CD Projekt SA

WSE:CDR

Earnings Call Analysis

Strong sales performance despite no new releases in Q3 2024.

In Q3 2024, the company generated PLN 228 million in revenues, significantly down from the previous year's Phantom Liberty launch. However, net profit rose to PLN 78 million, up PLN 8 million from Q2. The Witcher franchise performed well, with revenues increasing by 44%. Total research costs for new projects reached PLN 68.5 million, affecting profits only slightly, with a cumulative net profit of nearly PLN 250 million for 2024 so far. Looking forward, the company set ambitious goals, targeting PLN 2 billion in cumulative net profit for 2023-2026 and PLN 4 billion for 2025-2028.

Steady Growth Amidst Challenges

In the third quarter of 2024, CD Projekt Group faced the absence of new game launches, yet managed to achieve sales revenues of nearly PLN 228 million, which is approximately 50% less compared to the same period last year when Phantom Liberty was released. Despite this downturn, the company reported a net profit of PLN 78 million for Q3, a 12% increase from the previous quarter, highlighting its ability to maintain profitability even without new releases.

Balancing Costs with Strategic Investments

The company invested significantly in future developments, spending PLN 68.5 million on early-phase research and development (R&D) costs for new products and technologies, which burdened their income statement. Nonetheless, the net profit after three quarters stood at nearly PLN 250 million, thanks to a stable net profit margin of 38%. This reflects effective cost management strategies alongside strategic investments aimed at future growth.

Franchise Resilience: The Witcher and Cyberpunk

A notable highlight was the performance of The Witcher franchise, which saw a 44% increase in revenues compared to last year, partly due to the re-release of The Witcher 3 on PlayStation Plus. Meanwhile, Cyberpunk 2077's expansion, Phantom Liberty, has sold over 8 million copies to date, demonstrating the sustained popularity of its franchises even in off-peak times. This enduring engagement provides a hopeful outlook for further revenue generation.

Future Outlook: New Projects and Goals

CD Projekt Group is in the midst of developing several high-profile projects, such as Project Polaris and Project Orion. Polaris has recently completed preproduction and moved into the production phase, signaling that an estimated 400 developers are now primarily focused on this ambitious project. The company anticipates increasing production headcount, planning to double the team working on Project Sirius by the end of next year to bolster development further.

Exciting Future Collaborations and Adaptations

Additionally, CD Projekt has announced a collaboration with Netflix on a new animation project set in the Cyberpunk universe, potentially expanding the brand's reach and profitability. There is also an upcoming native release of Cyberpunk 2077 on Mac systems, showcasing efforts to tap into new gaming markets. These developments are expected to create new revenue channels and audience engagement.

Guidance on Profitability and Strategic Initiatives

Looking ahead, CD Projekt aims for ambitious financial goals, targeting cumulative net profits of PLN 2 billion from 2023 to 2026 and PLN 4 billion from 2025 to 2028 as part of their incentive program. Current guidance indicates that despite challenges, the company is optimistic about achieving these objectives by leveraging its strong franchise management and upcoming content releases. Investors should watch for these new project developments closely, as they could significantly impact future revenues.

Earnings Call Transcript 2024-Q3

[Michal Nowakowski, executive]

Good afternoon. My name is Michal Nowakowski, and I'll be your host during today's conference dedicated to the CD Projekt Group's financial results for the third quarter of 2024. I will be co-presenting with Piotr Nielubowicz. And after the presentation, we will invite you to participate in a Q&A session, where we'll be joined by Karolina Gnas, our VP and Head of Investor Relations.

So first of all, we are thrilled to kick things off with an exciting update from the Cyberpunk franchise. Cyberpunk 2077 has reached another huge milestone with over 30 million copies sold. We are extremely proud to see our title continuing to attract a growing community of players, who wish to dive deep into the rich dystopian future world. Night City's growing player community not only has a direct impact on our financial performance, but also bodes well for the next game in the series.

Moving to the sales performance of Cyberpunk 2077 expansion. Phantom Liberty topped 8 million copies this month. Achieving this result just over a year after the release clearly proves the quality of the expansion and enduring appeal of the Cyberpunk franchise. It also highlights the strong demand for new content from the series, motivating us to continue delivering experiences that resonate with our community.

