CD Projekt S.A. (OTCPK:OTGLF) Q1 2023 Earnings Conference Call May 29, 2023 12:00 PM ET
Company Participants
Adam Kicinski – President and Joint CEO
Piotr Nielubowicz – CFO
Michal Nowakowski – SVP of Business Development and Member of the Management Board
Conference Call Participants
Matthew Walker – Credit Suisse
Alexey Philippov – JPMorgan
Nick Dempsey – Barclays
Operator
Ladies and gentlemen, thank you for standing by and I would like to welcome you to CD Projekt’s Q1 Earnings Conference Call, on the 29th of May 2023. At this time, all participant lines are in listen only mode. The format of today’s recorded call will be a presentation by CD Projekt’s management team, followed by a question and answer session.
Without further ado, I would now like to pass the line to the Company’s CEO Adam Kicinski. Please go ahead, sir.
Adam Kicinski
Good afternoon. Welcome to call on CD Projekt Group’s financial results. Today we’ll briefly sum up the first quarter of 2023. My name is Adam Kicinski, and I will run this presentation together with Piotr Nielubowicz, Michal Nowakowski, will join us for the Q&A session.
Before talking about Q1, I would like to share with you some good news. I’m very proud to say that The Witcher 3 Wild Hunt hit 50 million copies sold. This, according to public data, ranks the Witcher 3 among the 10 best-selling video games of all time. At the same time, the whole trilogy, which is 1, 2 and 3, has reached a total of over 75 million copies sold. This clearly shows the strength of the franchise and we are excited looking forward to our next projects within the Witcher universe.
Let’s now move to Slide four, our developer’s involvement in ongoing projects. As of the end of April, The Phantom Liberty team working on the final phase of the project was over 320 people strong, making them our biggest team. The Polaris team is still growing and has reached 220 developers. Bearing in mind recent developments, I would like to take the opportunity and make some comments on two other teams.
First, Sirius. Following the evaluation of the game, we decided earlier this May on a new framework for the project. As a result, the composition of the team has changed mainly on the Molasses Flood side. Therefore, next time the red part of the chart will not be smaller.
Second, GWENT. Having decided to entrust its future into the hands of community, the resources and roles required are naturally declining. Over the past year, we’ve been transferring some of the developers to other projects. But at the same time, we have to part ways with a number of team members. So the GWENT development team will continue to gradually decrease in size till the end of this year.
And last but not least on my site, the marketing campaign for Phantom Liberty is kicking off soon. Less than two weeks from now, we’ll be taking part in summer game first play days in Los Angeles. We’ll have hands on sessions for press and content creators. And at a later date, we are also planning plenty of hands on opportunities for our community. So please stay tuned.
Now, let’s sum up the financials. Piotr, the floor is yours.
Piotr Nielubowicz
Thank you, Adam. Now let’s dive into our results for the first three months of this year. Let’s start with our consolidated profit and loss account on Slide seven. Unlike last year, when in Q1 we had the premiere of Cyberpunk Next-Gen edition, during the first quarter of this year, we had no special sales events. Internally both development wise and publishing wise we focus on preparations for the most important event of the year, the launch of Phantom Liberty. As a result, our sales revenue compared to last year was naturally lower, but still reached a robust PLN 175 million.
In contrast to total group sales, our cost of sales slightly increased, which comes mostly from increased depreciation due to the completion on release of The Witcher 3 Next-Gen edition in Q4 last year.
Moving on to operating costs, our selling expenses decreased by PLN 15 million down to PLN 39 million. This was mainly driven by a decrease in Cyberpunk servicing costs as well as in Cyberpunk IT related publishing expenses. As regards administrative expenses, they didn’t change much compared to last year.
Moving further to other operating income and expenses, the positive balance of over PLN 18 million it comes mostly from a partial reversal of the Sirius impairment iOS, we made back in 2022 books and partial write-off of our Q1 ‘23 development expenditures related to the project. All in all, Sirius impairment adjustments improved our EBIT by nearly PLN 90 million.
We are happy that we’ve managed to work out a new framework for the project and it’s already set on its new ambitious course. Another supporting driver is visible in the income tax line. Our income tax for the period decreased by half compared to last year. Mainly thanks to lower withholding taxes paid abroad. All-in-all our net profit for the first quarter of 2023, which PLN 69.7 million, which is slightly above the solid result of the previous Q1.
Let’s now move on to the next slide. Number eight, our consolidated balance sheet. Over the first quarter of 2023, our balance of expenditures and development projects increased by PLN 71 million. This figure represents the balance of new expenditures on development projects for the period, PLN 74 million, plus the already mentioned a PLN 90 million impairment adjustments related to project Sirius and less the amount we’ve recognized as costs for the period of $22 million.
