Paradox Interactive AB (publ)

STO:PDX

Earnings Call Transcript 2022-Q2

[Fredrik Wester, CEO]

Hello and welcome to the Paradox Quarter 2, 2022 live stream. My name is Fred.

[Alexander Bricca, CFO]

I am Alex, CFO.

[Fredrik Wester, CEO]

And I am the CEO which the next slide will tell you, that’s me. So what we’re going to take you through is basically the releases in the numbers for quarter two of 2022. So we had a pretty good quarter. We strengthen our core portfolio. We have some good releases high quality and quite a good attachment rate on the monthly active users as well. At the same time, we’ve maintained and strengthened our cost control as well. We’ve reduced a lot of the operating costs and we continue to do so.

And the mostly our margins, 4% to 6%, which Alex will tell you more about is due to, obviously, some good sales numbers, better operational efficiency than before, but also due to some currency tailwinds namely, the Dollar and the Euro has strengthened towards the Swedish Krona.

If you look at the core portfolio and what we released this quarter, it’s mainly DLCs and some console adoptions for some of the older games where you see Overlord for Stellaris performing really well. The Nemesis DLC for consoles, you have Shadowrun for consoles, and also the release of Fate of Iberia, which is the last release in our pre-order pack where the season pack that we sold together with the release of Crusader Kings Three. We also have the management simulation DLCs, where the surviving the aftermath Prison Architect and Surviving Mars.

We have now established our core base in the upper 5 million to 6 million range of monthly active users, which is slowly but steadily increasing month by month. And we see this positive trend that we got during COVID to actually stay and actually increase a bit not at the same rate, but it’s still staying up there increasing slowly.

The number of active users is obviously crucial to Paradox to continue to have a high recurring revenue. So what we’ll do going forward on the marketing side, and our main focus is going to be on continuing to have a good player dialogue and strengthening on the communities that we build around our core franchises.

As I might have said before, we have 14 projects in our core pipeline. And our focus right now is starting to deliver some of these games. And we already know that Victoria 3 is going to be released later on this year. We’ve also released earlier this year Crusader Kings III for consoles and Shadowrun for consoles, and our ambition is to provide you with at least one more release day before the end of the year. Not a release this year, but for release later on. We also gone to after announcing Bloodlines 2 way too early, we’re more restrictive when we announced. We need to have a concrete and set release date, or at least a release quarter before announcing anything.

On the side of our core pipeline, in our core business, our new games team is continuing to operate by signing smaller and more experimental titles that still fit well with our core audience in our portfolio, but they’re smaller. And the costs are also taken directly which Alex will explain further which has some effect on the numbers but will be different from before. But we’re going to look forward to having some updates on this more experimental pipeline somewhere in the near future, but at least within a couple of months.

Other events happening this year, we finally can meet our fans and gamers again in September for a new PDXCON. It’s going to be a bit smaller than it was the last time but we’re really excited to meet people in person again. We have a good DLC lineup that were already announced, for example, by blood alone for Hearts of Iron IV and some stuff for console as well. But we’re going to announce more hopefully within soon for things to be released during this fall. And with that I will leave the word to Alex and the numbers.

[Alexander Bricca, CFO]

Thank you. So let’s see what we did. So let’s start with the revenues, 459 million in the second quarter of this year. So that is an increase with 14% compared to the same quarter last year when we did 403 million and the main difference between these two quarters is the foreign exchange rates. So especially the dollar has increased significantly, versus the Swedish krona since Q2 last year, I think it’s up 17%. And that is where we have our largest share of the revenues. And then also the British pound and the Euro has increased. I think it’s 5% and 3%, respectively. So all in all, it’s up quite a lot, thanks to the weaken Krona.

Normally, it is what we release in terms of content that makes a difference. But if you look, if you compare it to this second quarter, with the same quarter last year, it’s fairly similar in terms of releases. This year, we had Overlord for Stellaris that performed very well. And we had the Fate of Iberia for CK3. We had some smaller DLCs as Frederick mentioned, very similar to last year security, we had Nemesis on Stellaris. We had Levis and we had console port for Stellaris and DLC on I think it was Prison Architect.