We also want to ensure that as many players as possible can experience our titles on the platforms of their choice. Recently, we announced that early next year, Cyberpunk 2077 ultimate edition would be arriving natively on Macs with Apple silicon. This includes the new iMac, Mac mini and MacBook Pro powered by the M4 family of chips. The game is optimized to take full advantage of Apple silicon and Metal to bring the immersive world of Night City and the deadly district of Dogtown to Mac gamers for the very first time.

And that's not all from the Cyberpunk franchise. Back in September, we announced our collaboration with Netflix on another Cyberpunk animation project. This will bring audiences back to the vibrant world of Night City. While we can't share more details just yet, stay tuned for the updates.

Moving on to The Witcher franchise. Several weeks ago, Project Polaris reached a very important milestone. We have completed preproduction. During this phase, we have been developing key aspects of the game, including the story line, main mechanics and design among other elements, and then tested how they worked together on a playable fragment. Ahead of us lies the main and most intense stage of development, which is the production phase. We'll now scale the solutions we have developed and validated thus far across the entire game.

I'd like to take this opportunity to express my congratulations to the team. I'm proud to see how you have progressed over time.

As for our current allocation of development teams, the differences in team sizes versus the end of July were very slight with our main focus remaining obviously on Project Polaris. The change from 410 developers at the end of July to 400 developers at the end of October, reflects natural transition as we completed the preproduction phase and adjusted the team set up to beat the current needs of the production that is. In the coming quarters, you can expect some fluctuations here driven by specific needs of each project base.

That's all for me. Now it's time for financial, which means Piotr Nielubowicz.

[Piotr Nielubowicz, executive]

Thank you, Michal, and good evening, everyone. Let's start with our consolidated profit and loss account on Slide 9. A year ago, in Q3, Phantom Liberty was released. The release had a significant impact on our revenues, costs and obviously, profits for the comparative period. This year, with no new launches, the group's Q3 sales revenues reached nearly PLN 228 million, which is approximately half of the revenues for the comparative period. Naturally, most of the difference came from Cyberpunk products. At the same time, our Witcher games generated 44% more revenue than during the comparative period.

Regular sales were supported by income attributable to bringing the Witcher 3 to PlayStation plus extra and premium. In line with the revenues, our cost of sales decreased as well. This change is mainly due to the digressive amortization scheme we applied for the Cyberpunk games. As a result, we saw a higher amount allocated to the cost of products sold during the Phantom Liberty during this quarter in 2023 compared to the corresponding quarter this year.

Moving on to operating costs. We also recorded lower selling expenses, which decreased by PLN 37 million down to PLN 29 million. This was mainly due to lower publishing costs related to Cyberpunk and Phantom Liberty as well as decrease in the maintenance cost of our release products.

As regards to administrative expenses, the increase in this category comes directly from our expenses and early phase work on new projects presented as research work costs that reached over PLN 22 million. This was mainly driven by Orion, Canis Majoris and Hadar. The good news here is that Orion completed all that is required to begin capitalization of its expenses starting September. At the same time, the total of all other administrative expenses decreased in comparison with the third quarter of the past year.

All in all, our net profit for the third quarter of this year amounted to PLN 78 million. To put this into a more current perspective, contrary to typical seasonality, this is PLN 8 million and 12% more than what we achieved in the second quarter of this year.

Given that the third quarter of last year alone, which is when we launched Phantom Liberty is naturally a challenging point of reference, I would also like to draw your attention to our results for the first 9 months of each of the discussed years presented on the next slide, #10. With no new releases, our cumulative revenues up until the end of September of the current year were PLN 115 million lower compared to the first 9 months of 2023, which, thanks to an overall strong sales performance this year is actually only 15% less than a year ago. Moreover, this year, we spent PLN 68.5 million on early phase research work costs dedicated to new products and technologies that are in no way related to our current sales.

This year research activities burdened our income statement by PLN 61 million more than in the comparative period. Regardless of the lower sales in the absence of any fresh release and PLN 68.5 million dedicated to research work on new products and technologies, our net profit for the first 3 quarters of this year was only PLN 42 million less than during the comparative period. Altogether, after 9 consecutive months of 2024, we have already obtained nearly PLN 0.25 billion in net profit. It's worth mentioning that the efficiency of our business measured by net profitability was maintained. It reached 38%, which is even slightly higher than a year ago.

