Earnings Transcript for PDX.ST - Q2 Fiscal Year 2024

Alex Bricca: Hello, everyone, and welcome to the second quarter stream of 2024 of Paradox Interactive. I'm the CFO, Alex Bricca. And with me on Link, I have our CEO, Fred Wester. How are you doing, Fred?

Fredrik Wester: I'm doing really well. And I want to start by apologizing for pushing this a couple of hours forward. I'm on a different time zone. So I appreciate very much that I can still take a part of the live stream for the Q2 report.

Alex Bricca: Good to have you with us. So what do you say?

Fredrik Wester: So let's get started. No, let's get started. Nothing to sit around just watching. So that's me. To summarize the quarter, like I always do, I would say that the top line, the cash flow looks very good and we are in a very stable position. The EBIT has taken a hit, obviously, due to the write-down of Life by You. But we still see, I think, on the top line and now you have to correct me if I'm wrong, Alex, I think it's the fourth best quarter ever historically, which is enormously strong, considering we don't have -- didn't have any major core games that we released. But we released expansions and many of them did really well for our core live games and hence, the good cash flow. You can also see that in this quarter, the full effect of everything from Arc is being taken directly as costs. So previously, it had a bigger hit on both the cash flow and the EBIT. Now EBIT is hard to measure, obviously, this quarter because of the write-down. But it has sort of caught up because the revenues are starting to flow in from the Arc titles as well. So they're balancing each other out, the costs and the revenue to some extent. As you know, the big event here is that we decided to cancel Life by You. It was SEK 208 million in write-downs, which weighs heavily, obviously, on the EBIT for this quarter. On the other hand, we're taking big positive steps on several of our core developments like Cities

Alex Bricca: Please do. Thank you, Fred. So let's begin. As Fred mentioned and you are not wrong, you are very right, this is the fourth greatest quarter in terms of revenue, SEK 576 million. We were beaten by last year's Q2, obviously, because what was the difference? Well, we released expansions on almost all titles last Q2, plus Age of Wonders 4. Age of Wonders 4 released the base game plus its first DLC in the same quarter, very strong performance. And we have Cities

Fredrik Wester: Yes. But the most important thing here is obviously the trend curve where you see that we're trending upwards. Maybe we should be trending at a higher pace. You always want to do that, but at least it's in the right direction.

Alex Bricca: I agree. I agree. Cost of goods sold, the yellow line, our biggest cost item. So this is all the costs we have to make the game. So costs for internal studios, cost for external studios, royalties to external studios. We have -- we amortized when we have acquired assets that we use to make our games like studios or IPs. We amortize that and we take that has cost under COGS. And what else? Yes, then we have technical costs in our publishing business to make nongame-specific development as well. So this is, by far, our largest item. So Q2 this year, SEK 456 million compared to SEK 338 million last year. So it's up, of course, you already understand that it's a lot driven by the write-down. But let's go through item by item. You can find items in the quarterly report. Amortizations came in at SEK 96 million Q2 this year compared to SEK 155 million same period last year. So it's down. Amortizations in Q1 this year was SEK 120 million. So it's down also from that. And what drives amortization, it's what has been released lately pretty much. And comparing it to Q2 of last year, then we had especially the release of Age of Wonders 4 that generated quite a lot of amortizations, but also the expansion on Crusader Kings III, which we don't have this year. So therefore, amortizations are lower. I mentioned that we take -- when we acquired assets that we use in our game production, we choose to amortize the vast, vast majority of those acquisitions. So we take them as costs little by little. In Q2, we took SEK 14 million, Q2 of this year. Q2 of last year, it was SEK 21 million, so it's down with 1/3 almost. And that's because the acquisitions of Prison Architect and Harebrained Schemes have come to an end. It has passed 5 years, which is our amortization period for most of these assets. So they are fully amortized. What is left this World of Darkness. I think we have something left on Triumph, Playrion and Across the Obelisk. And I think this is a very prudent way to handle this acquisition to amortize them over time. Write-downs, I mentioned, or we both mentioned, so SEK 208 million Q2 this year and 0 Q2 last year, so that makes the whole difference. Then we have royalties, SEK 19 million this year, Q2, which is low. It tends to be around SEK 30 million. And what normally drives royalties is sales on Cities, sales of Age of Wonders 4 and our Arc titles. The reason why it's extra low this quarter is, of course, the sales on Cities has been lower and the sales on Age of Wonders 4 has been lower compared to the quarter before. But we also went through Q4 and Q1 with slightly too high reservations for royalties for Cities

