PRXXF - Paradox Interactive AB (publ) (PRXXF) Q2 2023 Earnings Call Transcript
2023-08-01 05:03:08 ET
Paradox Interactive AB (publ) (PRXXF)
Q2 2023 Earnings Conference Call
July 27, 2023 06:00 AM ET
Company Participants
Alex Bricca - Chief Financial Officer
Fred Wester - Chief Executive Officer
Conference Call Participants
Presentation
Alex Bricca
Hello everyone and welcome to the Paradox Interactive Quarterly Stream. Hopefully you can hear me this time. We are very sorry about the delay. We have experienced some technical issues here in the studio. This morning we released our quarterly report for the second quarter and we are here to present it to you more in detail. I am Alex Bricca, I am the CFO. And with us on link, we have our CEO, Fred Wester. Are you there Fred?
Fred Wester
I'm here. It's really good to be with you on this stream. I think I'm the one who's going to I'm going to start talking, right?
Alex Bricca
Yes. Please go ahead.
Fred Wester
Right with the first slide that only has my name on it, I think we can skip that one. We should be done with that already and explained. As you can see -- in the quarterly report we have delivered, as we say in the -- in my words from the CEO, we've delivered on the strategy that we set out a couple years back. And obviously, the results of the quarter is also driven by the release of Age of Wonders 4 that was well-received both by critics and in sales numbers of the -- we also released the line -- a line of DLCs for all our core titles.
And also worth to mention here is a title from Paradox Arc called Mechabellum that released in the beginning of May, that's been doing fairly well with really promising retention numbers. We're looking forward to building further on whatever this game has for us in the future.
And as we know already it will vary a lot between quarters and depending what we released even if the baseline of the company continues to increase. And we can see a steady movement upwards in both topline and volume as a result of that.
If we move on to the next slide here we can see just a summary of the releases through the quarter. And as you can see it was especially a very busy May with Age of Wonders 4 releasing. We had Crusader Kings III: Tours & Tournaments. Age of Wonders released its first DLC in months -- a month and a half after the release of the full game Dragon Dawn. Victoria 3 had its first major DLC as well in Voice of the People. Galactic Paragons for Stellaris.
We also had Royal Court releasing for consoles. We also are aware that there has been a couple of problems with the console release that we're looking to solve as well, but Europa Universalis also had a big DLC. It's been a bit fewer from the Europa Universalis side while the game is getting older as well. It's turning 10 years any day now. We also released Hotels & Retreats for Cities: Skylines and a couple of content creator packs. As I already mentioned we released Mechabellum from Paradox Arc.
And if we want to know what happened after the quarter is next slide is we announced Star Trek: Infinite, which is a license. Probably -- I would say it's the first license in the company history.
We announced two things from Paradox Arc; Stellaris Nexus, which is a Stellaris multiplayer-focused experience where you play the game in one hour; and Space Trash Scavenger, which is basically a survival crafting game that takes place in space rig or space station et cetera.
We also announced Arms Against Tyranny for Hearts of Iron IV and Wards & Wardens for Crusader Kings III, both for release later on this fall. We have also changed just the other day the early access release date for Life by You, our life simulation game, which will now be released in quarter one next year namely -- more specifically, March 5. So, it's a release to look out for.
And back to you Alex.
Alex Bricca
Thanks Fred. So, let's as always dig a bit further into the numbers. So, a record-breaking quarter if we look at revenues. We landed on SEK737 million for the second quarter of this year. That can compare to SEK459 million the same quarter last year, so it's a 61% year-over-year increase.
And as it often is for us the revenue variations is driven by two things; one is the currency changes and when the Swedish krona is weakened against the bigger currencies, we are increasing sales. So compared to the second quarter of last year, the dollar, the British pound and the euro is up against the Swedish SEK, so that means that our revenues are increasing, thanks to that, but more importantly, our revenues is driven by what we release.
And as Fred went through in detail, we have released quite a lot. It's for sure a record in the second quarter: one new game in Age of Wonders 4; and DLCs on all our core titles except Hearts of Iron IV. So with that -- plus that we released Mechabellum as Fred said. So with that, as often happens when we have a lot of releases, we deliver very strong revenues and strong profits; and that is what we are seeing this quarter as well.