Now we can move on to the next slide, #11, our consolidated balance sheet. On the asset side, first, the usual expenditures on development projects. The balance here increased by PLN 45 million during the third quarter of 2024. Our new developments, mainly Polaris, Sirius, the new animation and Orion September expenditures were responsible for a PLN 71 million increase here. This was partly offset by a PLN 27 million decrease from amortization driven mainly by the already released Cyberpunk and Phantom Liberty.

The second biggest change in the assets concerns our financial reserves. The total value of cash deposits and bonds, which are included in the 3 asset items marked [indiscernible]. The total is summed up under the table and amounts to PLN 1.401 billion as of the end of September 2024. I'll have a separate slide to give some more insight on our main cash flow drivers during the quarter.

Moving forward to the second part of the balance sheet, Slide 12. The most noticeable change here is the increase in our equity driven mainly by profits for the period. There was no major change in other sections of liabilities apart from the provisions line, which grew mainly due to the increase in provisions for results-related bonuses.

Now please move on to the next Slide, #13, that the [ PROJEKT RED's ] expenditures on research, development and product maintenance quarterly for this year. The trend is clear. We scaled back service work on already released games in yellow and maintained our involvement in early phase research work in green. At the same time, we also increased our engagement in the more advanced development work in blue. As per our strategy, we are currently involved in and finance work on several games, animation and some pure technology research, including AI tech and its applications.

And finally, our simplified cash flow on Slide 14. The PLN 78 million group net profit, which included PLN 22.5 million in costs attributed to research work that I have taken the liberty of extracting as the next bar was supported by PLN 37 million in nonmonetary costs, depreciation, amortization and incentive program costs recognized for the period.

The change in other assets and liabilities allowed us to improve our cash flow by nearly PLN 10 million, mainly thanks to utilization of minimal guarantees and royalty prepayments by GOG.com, which is always good news. At the same time, PLN 27 million was expended on acquisition of tangible and intangible assets. Apart from the usual investments into machinery and licenses, that outflow was mostly driven by a construction project we are currently running at our Warsaw campus.

Summing up all the above, out of PLN 228 million sales revenue for Q3 this year, we came up with an estimation of PLN 123 million generated by our ongoing business, excluding R&D expenses. During the same time, we continued work on new projects and technologies either in the already mentioned research or development phase, expanding PLN 23 million and PLN 64 million, respectively.

All in all, our financial reserves in cash, bank deposits and bonds increased by PLN 36 million over the reporting period, reaching PLN 1.4 billion as of the end of September this year. And this brings me to the end of our financial part, but I also have one more announcement to share with you. At the end of October, we announced an extraordinary general meeting, which will take place in 2 days.

Among others, we proposed resolutions, which concern changes in the composition of our Supervisory Board and the earnings condition for the years 2025 until 2028 in the framework of our incentive program. The first 4-year goal of the program from 2023 until 2026 amounted to PLN 2 billion in cumulative net profit. The second goal amounted to PLN 3 billion for the 4-year window starting in 2024.

And the third one, which we now propose stands at PLN 4 billion in consolidated net profit as defined in the program regulations for the 4-year period starting in 2025 and ending in 2028. I would like to invite all registered shareholders to participate in this general meeting and support us in adopting the proposed resolutions.

That's all from me for now. We can now move on to the Q&A session. Thank you.

[Operator]

[Operator Instructions] Your first one comes from the line of Nick Dempsey calling from Barclays.

[Nick Dempsey, analyst]

I think you pointed at the first half stage to 4 to 5 years as a typical period for the completion of one of your AAA games. I wonder if you could perhaps qualify, did you mean from the beginning of the full production phase? Or did you mean from the beginning of when you start investigating ideas for the game?

Second question, in terms of Q4 versus Q3, obviously, normally, those of video games for a while expect Q4 to get a bit of a boost from the particular seasonal phase of buying. Could it be though that in Q3, you didn't have that much competition out there from other AAA titles, but you'll have some more competition in Q4 and therefore, that might balance out that normal kind of seasonal buying pattern, when we're comparing Q3 to Q4?

[Michal Nowakowski, executive]

Okay. I'm going to definitely take the first one. This is Michal Nowakowski. So I'm glad you asked the first question because I know there were some misconceptions after the -- I think it was the last call. So we're talking about from the very investigating ideas stage. So really, when the first couple of people went into one room and say, "Hey, how about we make next switching game? That's how long it takes from the moment they start actually working on the paper, not actually going into what we call production phase in our vocabulary when talking about games. So I'm glad we can clarify it here at the open.