So it’s very similar to this year, we had publisher weaknesses steam, both this Q2 and last year Q2. Last year’s Q2 we also had PDXCON remixed, so that generated some attention, which we didn’t have this year. But still we managed to beat. So but even if you would remove the currency effect, we still have a slight growth compared to last year’s Q2, top five contributors. If we look at franchises, the same as always, it’s a series of suspects, five usual suspects City Skylines, Stellaris Crusader Kings 3, Heart of Iron and [Indiscernible] is one more almost always those five.

Operating profit 214 million compared to 111 million last year. So that is up some 92% and profit before tax or profit off the financial items 213 million compared to 110 million. So that is 47% and 46% of profit margin compared to 28% to 27% last year. So it’s quite a significant increase. But just bear in mind, this quarter is almost optimal in its setup for delivering high margin. We had a very strong U.S. dollar rate and Pound and Euro rate. We had no write offs from council games.

[Fredrik Wester, CEO]

Or small ones, because it’s different now if we want to take that.

That’s because all everything that is handled through the new games team is being taken as costs directly. So it doesn’t we don’t put it on the balance sheet at all. It’s only for the core pipeline, if I understand correctly.

[Alexander Bricca, CFO]

That’s right. So we have actually Council Games in the second quarter, you’re none of those cancellations had led to any write offs, because we never capitalized them in the first place.

So and finally, I think, which helps us with the margin is that the revenue this quarter comes from DLCs, mainly, and DLCs are not that expensive to develop. And it’s quite some time since we released the new game and with new game releases comes big amortizations, so a very favorable quarter. It’s the most profitable thing we can do release DLCs. And not right that any project of.

The equity through asset ratio has increased a bit. So it’s 71% and number of employees, we have continued with our efficiency actions. So it’s down to 657 by the end of Q2. And we have continued throughout this year to be very selective with what replacement recruitments we make. So we have come down I think the top was 742 or something like that back in September last year. So we’ve managed to increase in publishing quite significantly. And we’re very happy that we’re continuing to deliver strong revenues. So quite an efficiency improvement, especially in our marketing teams, I would say.

Let’s move on to the next slide. So this is our classic slide where we show the trend of revenue and our three main costs. Revenue, you can see that we’re not taking any revenue records this quarter, but it’s one of the top quarters maybe it’s a third quarter or fourth quarter in history in terms of revenue, but we are hitting a profit record and that has to do with decreased costs, so increased revenues and decreased costs compared to the same quarter last year. So we have three main costs.

It’s the COGS selling expenses and administrative expenses that they will together and up at let’s see 261 million in the second quarter of this year compared to 289 million same quarter last year. So slightly down which is very good. Largest part is cost of goods sold. This includes all our development costs. So all our costs for all our nine studios or our external studios royalties that we pay, specially for City Skylines. What else is included?

Well, we do amortize. When we have acquired companies and assets, we try to amortize them quite quickly so that we take his cost that’s included in COGS. And also, as Fred mentioned, for example, the new games team, and that will take us immediate cost here. So COGS is down from 204 million second quarter last year to 197 million this year and the main driver here, I think, is the last year’s Q2 we took a write off of I think it was 42 million SEK, we terminated the game that we had on the balance sheet, the wrote it off. This is the second quarter in a row where we don’t have any write offs. We didn’t have any Q1 and in Q2.

If you look, historically, we have had, I would say three out of four quarters, we have made the write offs. And on average, it has been some 1.5% to 2% on the capitalist development. But that started to accelerate in 2020 and 2021. So we took some serious measures towards the end of 2021 and made good quality cleanup of the portfolio, we canceled several games. And we also changed the way we work with the most risky game projects. And I think we’re seeing the benefits of that in Q1 and Q2.

Let’s hope this is a trend. It’s definitely our ambition with the new setup to have less write offs. I’m sure we will have the same amount of cancellations, but it will happen earlier and it will happen on the game projects where we have undercapitalized anything.

If we looked at just the monetization part of the COGS, that is up slightly compared to same quarter of last year, and that has to do with that we have released overload Stellaris. We have released Fate of Iberia for CK3, Gangs for Prison Architect, Shadowrun Trilogy, all that costs of course, and when we release it, it comes over the P&L. So more game releases this more content releases this quarter slightly than last, so higher cost.

And I mentioned that we take, when we acquire businesses we take as much as possible over the P&L in terms of amortization. So 21 million of the COGS is that we are constantly amortizing on the acquisitions on try [Indiscernible] games play on World of Darkness.