To add on it, we had the Publisher Weekend with Steam as we often have in Q2 which helps revenues also. And we also saw the start of the Steam summer sale at the end of June. Top five contributors normally are the same five, but this time it's Age of Wonders 4 that has broken in on that list. So apart from Age of Wonders 4, it's Cities. It's Stellaris. It's Hearts of Iron and it's Crusader Kings III.
Operating profit for the second quarter reached SEK293 million compared to SEK214 million, same quarter last year, so that is an increase of 37%. If we move further down in the P&L, we can see that profit after financial items comes in at SEK311 million compared to SEK213 million same quarter last year. So profit after financial items is higher than the operating profit and that is thanks to us selling our shares in Hardsuit Labs.
That was a minority position we took some 5.5 years ago when we acquired 33% of that studio. And the main reason for that was that the studio was developing Bloodlines 2 for us. Since we shifted studio a couple of years ago, that holding was not strategic for us anymore and we decided to sell it. And we are very happy to sell it to Keywords Studios, a partner that we cooperate quite a lot with. So that added to our profit after financial items.
If we look at profit after tax. We come in at SEK239 million compared to SEK170 million last year. Profit margins: Profit-before-tax margin 42% second quarter this year compared to 46% same quarter last year, so even though the profit in SEK is up quite a lot the profit in margin is down and mainly three reasons to that. We have had quite a lot of marketing efforts in this quarter for games that we have not yet released. So Cities: Skylines II, Lamplighters League, Life by Star Trek.
We have all done significant marketing activities during the second quarter but of course we haven't seen any revenues yet. Those will come when we release a game so that has -- the games. So those activities of course the costs for them are taking immediately so that is pushing down the margins a bit further. So that is one explanation.
Also, we have released as we've said DLCs; and games new games in terms of Age of Wonders to quite some extent. And when we do that, since some -- since Q3 2020, we have started to use a degressive amortization method which means that we amortize quite a lot in the first months of -- after the release of a game. So for both let's say Age of Wonders 4 the DLCs for Crusader Kings III and Victoria 3, we released those in May so that means in practicality that we take 40% of the development costs for all those games and DLCs in the second quarter. So quite a significant cost of goods sold.
Of course, it pushes up revenues and profit, but the profit margins is often slightly lower when we do the releases. Therefore it's 42% this quarter, but still of course, very good.
We have also continued to explore our titles on VR. We had a similar launch in Q1 when we together with a partner launched Stellaris on VR. So these -- and now we have another game one of our Vampire brands that will come out on VR as well. And these cooperations are -- they are funded by another party. And those funds are immediately kind of handed over to the developer, so we have a zero margin effect on these cooperations so that has held back the margin slightly this quarter as well.
Employees, 676 at the end of this -- at the end of the second quarter. So we increased with two from 274 [ph] in Q1 yes. The organizational changes that we have made in the second quarter that we have spoken about before have not yet had impact on these numbers.
Let's move on and dig in a bit further to -- into especially the costs. So this slide shows our revenue in green over the years, over the quarters; and our three main cost items. So we have cost of goods sold, selling expenses and admin expenses.
Revenues you can see very clearly here that we are breaking the records first time over SEK 600 million. And we are over it by a good margin so SEK 737 million. Last record was Q4 last year. I think we had SEK 580 million so significant increase.
Costs, three major costs all in all SEK 454 million in the second quarter of this year, compared to SEK 261 million same quarter last year, or SEK 334 million first quarter of this year. And as you can see very clear both in the table and in the charts is that, it's the cost of goods sold and the selling expenses that has bumped up in this quarter, so let's go through both of them what has been driving them.
So cost of goods sold. These are the costs we have for all our now seven internal development studio, all costs for our external development royalties that we pay, amortizations that we do on acquired businesses and acquired brands, costs for publishing organizational works with game development and tech and maintenance. So cost of goods sold second quarter SEK 338 million compared to SEK 197 million same quarter last year, or SEK 263 million in Q1 of this year yes.