Fredrik Wester: Yes. And when we start not having these big write-downs, the yellow line will follow as well, hopefully, so.

Alex Bricca: Yes, we had a massive write-down in Q4 '23 and one in Q2 '24. So if we look at the rolling 12 months of the operating profit in Q2 2024, then we have included more than SEK 500 million of amortizations and write-downs for Lamplighters and Life by You. So of course, the operating profit rolling 12 months is weighed down by more than SEK 500 million from those 2 projects.

Fredrik Wester: Great.

Alex Bricca: So what else can we look at? Cash, of course, very important. So very strong cash flow this quarter. A few special items, I think, in here. So we have cash flow from operating activities is almost as strong as this was Q2 of last year, even though we had almost SEK 300 million more of, almost SEK 300 million more of operating profit last year than this year or at least SEK 250 million. But pretty much the same cash flow. And the reason, of course, is that what pushes down the operating profit this year is the write-downs, but that doesn't impact cash flow. It doesn't impact cash flow this quarter. It has impacted the previous quarters, of course. We also have a onetime off effect. We have over the last year built up a little too large cash position at our tax accounts and that we have moved back in this quarter, moved it back to our bank account because it gets more interest there. But very, very strong cash flow. Looking at the cash flow from the investing activities, it looks very low and it is very low, but it's for a reason. It's SEK 81 million compared to, I think, SEK 170 million of last year. So it's low because 1 year ago, we invested our surplus cash into bonds and 2 of those bonds representing SEK 70 million came to an end in Q2 this year. So we got the money back and instead of pushing it into new bonds, we found a bank account with a Swedish bank that yields even higher interest with the same low risk level. So therefore, we choose to have the money there and that has improved the cash position with SEK 70 million. If we look at just what we invested in game development, it's SEK 151 million this quarter, so still quite high. It's lower than what we had some 12 months ago. And the reason is we have canceled, we canceled Lamplighters League half year.

Fredrik Wester: And we wrote it down -- we did a write-down of Lamplighters. We did release the game, but we didn't. We took all of the costs in the same quarter to be more realistic about the future chances of the game.

Alex Bricca: Yes. And if we look at the cash flow from investing activities up until, let's say, especially Q2 of 2023, but also throughout the whole 2023, we had investments into Lamplighters, a decent amount. We were 60 people making that game in the U.S. West Coast, which is not the least expensive part of the world. So it's a massive cash flow that we have 0 this year. And it will be the same for Tectonic and Life by You. Throughout the last 12 months, we have had a massive investment year after year into that studio and that project, which we won't have after this quarter. So that will take down the investments into game development.

Fredrik Wester: Right.

Alex Bricca: I think I have one more slide. Yes, it's the balance position. So you can see the total equity in green goes up with -- it pretty much represents the accumulated profit after tax, minus what we have paid in dividend. And you can see in Q2, we paid some SEK 315 million, I think you said it, Fred, in dividends and we didn't have much of a profit after tax due to the write-down. So therefore, the equity has decreased in Q2. The total noncurrent assets are -- is mainly capitalized development and that has come down. You can see 2 big bumps, one in Q4 2023 when we amortized and wrote down Lamplighters. And now again in Q2 when we wrote down Life by You. So that has come down from above SEK 2 billion to I think we're at SEK 1.6 billion at this moment. Those were the slides that we plan to show you. The line is open for questions. And I know that we have already received a few before the stream. So I don't know, Fred, I think it's easier perhaps if I read the questions and then we can perhaps answer every second one.