Royalty is very similar to last year, but it’s down. If you look at Q1 you can see, if you look at the yellow line, we have decreased COGS from Q1 this year. And that is mainly to do with royalties. A large part of the revenues back in Q1 came from Cities: Skylines. So that meant higher royalties. So another reason why the second quarter is so optimal from a margin perspective is that a large part of the revenues came from our in house games where we don’t pay any royalties.

What else do we have, we have our selling expenses. There, I think we have done a good job decreasing it from 56 million SEK last year, two 40 million SEK last this Q2. The selling expenses tend to fluctuate a bit with the releases, but so you need to look at a few quarters together. But even if you do so you can see that there is a clear trend over the last 12 months where we have been able to decrease selling expenses while maintaining good sales. So it’s a clear efficiency improvement. Selling expenses will go up once we start to release new games, of course, but where that should, of course come in even more revenue.

So we were looking forward to increase selling expenses at a later point. Administrative expenses, also down compared to last year 29 million to 24 million. I think, again, they fluctuate a bit between the quarters. But also for this cost item, you can see there is a trend or if you look at 12 to 18 months, very good.

If you look at our P&L or our income statement, you will see two items called other income and other expenses. We don’t talk about them on each stream because normally they don’t move that much, but this time it has. It has a positive impact this quarter, or sorry, the second quarter of this year, and it had a negative impact the second quarter of last year and this is part of the currency impact that we see, so when we, this represent the currency movement during the quarter.

So if we send an invoice to Steam, we send it in dollars. When we send out the invoice, we booked the revenue SEK according to the currency rate that we have on that day, then when we receive the dollars from Steam then we do the exchange, the actual exchange and get SEK and at that point, which has happened during this quarter, it has been more SEK than we took revenue. So all the difference and up as other income. And as you can see 16 million plus that means that the SEK has become weaker during the second quarter of this year.

So I think, let’s move forward to the next chart. Well here it shows revenues and profit quarter-by-quarter. It’s difficult to see but it’s, if you look at the yellow line, it’s the top level all time. So it’s 213 million. Previous record was Q1 or so one quarter ago 208 million and as you can see, it’s not the top quarter in terms of revenue. So it’s a mix of strong revenues from the right product with control costs.

Another thing that the chart shows is that our results and revenues are quite fluctuating. And if you look at the few quarters together, only you can see trends. But I think you should expect going forward, it will continue to swing up and down for both revenue and profit.

But again, if lump the quarters together, so we see 12 months, rolling 12 months then the trends are clearer and it’s obvious that we have had a negative trend up until Q3 last year. And since then, it has been going upwards, both revenue and profit.

And when we come to Q3 this year for those of you who remember, we had a very negative Q3 last year in terms of results, because we did this cleanup process. So the yellow line is likely going to continue up being in Q3 as well.

Cash flow, strong cash flow from our operating activities, I think it’s 262 million SEK almost all that we invest as we do into game development, I think 219 million SEK into the game development and we also pay the yearly dividend as always one SEK per share, so 105.6 million SEK as dividends.

And our equity through non-current asset ratio is solid. Equity is increasing and the total non-current asset, it’s mainly capitalist development that’s our biggest pot, it’s 1.4 billion SEK now. So that represents new games and DLCs that we will release over the next years. That’s it. We have a few questions.

[Fredrik Wester, CEO]

We have a couple of questions that came in through email I think. And I’ll do like this, I’ll read my questions, and then I’ll answer my questions just as it should be. So the first one is the question is, is there in your opinion, a right amount of DLC for a Paradox game, was there a limit beyond which profits or technical state of the game become unsustainable?

Obviously, it’s a very good question. I don’t think there’s a right amount of DLC for a game specifically. It’s three different things which are mentioned also in the question to a certain extent. One is obviously, is there a value for the gamer, more value that we can add to the game that people are actually willing to pay for, and they see as actual value that adds to the gameplay.

Second one is creative limits. Do we feel that we can do things internally, that actually adds this value. And the third one is obviously technical limitations and issues that lies within our own engine and our own code base.

So every game will have its own personality and its own DLC structure and what is right and not. And we will continue to experiment with what we feel is the right way forward. And sometimes we’ll make huge successes, and sometimes they will not be as good, but we hope will improve over time at least that’s the ambition.

[Alexander Bricca, CFO]

It seems like there is a significant negative working capital effect on the operating cash flow of the company if you look at six months, page 15 of the report. Could you please explain also why the numbers are different than the same period last year?

