couple of years, been looking at IPs, studios that we would think would fit in greatly with Paradox. But historically, we think the price on those assets have been high.

Yes.

Now it's probable that prices are coming down. We have already seen them come down. So maybe that can open up some interesting opportunities for us.

For sure.

Question for you, Fred. Any studio -- well, on that subject, any studio acquisition targets for the year?

Those of you who have followed us for a longer period of time know that we are not very prone to make a lot of acquisitions of studios or -- that being said, we've acquired a handful of studios and we also acquired, for example, World of Darkness even before we listed the company. So we are more opportunity-based on this. And if you invest in Paradox, like you know that our main source of growth is not going to be from M&A activities. It's going to be from us growing our business organically and that's going to be the goal going forward as well. That being said, if we see something of an opportunity for an IP, a studio, a game that is worth looking into for us, we might do something with like Alex mentioned that we're in a good financial position. We have money in the bank, we have no loans, so we're in a good position to do M&As, but it's not what's going to make this company fly in the coming 2 years. There are other things that will help us do that. So Alex, the FTEs, the number of employees seem stable. Are you satisfied with your ability to retain employees?

Good question. So in '21, but also in '22, we have seen a significant increase in turnover. Many good reasons for it. I think the work-from-home situation was one. We could see that increase not only ours, but other companies staff turnover. 1.5 years ago, we started to cancel several projects. With that, of course, came people involved in those projects leaving and we have been very conservative in rehiring, not only for those projects, but in general. Now we are -- so I mentioned earlier that we have decreased our staff from 742 to I think it was 656 or 665 at the end of the year. I think we are at a level which is very good now. So I'm satisfied in that sense with our ability to retain employees. But even though I'm happy with the level of staff, I would be even happier if the turnover was slightly lower. We are suffering sometimes from having to train new employees. It takes a lot of time, not only before they can become productive, but it only also takes productivity away from our existing employees and…

From the experience, yes.

Yes. And if we could get that down a bit, I think we would be helped. But then, of course, some turnover is unavoidable and I think it's even good to have a certain level of turnover.

It's healthy.

Fred, Victoria 3, you were experimenting with new design elements, not always welcomed by the fans. A few months after the release, what is your opinion on the games performance with the players?

Well, Victoria 3 released to a bit of mixed reviews and it was a mix between different things, some game design decisions, for example. And overall, I'm happy with the games release. I think we're all happy here at Paradox. But if you by happy mean totally satisfied and we're not going to do any improvements in the game, that's not the case. So we're constantly working to improve all our titles. I mean, basically, if you want to look at it very specifically, the release version of the game is always the worst version that a player is ever going to see. From there, we're going to make the game better. So we're listening to the community. We're developing the things according to certain guidelines that we think is going to make the game better and we're constantly improving on things that we think is going to make the game better. So we're happy now. We're going to be even happier in the year and it's going to grow into a great, even greater product. That being said, I mean, Victoria is one of our more niche experiences in the ground strategy portfolio, meaning that the target audience historically has always been a bit smaller as well. So it might be that some people were expecting a more open like or broader approach, while I think the core audience has been quite happy from the start. Maybe it's a stretch to say that, but I dare to say.

So we announced a month after release that we had sold 0.5 million copies.

Yes.

If we look back to CK3, we did a similar announcement 6, 7 weeks after release when we have sold 1 million copies. So it had sold roughly half of CK3, and that is in line with what we expected before the release.

Yes, that's correct. Yes. Yes, we knew that Victoria has a smaller target audience and we knew that all along. So Alex, can you talk about the investment that went into Age of Wonders 4? Are they comparable to Victoria 3? Or are they smaller? Are they larger? What's the deal?

What's the deal? So I can say, in general, our investments both in our own games, but also in our -- in games developed by external studios are constantly increasing. They have been for the last 5, 6, 7, 8 years. And I think they will continue for some while to do so. So even though Victoria 3 was, you could say, a smaller game than CK3, it still cost a little bit more to do because it came 2 years later. Age of Wonders 4 developed by Triumph in the Netherlands. I would say one of our most cost-efficient studios.

Yes.

So I expect the investments in Age of Wonders 4 to be slightly less than Victoria 3.

Yes. But normally, we don't disclose numbers. No, just a general rule of thumb. I just spoke to Leonard actually from Triumph and he said that we concluded that by the end of next week, I'm going to start playing Age of Wonders 4 as well.

Interesting.

I always wait until the game is like almost in like on the finish line, so you don't have to experience too many bugs.

Nice.

It's great. Looking forward to that one.

Fred, with the shorter time frame between the announcement and release for Age of Wonders 4, can we expect a shorter announcement to release time frames for future projects as well?