COGS is built up by several sub-items. Let's go through them. The major one is amortizations, yes. So amortizations second quarter came in at SEK 155 million, as you can see in the report compared to SEK 86 million same quarter last year, or SEK 110 million in the first quarter of this year.
So why has it gone up from SEK 110 million last quarter to SEK 155 million in this quarter? Mainly two reasons. We have touched on them already. We released Age of Wonders 4 in May. And as I said we have a degressive amortization method, so we took 40% of the development costs already in Q2, so that pushes up the amortizations quite a lot.
And the same applies for Crusader Kings III and Victoria 3. Both those base games were launched after Q3 2020. That means that we apply the same degressive amortization method also on the DLCs that we release on those base games, so both those DLCs have -- we have taken 40% of the development costs for those DLCs. And those development costs are significant.
So if we look at Crusader Kings III the last time, we released a DLC on that game was a year ago in May, so it's pretty much the full studio's development costs for a year that we take 40% of now in the second quarter. So that push -- those are the main reasons why the amortizations are up SEK 45 million from Q1 to Q2 this year.
Then continuing to dig into the COGS, we take SEK 21 million for amortization of acquired businesses and assets like, when we acquired the Triumph World of Darkness, Playrion and so on. So we amortize that according to a plan. So SEK 21 million this quarter. That has been fairly stable over the last years. Another SEK 9 million in amortizations of fixed assets. That also includes rent for all the studios.
We didn't cancel any developed or any capitalized projects at all this quarter. We used to do this a couple of years ago quite a lot, but yes, now I think over the last six quarters, it's five quarters that we haven't had any write-downs at all. And that is -- thanks to us changing our approach to high-risk projects as we have discussed several times before.
Finally, we have royalties, tech costs in the publishing organization and noncapitalized development costs. That's an item that reached SEK 153 million in the second quarter this year compared to SEK 83 million same quarter last year or SEK 113 million in Q1 2023. And let's start with royalties. So, we have had royalties of roughly SEK 30 million over the last quarters. Now, the royalties came in at SEK 50 million, so it's SEK 20 million more. And what often drives the royalties for us is the amount of revenues we have on Cities: Skylines and what we released on Arc because -- on Cities: Skylines, it's an externally developed game, so we pay the studio Colossal Order a royalty.
This quarter, we have come out with content on Cities, so Cities have sold quite well. Therefore we have significant royalties to Colossal Order, but that's not any different compared to the last two, three quarters. The same goes with Arc titles. We have released Mechabellum this quarter, but we have had revenues from the Arc titles like Across the Obelisk and Stardeus previous quarters as well, so it's another thing that is driving up the royalties. And that's the substantial revenues we have had from Age of Wonders 4.
Now Age of Wonders four is a studio that we own, but we acquired -- sorry. The -- Triumph the studio that has developed Age of Wonders 4 is a studio that we owned. We acquired Triumph some six years ago and we agreed on an earn-out structure, so we are paying the sellers of the Triumph Studios, who are still running the studio. They receive an earn-out based on what the games that the studio has developed -- generating revenues. It was the same for Age of Wonders: Planetfall that we released in 2019, but that game didn't sell to the same extent as Age of Wonders 4 is doing, so now when age of four -- Age of Wonders 4 is performing very well, we are seeing an increased level of earn-out to the sellers. And that is being booked as royalties. Therefore, the royalties are up compared to the last quarters.
Finally noncapitalized development costs and costs for the tech development we have in the publishing part of the business, SEK 103 million compared to SEK 64 million of the same quarter last year or SEK 83 million in Q1. So that is also up mainly three reasons. One is, I mentioned this VR collaboration we have for one of our Vampire brands. We have taken I think SEK 9 million as costs here. Those costs are met with an identical amount of revenues, so that has helped the revenues, but we also have then additional costs of SEK 9 million.