Very good observation, if you compare cash flow during the first half of this year, and the operating profit, the cash flow is not as good as operating profit. And that has to do, the largest explanation is that when we released CK3 we had a lot of sales of what we call the royal edition. So it’s an expansion pass. So we got a lot of pre-paid revenues back in 2020. And it continued during 2021.

And this prepaid revenue even though we get the cash immediately, we don’t recognize it as revenue until we have released the content that is included in this expansion passes.

So when we went into 2020, we had a debt on the balance sheet because we consider this as a debt because, in theory, if we wouldn’t deliver the DLCs that are included in the package that the players are paid for, we would have to repay this. So we had the big debt on the balance sheet.

But then when we released first it was royal court back in February, I think it was and then now Fate of Iberia, in Q2. That meant that we could recognize that revenue and remove that debt from the balance sheet. So that decreased the prepaid revenue, and had the negative effect on the cash flow working capital wise, because this significant amount of money, it showed up on the profit and loss statement this year, but cash wise, we had already got the money.

[Fredrik Wester, CEO]

So the question is, are you still planning to have to published games are released per year, or that is no longer the case? So the plan is to have as many games as we can both from a production standpoint and also from a publishing standpoint. If you want to count, you can count it as three releases this year if you count Shadowrun Trilogy and CK3 console edition together with Victoria 3 or if you only count new ones, it’s obviously Victoria 3, if you want to be very strict.

But I don’t think we’re not limited to two releases per year. No, I wouldn’t say that. And some years, it might be this last year, for example, we didn’t release any games, if I understand correctly, right. So we have 14 games in the core pipeline that we’re going to release over the next four years. So if you just divide it, it’s going to be three to four games a year. Some of them are internally developed, and some of them are externally developed.

And on top of that, we have the new games team that we told you about that is working with smaller and more experimental titles. And we’ll let you know more about this within short, like I said, a new games team is going to be pretty soon in time and at least one more announcement before the end of the year. We’ll see how many actually pops up. We want to we want to avoid a Bloodlines 2 situation where we announce game and then we have to delay it for a couple of years before telling you more. So we want to be fairly certain of at least release timing, before we actually go out and announce new game.

[Alexander Bricca, CFO]

Could explain the currency benefits of the company’s financial statements these past six months? Sure, so we have 97%, revenues coming in external currencies, where the U.S. dollar is by far the largest, followed by Euro and British Pound. And as I said, I think dollar it was up 17%. If you just look at Q2 versus Q2 last year, you earn a pound 3% to 5%.

So if you add that together, we haven’t disclosed the exact number, but I think estimations on the market are around 10%. So it has at least in Q2, Q1 I think it was a bit less, but it has a significant positive impact when it moves this direction on our P&L.

[Fredrik Wester, CEO]

But one thing that is important, sorry for just cutting in here, but one thing that is important to remember is that Steam also has underlying. They charge in I don’t know how many different currencies. It’s probably over 50 local currencies. So we get paid in those but then they transfer the money to us in dollars. So the underlying like balance is pretty global, if you see even if you as dollars is the biggest, because the United States is a big market for us.

And dollar territories in general. I reply to all questions. I like them. When will we hear something from your USB studios Paradox Tectonic and Harebrained Schemes? When we are ready to tell you more about their games, and I get reports every week. So I’m happy personally, and it looks good. But when they’re closer to release, we promise to tell you more. That’s all I can say.

[Alexander Bricca, CFO]

With regards to the revenue breakdown, it seems like revenue growth from console somewhat stole from mobile more than half. Why this?

Well console, it depends what to compare it. If you just look at Q2 this year compared to last year or first half of the year, this year compared to last year, it’s quite similar. I think it’s 10% to 11%. It does vary from quarter-to-quarter, depending on what you release. But it was slightly higher. It was around 14% - 15%, 18 to 24 months ago. And at that point, we had back catalog of PCDLC so on Cities and Stellaris that we could port in in a fairly quick manner.

And I think on Stellaris and Cities we have ported almost all the DLCs now. So the pace is a bit slower now. So I think that explains why we have seen a slight decrease in the console part of the revenue.

Mobile wise well, together with last autumn’s refocus where we focus on PC and console. Now it’s only our studio in Paris playground that develops and publishes mobile games, so the revenue has come down over the last year. And also initially when we published the report, part of the mobile revenues was classified in one of the notes under PC, but that has now been corrected. So if you look at the website now, you will see that the mobile revenues for Q2 was 8 million SEK. And I think it went from 13 million - 14 million last year. So it is a decrease.