A - Fredrik Wester: Yes. Sure...

Alex Bricca: So let's start with the question for you then. Aside from Prison Architect 2 and Bloodlines 2, are there any other remaining projects in the pipeline that were given the green light prior to you, Fred, coming back as CEO? Or is the current pipeline from now onwards truly product of current management?

Fredrik Wester: Yes. Except the 2 mentioned titles, we don't have any projects that are outside of our core in the main pipeline as for now. And we don't plan to greenlight anything outside of Paradox Arc that isn't exactly in our core either. However, a few core projects were greenlighted before I came back as well and they're still in development. But these titles are within the segments where we feel very comfortable. And these gains would have been greenlighted regardless of who the whole project schedule or the project management that we were using. So I guess that's the answer to the question.

Alex Bricca: Thanks. All right. I can take the next one then. Excluding the recent poor releases/write-downs, can you talk a bit about how the core portfolio of the big 5 franchises and other smaller titles are faring? Are you happy with the results there? Are you seeing things you want to improve?

Fredrik Wester: Well, can we talk about the big -- maybe big 7? I don't know if Age of Wonders is disregarded for example, but sure. No, go ahead. We can call it big 5 as well, but I think we have more than 5 good franchises.

Alex Bricca: I think what we sometimes refer to with -- I don't know if you used the title big 5, but we have seen a different -- we have had 5 franchises for many, many, many years that have continued to generate high revenues and high profits year after year after year. I think Age of Wonders 4 is a very successful game. But of course, we have a question mark whether it will have the same longevity as our grand strategy game has. But for sure, it's a big and important game for us. But I think we are very happy with the results of these big 6 games in general and in the quarter. They have contributed quite a lot to a very, very strong top line. We have released strong releases on strong content on several of them and good cash flow and very, very strong margins as pretty much always with these titles. So we are very happy with them. But that doesn't mean that we want more. We think that at least several of these titles can do even better. And we have the benefit of having 6 titles that have their similarities, but also the difference -- there are differences in between them. So it means that we can look at some of them and try to copy and paste the successes in some of them to the others and that is what we, of course, are trying to do. But this is an ongoing work. And I've been with the company for 6, 6.5 years and we have never kind of been satisfied during my period here and I guess we will never be satisfied completely with it going forward either. I think there's always something to be done.

Fredrik Wester: No. I mean, to be honest, I mean, in our management meetings, this is the question that comes up all the time, how to be better at things like this. So it's a constant process. So I think a lot of people are focusing on new games and the new pipeline and everything that is new, which is important as well. But we're in the like, if you want to call it, evergreen games industry, which means that our games get better over time and more worthy of play. So a game can last for 10, 15, 20 years and still be better and better every year. So, yes.

Alex Bricca: Thanks, Fred. New question to you. All right. What actions are being taken to ensure that new game projects have a high chance of meeting expected quality standards and being completed successfully?

Fredrik Wester: Well, recently, we've spent most of our focus ensuring that projects have the right quality and risk balance. That's the first thing. Second is that if we -- or any company that works with trying to take a lot of risk on new projects will fail more. The way -- however, the way we have communicated has not been satisfactory. So we have announced games and then canceled them, which is not an optimal way to go. But we have work to do within production risk assessment and continued efforts on quality, especially with things that lay a bit outside of our core, where we don't feel as comfortable all the time. But it's everything, small and large measures. It's from how we handle projects to how we give feedback to developers and who is responsible for what and who has ownership for what in the project. So it's a constant, like, thing that we're developing to be better at every day. And it's very hard to go into details on this, but it's something that we're continuously looking at. And I personally am looking a lot at this. I wouldn't say every day, but at least every week.