In general, I will say yes to that question. A shorter time frame between announcement and release is the way we're going to work in general. Age of Wonders 4 specifically, we think will gain from a shorter marketing cycle. There might be some that have a bit of a longer marketing cycle, but in general, it's going to be shorter than it has been historically with Paradox because we don't want to announce anything and then having to postpone the game time after time. So when we know the release quarter, we will announce the game. And sometimes we'll tell you what quarter we announced it in. Sometimes we'll tell you what date like we did with Age of Wonders 4, which is May 2 this year. So Alex, are there going to be any changes in the Paradox monetization methods and models?

I think we and the players are very happy with the current model, which is the DLC model where we come out with new content and the players that want to play that content pays for it. But we have also since almost 4 years now we've been exploring with subscriptions. First, Game Pass, I think they launched in June '19 on the PC version. We have been there from the start with several of our big games. We have also experimented with our own subscription models. We have, is it CK2, HOI4 and U4 that we have a subscription offer where you pay $5 per month and you get all the DLCs.

On steam.

Yes, on steam. So this is something we do also to learn how the player behavior is. But with monetization model, it goes as with anything. I think we want to make our games available to our players in a way they want to play them and consume them.

Yes.

So if they would, in the future, prefer a different way to pay for the content, I'm sure that we are happy to move towards that way, whatever that is. But for now I think we and the players are very happy with the DLC model.

Yes, I think so.

Fred, how many games is Paradox Arc going to release in '23? Are you providing upfront capital for these games?

2 questions in one. How many games are -- is Arc going to release? It -- I can promise you a handful. So it's anything between 3 and 6, I don't know, somewhere around those numbers. We have a super interesting lineup of a wide variety of different games that we're working on at the moment. We normally take all the investments as direct costs as we go along and sometimes we offer upfront payment. Yes. Sometimes, the developers have already developed the game in such a way that we can publish it together. So the model on how to finance is different from game to game and depends on developer to developer as well. I have a couple of favorites already in this portfolio, but I can't wait to tell you more about that. It's amazing. We have this little chat group on one of the games which goes wild every lunch-hour. So -- and that's always a sign that something is brewing, right? Alex, should we expect the 30% dividend payout ratio to continue going forward? Or could it be higher given the excess cash?

It's -- it will be a new decision each year. So 30% payout ratio, I think it refers to that it's 30% of the after-tax profit that is being paid out.

Yes.

That is similar to -- that is where it is now if we are going to go through with SEK 2 as the Board has proposed. And I think it's close to 30% last year as well. So maybe it's a good level. But it's not the only thing that the Board and the shareholders will look at when deciding historic profit, of course, it's kind of a limitation or setting the frame. But we also look at the current cash position and what we expect the cash flow needs and incoming cash as well what is going to be for the upcoming years. So at this point, we think 30% or SEK 2 per share is a decent level. Next year, we'll see where we are at that point, I think.

Yes.

More questions? Yes. What should we expect in terms of number of new game releases in 2023 and new game announcements?

Yes, this question keeps coming back. So we can never provide like a fixed number of announcements that we make every year. But since I said we also tend to announce closer to the game release now however, there should be a couple, right? Can we say that much?

It should be.

Should be a couple. Right. Alex, you have 40% margins, decent, what is FCF?

Free cash flow.

Free cash flow, of course free cash flow. You have $750 million of cash, why are you only paying SEK 2 per share? If you're not going to use the cash, why not return it to the shareholders?

Only SEK 2 per share. We just doubled it.

We just doubled it now. What do you guys expect?

Well, I think as any company at the end of the day, should pay out everything, all the profit should go to the shareholders. But we are keeping most of the profits because we think that we can capitalize on it, invest it with high returns. And we have been in the growth situations for a long time and we will continue to be in a growth stage going forward as well. So during those stages, the majority of the profit will be reinvested in the company.

Yes.

So whether it's -- so it's SEK 2 this year. I think -- yes, we'll see going forward. But I think and the Board seems to think that SEK 2 is the right amount this year and probably the shareholders think that as well. But the short answer is we are not giving out more because we think that we can use the cash flow better.

Yes. Good answer. I like it.

No more questions?

No more questions. That's it for this time, folks.

And if you have more questions, if we missed to answer anything, we will go through the e-mail and try to answer them during the day or later in the week. And if you come up with new questions, send them in, you have the mail address. Otherwise see you in, I think it's end of April, where we will announce the Q1 results.

Q1 report. Sounds great. And until then, have a great time, and we'll see you soon.

Thank you for looking.

Take care. Cheers.

Bye.

Bye.