[Fredrik Wester, CEO]

It still less than 2% of total revenue.

But still. Do you see a flattening demand of your games considering inflationary pressure? And we have not and sales have been stable, and we’re not experienced any downturn or flattening demand. But in general, our games I think might be counter cyclical or like work, I don’t know, I’m not sure we are affected that much by a negative downturn in the general economy. But I also think that one of the strengths of our game is the number of hours you can play. So people keep on playing and people keep on buying our games.

But we have, we made a small regional adjustment to the prices a couple of months back. We haven’t done any inflationary adjustment at the moment. We haven’t seen a need for it. But what we’ll see if the need arises going forward. If the inflation stays at this bit higher rate that we’ve seen recently in the U.S. and all across Europe as well. But we haven’t seen any need to do it at the moment. No.

[Alexander Bricca, CFO]

Long question. Investments in capitalist development keep increasing? Yes. More than half of your assets stem from capitalist development? Could you give some flavor on the split between new games and DLCs in that basket?

And secondly, historically speaking, increased development means increased releases. So does that mean that we should expect higher cadence of not only DLCs but also larger releases?

Well, yes so we don’t share that much detail on what the capitalist development is split up on. But it’s 14 projects. It’s a mix of DLCs, sequels on existing franchises and completely new IPS as well, focus on grand strategy and management games, vast focus on that. There is one RPG at least we know Bloodlines.

PC and console games only in those 14 and yes, between what can we say between DLC and new games well, if you look at the money, if you look at the capitalized development amount, the vast majority is on new games and not DLC since DLCs are substantially less expensive to make.

And then there was a second question, towards the end of the sentence. Does that mean that we should expect higher cadence? Definitely higher cadence than the last two years.

[Fredrik Wester, CEO]

And for the sake of clarity as well, the 14 games that we are mentioning is not counting DLCs.

It’s full game release. Yes. Yes. But can you also expect larger releases as well? Yes, if we look historically, the last 2, 3, 4 or 5 years, I think the game projects have increased, they are continuing to do so. And so the games that are being released are going to be bigger. And I think you also see it on the DLCs. For example, the Royal Court edition, quite a massive DLC. But we don’t know for how much longer it’s going to continue to just become bigger and bigger. I think at some point, we will reach an optimum amount.

[Alexander Bricca, CFO]

If you see diminishing return on every dollar you put in. So we’ll see we haven’t reached that yet. Our games keep on having bigger budgets, who can conclude that at least. That’s what you see in the balance sheet as well.

What is your long term goal for Paradox and its games? That is a very, very good question. What we want to be the best at what we do. We want to make a lot of super fun games to people keep on playing. We want to have the best experience in the market for people who play games. And we think our games matter. We think our games mean a lot to the people who play them. You can see that in the play time they have. You can see that in the attachment rate of DLCs, as well. We believe we make an impact in people’s lives. And we think it’s important. Games are important and the games that we make are important. And that’s what we want to continue doing.

[Fredrik Wester, CEO]

Can you explain what goes into setting the pricing policy for your game DLCs? Well, several different things. We look, of course, at how much time and value that has gone in from our side developing the content, but perhaps more importantly is kind of end results. What do we think it amounts in terms of entertainment value for the players and I think especially recently, we’ve started to focus a bit more on what we think the entertainment value is than our actual costs.

And of course, we will become much better at that now. But we look at what our peers price similar content in the different regions. So all that I would say that those are the main ingredients that goes into our pricing policy. No more questions.

[Alexander Bricca, CFO]

No more questions. That is good questions, though. Really appreciate that.

[Fredrik Wester, CEO]

And if you have if you have any questions, whether you have already sent them in or we haven’t responded, or if you come up with new questions, please continue to send them via email and we will answer them via email.

[Alexander Bricca, CFO]

Perfect, and we’ll see you hopefully again at the next quarterly stream in Q3 and in a couple of months.

[Fredrik Wester, CEO]

Yes. Beginning on November.

[Alexander Bricca, CFO]

Yes. Until then keep on buying and playing our games.

[Fredrik Wester, CEO]

Thanks for listening.

[Alexander Bricca, CFO]

Thank you. Cheers.