A second reason to the increase is that we have for many, many years had a profit-sharing program at Paradox which means that we set aside 5% of the profit, plus social contribution and share that with all the staff. So, 5% plus social contribution means 6.5% roughly. And a quarter like this like the second quarter in this year, when we do very well, means of course increased profit share. So, if we compare it to the first quarter of the year, we are having SEK 154 million higher profit, so that also means roughly SEK 10 million more profit share, which translates to SEK 10 million more personnel cost. And the majority of our personnel works in our studios, so therefore, the majority of the SEK10 million ends up as a cost under COGS. Therefore it increases. I think that was enough about COGS.
Let's move a bit quicker through selling expenses also quite an increase compared to the last quarter's levels, SEK90 million of total selling expenses compared to SEK40 million same quarter last year; two drivers, one we have released a lot during the quarter a new game in Age of Wonders 4 and a lot of DLCs. That drives of course selling expenses.
The second reason is that we have also already mentioned, we have started to market the games that we release in the upcoming quarters like Cities: Skylines II, Lamplighters League, Star Trek and Life by You. So we have taken those costs -- some of those costs already now. Therefore, the selling expenses are up.
Admin expenses almost the same, slightly up. And it's up due to the same reason I mentioned under the COGS walk-through. The increased profit sharing comes with increased personnel costs. That impacts slightly less, but some admin expenses and on selling expenses.
Below the operational -- below those three lines, we have other income and other expenses, SEK10 million this year compared to SEK16 million last year. These are movements in currencies especially during the quarter and especially how the dollar moves against the SEK. So both quarters dollar has increased against SEK, so therefore we see positive impacts.
Now we have a new item that we normally don't mention during these calls, but we have financial items below EBIT. And that has -- normally it's fairly low but -- or not that significant but this quarter it's SEK18 million. And it's built up by three things. The major thing and what stands out this quarter is the sale of our shares in Hardsuit Labs, so that has increased those financial items quite a lot yes.
The other two items are interest on our cash holdings. We have some SEK800 million of cash and now with increased interest that is yielding some interest for us. And then we have also calculated it's -- and accounting-wise, it's calculated interest according to the IFRS lease rules, so instead of booking our rent as rent, it comes in as an amortization and as -- and calculated interest that is also showing up on the financial items. And that's why it was negative, the same quarter of last year.
Let's move to the next slide, revenues and operational -- operating profit quarter-by-quarter. Again you can see the record in both profit and revenue, but perhaps more importantly you can see that it varies a lot. And even though it might look like a trend, it might be a trend but our revenues and profits -- we have said it so many times, but I want to say it once again. It varies with what we release. This quarter we had a lot of releases, so we are making record revenues and record profits.
If the next quarter comes with less releases, we're going to see a decline. And we have had a history of very volatile quarters, because the release pace is even -- is uneven. And I think I'm pretty sure we're going to continue to see that we're going to see quarters like this where we go up a lot. And we're going to for sure see quarters where we go down, but hopefully we'll go up more than we go down. That's the very hard aim.
If we group four quarters together and look at a rolling 12-month picture, it's much easier to see the trend. And if we remove the spike we saw during the initial -- the start of the COVID years, and the following downturn it's a fairly stable trend both in terms of revenue and profits.
Cash flow important -- very strong cash flow during the second quarter of this year. Operating activities generated SEK 422 million. If we look at last year so last 12 months it's SEK 1.253 billion in positive cash flow. I think it's the first time we are above SEK 1 billion and we are with some margin.
Investing -- cash flow from investing activities reached SEK 172 million. The item consists of two sub-items. One is investment in game development. That amounted to SEK 224 million, but then we have a positive side here. And that is the sale of our shares in Hardsuit Labs and that has a positive effect of SEK 53 million.
So what we don't see in this chart but -- that is cash flow from financing activities. We paid dividends of SEK 211 million in the second quarter. So we paid that out to the shareholders, but despite that -- despite of paying out SEK 211 million as dividends we have increased the cash position slightly during the quarter which we are very happy about.
Next page. Total non-current assets and total equity continues to go up. Total equity has increased and this is pretty much our profit after-tax minus what we have paid in dividends. And here you can see what I said yes. The equity has gone up between end of Q1 and end of Q2 despite us having the dividends of more than SEK 200 million.