Alex Bricca: Thank you. Are there plans for Paradox to pivot to a subscription model instead of the current DLC model? Has a subscription-wide -- has a Paradox-wide subscription rather than game-specific ones been considered? I can answer this one. You can chip in if you don't agree, Fred. But I mean, we want to use the business models and be on the platforms that our fans like to consume our games in. I think that's the main focus. And currently, the model that we have with the base game and pay the deals -- pay them 3 DLCs is a model that it seems that our fans like and we like. So I'm pretty sure that this will remain our main business model for the foreseeable future. But we have -- we have since 2019, I think, maybe before that, Fred, I don't know. But 2019, I think, Microsoft launched the game pass service on PC. And since then, we have happily been on their platform with several of our games to test that out. We have also had, as a question refers to our own subscription models, where we have -- you can subscribe for all the DLCs for -- I think we have it on HOI, CK 2, EU 4 and Stellaris now. And that's -- we have considered different kinds of subscriptions. But I think those are where we would bundle in more game titles into one. But for now the current setup is the one that we're going with. I don't know if you want to add something there, Fred.

Fredrik Wester: No. I mean, we added this as more of a fan service, so you don't have to buy all the DLCs at once, so -- and we're still like experimenting with how we're going to take it forward. It's not going to be our key way of operating in any foreseeable future, like you mentioned, but it's a good way to combine with the DLC model that we currently are using.

Alex Bricca: All right. Do we have more questions? Yes. Is Paradox considering developing more original IPs in the business management genre rather than focusing on acquiring existing games? Or is this not the current priority for the company?

Fredrik Wester: I'm not sure if it's games in the business management genre per se, there was a game called Capitalist once upon a while developed by a Hong Kong studio that I enjoyed very much. That's not an immediate priority. But they're all being original IP internally, if that's the question, yes, we're looking at that. And we're looking at it from different angles like we want to -- do we want to do something historical? Do we want to do something more Stellaris-like where the IP kind of grows organically from within? But also, we're also looking at acquiring existing games, existing IP, existing studios to complement our current business. And like I said before, the market right now is very interesting for these types of deals because there are a lot of distressed assets out there and there are a lot of -- it has been a small crisis in the industry with funding and with selling games and with actually living up to expectations for a lot of games. So I think the opportunities for us are going to present themselves. We see new things being presented to us every week. However, we are very specific with what type of games or IPs that we're looking for. So I wouldn't promise anything to be acquired in the coming year, but we continuously look at opportunities that are being presented. So we'll see. I mean, it's not -- it's not -- our core strategy is growing what we already have. Everything else is kind of gravy, but there will happen some things with new IP and hopefully something external as well. We'll see.

Alex Bricca: Thanks. All right. Here's a long one. You're referencing good development in the core revenues in Q2. If you look at your core revenues, how much are they representing of the total revenues last 12 months? And what was -- or I'll stop there and I will try to answer that and continue later on with the rest of the question. We don't share that granularity of our revenues externally. But of course, it's a vast, vast majority that comes from our core. It's fairly easy to go through over the last 12 months, what have we released that is not core. And it's nothing that has really got a big impact. I think the largest impact was even though it was not a successful project, was Lamplighters League. There we got at least, I think you can calculate it backwards, but some SEK 70-maybe million in revenues, even though the costs were much more. But back to the question, it's -- the vast, vast majority comes from our core. I think the question changed a bit. You're referencing good -- directionally, how do you look at those revenues, organic growth ambitions for the coming 3, 4 years? Same, we kind of never give forward-looking statements, neither for specific games, nor for the portfolio as its whole. But we have seen these core games grow very, very strongly over the last 5, 6, 7, 8 years. And we expect them to be the base for our growth going forward as well. So I can't share any percentage number with you, but we have big expectations on these franchises for many, many years going forward. All right, Fred. If you look at the pipeline, there are fewer games there now than 2 years, say, 6 to 7. How do you look at the health of that pipeline in terms of sequels, strategy games versus other games and riskiness?