So from the very, very beginning when we're starting discussing the ideas, earlier ideas for the game is the time that we are providing for the development of the games. It's usually -- but it's not 3 to 5. It's actually more 5 to 6. I would clarify that point as well.

In terms of Q4 versus Q3, I would not really say, it works like that, to be honest. It hasn't in the past. It's not like there are things coming out that are sucking out the year out of the whole industry. So we would rather expect to enjoy regular boosts of seasonal sales as we do in every Q4, nothing unusual in that regard.

[Operator]

We currently have no questions on the line. [Operator Instructions] The next question comes from the line of Ed Young calling from Morgan Stanley.

[Edward Young, analyst]

I've just got one follow-up to Nick. When would you say the company first started conceptualizing Polaris? When did you first have the idea to do that again, do you think?

[Michal Nowakowski, executive]

Well, I'm not going to answer that question, obviously, because that will be leading to pointing out towards the date, which we're not doing. But thank you that was a very clever way to ask the question.

[Operator]

Well, there are no further questions coming from the line. So we are going to take the question now from the webcast. I'll send it back to you.

[Michal Nowakowski, executive]

So the first question is actually coming from Piotr Poniatowski from mBank. And it reads mobile game, is anything happening at the moment? Or is it just a possibility in a Galaxy far, far away?

So mobile game licensing, which we were talking about before, it's in talks. It's one of our strategic goals. At the same time, we don't really have anything that we can announce when the time for the announcement is going to come, we will make it for sure and share it with you.

[Karolina Gnas, executive]

Okay. So the second question comes from Christoph Koch from BDM. And the question is, could you tell us what part of the team working on Orion is from the U.S.A.

Currently, just over 1/3 of the team works from our Boston hub, while the remaining 2/3 are based in Canada and Poland.

[Michal Nowakowski, executive]

The next one comes from Piotr Poniatowski from mBank. Thinking about 2025 and 2026, what will be the main driver of your results? Cyberpunk 2077 sales will probably fade away as there will be no more major updates. Polaris, Sirius, Scanis [indiscernible] are nowhere in new release. [ Animal ] Live action will probably have small impact on P&L. Are there any catalysts for 2025, 2026?

What I can say today is that our business success is based on longevity of our products, active franchise flywheel management and releases of new content. We expect the next 2 years to be active in all the mentioned areas. Some may be surprising, and I believe this is also something we are good at when running our marketing campaigns.

[Karolina Gnas, executive]

Okay. And another from Piotr Poniatowski from mBank. Please give us an update on your class action lawsuit regarding the technical solutions used by GOG.

Piotr, unfortunately, I do not have any updates on this topic. I can only reiterate that we are working with a law firm experienced in this kind of lawsuits, and we are eager to find a solution. And any new developments on this will be definitely communicated through a stock report.

And another one from Piotr from mBank. Why are you having so much trouble scaling up Orion? Lack of candidates, mismatch of wages, expectation and budget?

And here, I can state that we do not have any issues here apart from regular like scouting for talent in -- that is like normal in Poland and in the U.S. The current team size is aligned with our needs, and we plan to further expand the size of the team next year. We actually plan to double the team by the end of the next year.

[Michal Nowakowski, executive]

Another question comes from Tomasz Rodak, BOS. Orion started capitalizing expenses. Does it mean it moved to preproduction phase? How much less of cost per quarter will be booked in SG&A from now on?

No, it does not mean it moved automatically to preproduction. It means it completed all what is required by IFRS to start capitalizing the project. There is a number of criteria the project must meet in order to be capitalized and Orion delivered all the milestones, all the documentation, all the plans and designs that are required for that. And as usually, we are not sharing detailed information on how much we spend per project or how much per project will be moved from one line, the research phase into the development phase.

[Unknown Executive]

Okay. The next one is also from Piotr Poniatowski, mBank. What about the Live Action project? Who is funding it? Is it still in the concept stage?