And the total non-current asset continues up. The biggest part is capitalized development. That is close to SEK 1.8 billion now 26% up versus last year. So this is developed games that we are waiting to release.
That was all I had planned to walk through. I know that we -- now we have time for questions. I know we have received questions in advance. And please feel free to write questions to ir@paradoxinteractive.com and we will try to answer them now. If we don't have time enough we will answer them after this call, but let's start.
Question-and-Answer Session
A - Alex Bricca
This is a question for you Fred. How is Paradox adapting to the rapidly growing and shifting AI landscape in the games industry?
Fred Wester
Yes, man. It's a very broad question. And as we know and I've said it before that AI is going to in the long-term at least transform this industry into something completely different than it is today. And it's going to help us with a lot of things. That being said, in the short-term, we're exploring AI more as a tool for helping us out and being more efficient in game development. So I will say our main focus at the moment [Audio Gap] is testing AI from the core. Again just speaking long term improving game development in every part from programming coding into art and even game design as well so -- and writing stories obviously and -- but one thing with AI as well is we also need to be very careful about the technical and legal aspects and who owns what et cetera in this little environment that is AI. So --- but we're really forward leaning and hope to learn a lot more in the coming year and years on AI because it's very important to us. I'll take -- sorry.
Alex Bricca
Yes, no. Thank you. Go ahead.
Fred Wester
Yes. Next question Alex is for you. And have sales from console players been significant? And is it profitable to continue to port PC games to console?
Alex Bricca
Yes, it has been significant. This quarter it went up. We had almost SEK 100 million or perhaps even a bit more from consoles in this quarter so it's -- that's up to 15% of the total sales so it's for sure significant. And then you should remember that we don't -- we haven't ported all our games to console. It's, especially, Cities: Skylines is doing quite well on console; Stellaris and CK III not that great, but still an important part of our business yes. Normally, it comes with limited cost to do this port, but with significant revenue, so it's for sure something we continue to do as long as our fans like to play our games on the console platforms. Okay. A question for you Fred. Okay, at the recent investor deep dive that we had in May Victoria 3 was not listed as an endless title yet. Are you seeing progress toward that metric with the release of Voice of the People the last DLC? Are you there Fred?
Fred Wester
All we could -- Victoria 3 – hello? Alex, do you hear me?
Alex Bricca
Now, I hear you.
Fred Wester
Okay. Good. Some technical difficulties here in the middle of the forest, but so speaking about Victoria 3, overall, all-in-all we consider it a good release. It -- however to be included in our portfolio that we consider endless games, there are a couple of things we want to see from the title, retention numbers, DLC attachment rate et cetera, but the team is really focused on working together with the community to work on the things that has been challenging for the game since release. And we have good hopes for this game, and we hope to present a lot more during this fall and the coming year. So, it's getting there, but there is a little bit weak.
Alex Bricca
Thank you.
Fred Wester
And Alex looking at selling expenses should we view Q2 as a full marketing quarter? And should we expect selling expenses to increase further or rather stay flat in second half of the year?
Alex Bricca
It's a relevant question. So Q2 was kind of record high in terms of selling expenses driven by two things as I mentioned, and that -- so we had record many releases in Q2. That will shift. So in Q3, it's of course likely that we won't have the same number of releases so that part of the selling expenses is likely to go down, yes, but the part of the selling expenses in Q2 that regarded games to be released, I think that will continue to be at this level perhaps even increase like -- the closer we come to release.
Alex Bricca
All right, I don't see any more questions. No more questions. And as I said, please, if you have more questions continue to write at ir@paradoxinteractive.com; and we will answer them after this stream. Thank you very much for listening in. And again sorry about the technical difficulties. We will see you again at the end of November -- no at the end of October, when we release our Q3 report. And I hope to see you in the studio then Fred, so we have slightly less technical challenges.
Fred Wester
I will be there for sure. And looking forward to seeing all of you viewers as well by then. And until then bye-bye and take care out there.
Alex Bricca
Thanks everyone. Have a good day.
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Paradox Interactive AB (publ) (PRXXF) Q2 2023 Earnings Call Transcript