At the same time, among current assets, our trade receivables decreased by PLN 91 million, which is standard for Q1 when we collect receivables for the preceding Q4 period. And last but not least, the total volume of cash deposits and treasury bonds included in the three assets items marked with an asterisk is some that under the table, and those PLN 1,112 billion as of the end of March 2023.
I will walk you through our main cash flow drivers in a moment. Let’s move on to the second part of the balance sheet, Slide nine. This time the situation regarding equity and liabilities is quite simple. Our equity grew mainly due to profits for the current period and our liabilities, mostly trade liabilities decreased since the end of 2022, similarly to the decrease in receivables.
Now please move on to the next slide, number 10. To the Projekt RED’s expenditures on research development and service games are represented quarterly since 2021 to illustrate the changes happening at the studio after the launch of Cyberpunk. I will now focus on comparing this Q1 to the past Q4 to highlight the most recent change.
The yellow part represents our total cost of servicing our release games. The increase in Q1 comes from additional support we allocated for the next-gen addition of the Witcher 3 released recently in Q4, and also as we are getting closer to completing Phantom Liberty, initial research works on new projects are on the rise, mainly Hadar, and Orion. Hence the slightly shorter blue bar and the more visible green bar. The main projects included in the blue part in Q1 was Cyberpunk Phantom Liberty, Polaris and Sirius.
And now our simplified cash flow on slide 11. Cash wise this PLN 70 million in net book profit for the period was supported by PLN 25 million in depreciation and amortization for the period. At the same time, when talking about cash expenses, the Sirius impairment allowance adjustment in the amount of PLN 90 million needs to be deducted. The already mentioned change in our receivables and liabilities represented by the next two bars also significantly boosted our cash flows this Q1.
We use the positive operating cash flows to finance over PLN 70 million of expenditures on our development projects, which are the core of our business. Altogether, our financial reserves kept in cash bank deposits and T-bonds increased by PLN 21 million over the first quarter.
Our strong cash position leads us to the next page and the recent announcement regarding the recommended allocation of profit earned in 2022. The Board of CD Projekt recommended to the general meeting to allocate PLN 241 million to the reserve capital and to share PLN 100 million with our shareholders by way of a dividend payout. We continue to believe that a dividend is the most straightforward, instant and democratic way of sharing profits on equal terms with all shareholders.
That’s all from me for now. Thank you for your attention, we can now move on to the Q&A section.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Mr. Matthew Walker from Credit Suisse. Please go ahead, sir. Your line is open.
Matthew Walker
Thank you. Hope you can hear my questions? The first question is just on Reuters and elsewhere, there’s been some rumors around Sony being interested in the business. In the past, you’ve made it pretty clear, you want to remain independent. So just an update on your thoughts on that would be helpful?
And then if you’ve got any more clarity around the Phantom Liberty, I know you’d haven’t announced a particular release date yet. But if you could give us a bit of help on the modeling, and is it more likely to be in the third quarter or the fourth quarter of this year? Thank you.
Adam Kicinski
Hello, can you hear me?
Matthew Walker
Yes.
Adam Kicinski
All right. So I’ll take the first one. Nothing has changed on our end. So I can repeat what we’ve been saying throughout the years. CD Projekt is not for sale. We want to remain independent. We have — I believe excellent strategy, not easy to execute. For sure. But it’s very exciting to follow our own path. So it’s a pure remark [ph].
Matthew Walker
Okay.
Piotr Nielubowicz
Hello. And I’ll take the second one. We are unfortunately not guiding specifically on the release date. Sorry, I’m muted. I have some technical issue. So we’re not guiding specifically on the release dates, we’ll give more details from June, so very, very soon, as we have previously mentioned in our communication.
Matthew Walker
Okay, just a quick follow-up if I can. Is there any more reversals of expenses around the Sirius project to come? Or is that basically finished now?
Adam Kicinski
We naturally believe there is no more reversals or write-offs for projects Sirius, everything we knew, we adopted into the financial report that was published today. So as for today, and I hope nothing will change in the future. This has been a status quo.
Matthew Walker
Okay. Thank you so much. Good luck.
Operator
Thank you very much. Our next question comes from Mr. Alexey Philippov from J.P. Morgan. Please go ahead, sir. Your line is open.
Alexey Philippov
Yes. Good evening. And thank you very much for the opportunity to ask the question. The first one on development costs, which accelerated quarter-on-quarter quite significantly. At the same time the number of developers should have been broadly flat and you’re basically maintaining your key projects. So shall we treat this increase as the underlying inflation in wages that you capitalize?
And the second question on, can you please talk about the withholding tax effect? Was it a one off? And how shall they model the effective tax rate for the rest of the year? Thank you.
Adam Kicinski
So, first of all, I’m not sure what are the thesis that is part of the first bullet is so your first question is true. Cash wise, as far as I remember, and as it was presented on the presentation, the expenditures and development we had in Q1 were very similar to what we had in Q4 last year, actually were slightly lower. And yes, a bit higher than in previous quarters.