Fredrik Wester: Yes. First and foremost, we are not that dependent upon new releases, as you already know. However, it gives a boost, initial boost at least to revenues. So it's always good to upgrade games, make sequels and release new games as well. The thing is what we call the pipeline as well is games that are capitalized on the balance sheet. So the pipeline is actually 2 things. It's the, I don't know if we said 8 games in the report, but there's a lot more going on at Paradox Arc as well, where we have a game like Mechabellum releases, I think the 1.0 version in September, for example, which is not calculated in our balance sheet and therefore, not part of what we call the pipeline either. And we believe it's a healthy way to do it. And looking at unannounced titles, it's a mix of strategy and management games that are close to our core and also a mix of sequels and new IPs. I think the balance in between different types of games, different types of genres where experimenting a bit where the some new creative things in our games. So it's going to be super interesting to see how people receive it.

Alex Bricca: And I can add in terms of riskiness, of course, the risk in the pipeline has gone down since you came back 3 years ago, Fred. I don't think we have started --

Fredrik Wester: Yes.

Alex Bricca: -- with one singular project where we have high risk and high cost that has gone into this pipeline. Everything that we start with high risk is at much lesser costs and outside of this kind of main pipeline or what we should call it. So I think the risk mix is at a much lower level.

Fredrik Wester: Yes, yes, agreed, agreed. I mean, we're much more focused on the games that we make today and the games that we feel are outside of our core are smaller and less risky when it comes from a financial standpoint. And when it comes to -- when it comes to Paradox Arc, we are not announcing anything there that we don't -- that we're not sure that we're going to release. And we have quite a few games and we closed games there as well that we feel that this is not going to be -- this is never going to be finished or it's not going to reach the level of quality that we're looking for. We're closing the games. And these are games that we never announced and they didn't cost too much either and they're taken directly as costs. So no one is going to be bothered by them. But therefore, it's also harder to say what the like pipeline, if you want to say that, looks like because the experimental way of working gives room for a larger pipeline, but also we close a lot of more games. It's hard to say at any given point.

Alex Bricca: Yes, it's a good point for that. I don't know if I forgot to mention that. But when we went through the COGS item, as a last sub-item I mentioned cost that we take -- kind of development costs that we take directly as costs. I mentioned it was up compared to last year's Q2 due to Life by You and the termination costs of Tectonic. But another reason is what Fred is pointing out, the part of our business that consists of game development projects that we don't capitalize has increased. So -- and I think this is a very healthy way to handle it. All right. It's the last question perhaps. In terms of pricing levels, where do you think you are now compared to your competitors? Also, should you view your pricing strategy for CK III as a benchmark for coming sequels and core games? I can try to answer it, Fred, but you can chip in. We have play -- we have made a significant effort, I think, on pricing strategy over the last 18 to 24 months, where we are spending much more time on the issue or the opportunity. We come from a period, I think, where we have been not having the right price, some quite often too low price compared to competitors. Now we have done a significant uplift, I think, both in terms of kind of base price in dollars, but also in terms of regional discounting. But this is -- in order to have the right price, this is an ongoing challenge or work to be done. But I think we are at a pretty good position today, but there's probably room for some revenue increases from price increases still. What do you think, Fred?

Fredrik Wester: Yes. Yes. Also, when it comes to pricing, there are two things you need to take into account. One of them is market fairness that we feel that people should feel that it's fair, the pricing in between different markets. So we've had some markets that's been lagging behind on pricing. The other one is value to the gamers. I mean, we can't overprice our products. I mean, even if some of the Crusader Kings III content has been higher in pricing, it's not like we can just raise the price on everything that we do because we also feel that we need to deliver the value that people are expecting because if we don't, over time, we won't sell anything. So yes, that's pretty much what I wanted to add on pricing.

Alex Bricca: Any more questions? No? That was the last one. So I guess the stream is coming to its end. Thanks, everyone, for watching. And if you didn't get your question answered on the stream, we will answer them afterwards via e-mail. If you come up with questions that you haven't had, please feel free to send them in afterwards. And see you in, I think it's the very last of October when we have the Q3 stream. So see you then.

Fredrik Wester: Definitely. Yes. See you then. Thank you very much for watching. Bye-bye.