So Live Action is still in the conceptual stage, but I'm not sure what is implied in the question. I mean the conceptual stage has various stages of advancement. So we're, for sure, further in than we were a year ago, but we're also not yet at the stage, where we would be shopping around the concept to potential streamers or studios. I'd say it's probably a similar window between here and now as was between when we announced it about a year ago and today. So within that window, I would expect we're going to get to shopping around. Who is funding it. The very early production package is traditionally financed by the one who is preparing it.

So in this case, it is us, but we would not be funding the whole, I don't know, shooting of the Live Action project that is not in the plan. And obviously, the cost of the early production package is not comparable to the full-blown production of the actual Live Action project.

Okay. And the next one is from Michal Wojciechowski, IPOPEMA. As the game entered full production phase, can you say that your internal production schedule is more predictable than it was in preproduction phase?

I mean we have a high belief in our current pipelines and production setup and analysis. So I wouldn't say one is more predictable than the other. I mean there is always some degree of certainty and some degree of uncertainty. But what I think has changed is now we are set on target. We know what we want to achieve within the game. And now it's a question of actually filling in the blanks. It's super oversimplification, of course, but this is really what entering the production phase means. We have a big chunk of game made that proves certain concepts. And now we need to kind of populate the whole game per plan. I'm not sure, if it addresses the question exactly like you were hoping to, but that's my answer.

[Michal Nowakowski, executive]

The next question comes from Piotr Poniatowski, mBank. Which projects are included in the CapEx in Q3 2024? So the main projects are included in the CapEx in the last quarter was obviously Polaris, Sirius, the new animation and Orion that was moved from the research works into the expenses on development and started to be capitalized in September '24. There are some other smaller projects, not all of them are announced so far. So some of them are also unannounced, but these are the main ones.

[Karolina Gnas, executive]

Okay. So the next question comes from Piotr Poniatowski, mBank. When do you plan to increase the headcount on Project Sirius? What headcount do you expect at the peak of production?

I can say that the increase is happening as we speak because just recently, we greenlighted some new roles to be added to the Sirius. And we plan to double the headcount we currently have by the end of the next year.

[Piotr Nielubowicz, executive]

The next question comes from Michal Wojciechowski, IPOPEMA. Do you perceive 2023-2026 incentive target as still achievable, considering that more than 60% of the target remains to be achieved?

What I can say is that after 44% of the vesting period, we have already achieved 36% talking about the -- or referring to the percent you mentioned, which is slightly below the time that remained. However, the difference is not that huge. No doubt, the program is based on ambitious and challenging goals. And as you know us, in general, we like ambitious challenges.

The next question comes from Alexey Philippov, JPMorgan. The payment that you received from Sony after Witcher 3 became available through PlayStation Plus Extra subscription. Can you confirm it was onetime payment? And what was the size of it?

So I'm not referring to payments directly, but yes, the income that is related to our cooperation with Sony on the PlayStation subscription was recognized onetime in our revenues of the third quarter. But at the same time, I'm really sorry, but I'm not in a position to refill our business details of the contract done with Sony on it.

Another one is also from Alexey Philippov from JPMorgan. My other question would be on the Mac Gamers. Where do you see the percent of Mac Gamers among your potential clients? We have some experience in the past. We had ports of Witcher 1 and Witcher 2 available on Macs -- and obviously, this is a bit of a new waters we're going to be testing here because we're talking about the new chipsets, new hardware that Apple is going to be introducing.

So I don't think referring back to the numbers we had with Witcher 1 and Witcher 2, there was a certain percentage of sales that we were able to then deduce is going to be selling among the Mac gamers, is going to be valid. But we are quite optimistic. And I think what I can say is definitely we would not be entering this, if we were not seeing that as a profitable and promising new hardware to be on. I think I would put a full stop here.

[Karolina Gnas, executive]

And the next one is from Stan Clark. Will there be a step-up in Polaris head count now that it has entered full production? I understand it might be volatile, but any sense you are able to give at this stage?

Currently, as you saw, we have 400-plus developers involved into Polaris project that are supported daily by our shared services teams. And of course, this number might fluctuate here and there depending on the needs of the project in various phases, but we believe that this number, meaning 400 plus is the final kind of number we would like to have on this project.

[Michal Nowakowski, executive]

The next one is Tomasz Rodak, BOS. Can you please update the development status of the Witcher 1 rebate?

We don't have any official statements to be made. I mean the work is progressing the full series continuing the work on the remake. And obviously, once we're going to have anything to share in that regard, we will. Thank you.