So that’s what happened. But on the other hand, we can expect the expenses on development which are mainly driven by salaries to increase as a natural way of wage inflation and adopting new salaries and new remuneration policy accelerate in 2023.
Regarding the withholding tax, how to model it, it’s really hard to guide in this respect you regarding the future, as the withholding tax depends on our international partners withholding this tax from payments to us. And we are at the end of the chain in this respect receiving the reports under declarations on what taxes were withheld and this is not directly in our control. Having said that, — I was somehow on mute.
Having said that, in many jurisdictions, some the taxes withheld are being deducted however on some things the treaties total and signed with partnering countries their withholding tax is not to be applied.
Alexey Philippov
Thank you, and if I may, one more question on the upcoming game fest. So what will be happening there in particular, can you explain that in more details, please? You will be showing the gameplay, or you’re not disclosing at this point? Thank you.
Michal Nowakowski
So I’ll take that. We have a [indiscernible]. So it’s meant to be a surprise, so if it’s still meant to be surprised come June I cannot disclose it here. So I would still — we would still have to ask you to be a little bit more patient. But we seriously hope it’s going to be worth it for you and for the fans of the game. So please have some patience.
Alexey Philippov
Very clear. Thank you very much.
Operator
Thank you very much. Our next question comes from Nick Dempsey from Barclays. Please go ahead, sir, your line is open.
Nick Dempsey
Yes. Good evening, guys. I’ve just got one question. I mean, if we look at slide 10. I’m interested in how this chart phases over the rest of the year broadly and in numbers terms in conceptual terms. Do we get any of the new Boston studio landing inside here before the end of the year, so that will stack up a new element perhaps in development expenditure? Then when Phantom Liberty is released, presumably some of the development expenditure box will go into the P&L — a new P&L line. I’m just interested in in the elements that will feed into Q2, Q3, and Q4 for slide 10.
Adam Kicinski
So, regarding the Boston studio, it is included in the numbers on the bars presented on slide number 10. Since the Boston studio is doing this project for to the PROJEKT RED, who is the publisher, and we accumulate all of the expenditures on the Sirius project in our books. That’s why Sirius is part of the expenditures you see on slide 10.
Nick Dempsey
Yes, sorry, I didn’t mean the Molasses flood. So I know it’s confusing with Boston, I meant your new planned own studio in Boston and also in Vancouver working on Project Orion if I’m not wrong?
Adam Kicinski
So once we accelerated our engagement on Orion, it will be first visible among the research carts. And then one day once we move to the development phase, it will power the blue development expenditures part of the chart.
Nick Dempsey
And so should I see it pushing up the green line here during the second half of 2023 or that’s not something I should be considering in my modeling.
Adam Kicinski
We believe the studio should start operation beginning of 2024. However, we already have some expenses related to Project Orion and Project Hadar. Both included in the green part, once the studio is set up and starts operating in 2024, the green bars should increase.
Nick Dempsey
Okay, sure. And then there will be — once Phantom Liberty is released, there will be — the P&L part of this bar will go up and the blue part will go down.
Adam Kicinski
Once Phantom Liberty is released, we’ll definitely need to dedicate some resources to patching and updating Phantom Liberty. This will be represented by the yellow service costs part. Some people will join Polaris that is already in the development phase. So it should boost the Polaris part of the blue part. And some will join Orion that will be initially present that green among the research phase expenses.
Nick Dempsey
Great, that’s really helpful. Thank you.
Operator
Thank you very much. I am seeing no further voice questions. I will pass the line to the management team for — to take any text questions that we have received.
Adam Kicinski
So just speaking, I read the first question from [indiscernible]. Could you explain what is Cyberpunk anti-publishing service in selling costs?
Piotr, I think is for you.
Piotr Nielubowicz
Sure. So last year, in the first quarter of 2022, most of the costs were related to the next-gen edition of Cyberpunk that was then premiered. However, this year during the first quarter of this year most of the amounts of PLN 9 million was related to our preparation of campaign dedicated to Phantom Liberty launch. There was also some amount coming from directly from supporting Cyberpunk itself the base edition of the game, but most is to be attributable to the preparations on publishing campaign for the Phantom Liberty.
Adam Kicinski
All right, the next question is from Bloomberg. You gave total number of Witcher 3 sales. What can we say about copies of Cyberpunk sold? Still, no next large level reached?
Michal Nowakowski
Okay, I’ll take this one. So, when it comes to that question, I mean, we have announced the new thresholds of the Witcher 3. And when we’ll have a next round of thresholds of Cyberpunk we’ll share the news as well. So I’ll leave that as an answer.
Adam Kicinski
All right, as we have no more questions. Thank you very much for joining us today. If you have any follow up questions do not hesitate to contact our IR team directly by mail or by phone. Have a nice evening. Goodbye.
Operator
Thank you very much. This concludes our conference call. We will now be closing all the lines. Thank you and goodbye.
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