My Royalty Report

Says

I Owe How Much?

The hard part’s done... right?

You’ve pitched the product and beat the competition Negotiated the deal Developed the game

Which cost more than you thought, so the margin is less

Checked the review scores and smiled Seen the game published and smiled Received the first royalty report, and…….. Wept!

Welcome to our world!

Royalty accounting has become a major undertaking, complicated by

The growth of the industry More data to capture Millions of dollars, millions of units, dozens of territories Online and mobile gaming

Non-standard publishing and development deals Standard royalty reporting formats by publisher

So squeezing non-standard data into standard reports Merger, acquisition and bankruptcy of developers and

publishers alike Legacy accounting systems forced into an Excel spreadsheet

Publishers aren’t thieves!

Almost all the publishers MF audits strive to do well The royalty staff who work for them are not personally motivated

to deliberately defraud the developer Honest people trying to do a competent job Under-investment in accounting systems

There are exceptions Some publishers are less rigorous and accurate than others Royalties are a cost centre item and will be controlled like any

other cost – especially when cash is tight

Developers historically don’t push hard enough for what’s rightfully theirs

What is a royalty report?

A quarterly review of a title’s performance Calendar quarter reporting, but not always calendar quarters

reported E.g. December – February reported as Quarter 1, with the royalty

report being received 45 - 60 days after the quarter end. Cash flow effect means that royalties on sales made in December will

be paid to you in mid-May. Royalty report

Percentage of net receipts, however defined Fixed $ amount per unit

Distribution report Share of net income/profit of the game More complex analysis

The developer challenges

Every publisher has a different reporting style More than one publisher = numerous reports One style to accommodate numerous different contractual

requirements Lack of detailed information on the report Lowest common denominator information provided

Less work for the royalty accountant Less information = fewer questions In-house ability to interpret the information

Reporting styles change over time Systems changes Acquisitions and Mergers

The wish list

Detail the information requirements in the contract Include a royalty report template in the contract Get as much detail as possible

Sales units, gross revenues, returns units, returns amounts, price protection, net sales units, manufacturing costs, marketing spend and any other deductions……….by country

Whatever the contract specifies, make sure the detail is on the report.

Reject the royalty report if it doesn’t match up Ask questions – and don’t give up.

What can you do?

“Do the math” Publishers’ staff do make mistakes

$$ millions invested in SAP and Oracle and the royalty reports are put together on………….Excel!

People mess with the formulae on the spreadsheet And then they quit!

Check the column totals Check the brought forward numbers Check the percentage calculations Check for sub-licence and bundle activity

Especially if you’ve seen the products in store or on the web

What can you do?

“Do even more math” Divide gross revenues by gross units to get gross revenue per

unit New full price release should be minimum $30

Net sales units and revenues as a % of gross Top titles net sales usually > 85% of gross sales

Manufacturing costs PC CD < $1.50 Videogame <$9.00

If you can’t do the checks – hire someone who can

Outcome of actual games industry reviews

Understated sales revenues Overstated manufacturing/distribution/marketing costs

and other deductions Transposition errors onto statements Overstated bad debt provisions Incorrectly calculated and held retentions Inappropriate low price selling activity Weak consolidation activity by HQ

Understated sales revenues

Generally, revenue reporting is accurate Sales invoicing systems for sales to retail are the most robust Online and mobile gaming – different challenges

Errors and omissions of non-routine sales Rental income from Blockbuster and others Sales in new territories, missed off report Sub-licence, OEM and bundle activity not captured

Overstated deductions

Deductions may include Manufacturing (cost of goods) Distribution Marketing and MDF

Standard costs applied at the start of the deal Always err on the side of the publisher Rarely updated for actual cost unless audited Beware publisher inclusion of a percentage for their own staff

costs

Always seek support for marketing and MDF spend

Transposition errors

Not all publishers’ systems are “joined-up” i.e. sales and other data sources feeding directly into the royalty

report

Royalty report compiled by taking numbers from different reports and sources

Human error can and will happen And errors can go both ways!

Overstated bad debt provisions

Again, publisher will always be conservative i.e. they will over-provide initially, say, a “standard” 2.5%

Most publishers have actual bad debt of 1.0% – 1.5% A minimum of an extra 1% of revenue is being retained

by the publisher, which goes straight to their bottom line A 1m unit seller will have revenues of say $25m

1% over-retention is $250k A 15% royalty would mean you are owed $37,500

Only an audit would expose this over-statement

Retentions wrongly calculated and held

Provisions for returns and price protection i.e. a “standard” percentage of net revenues Usually 10% - 20%, released 3 – 12 months later

Beware Retentions at different rates to the contract Retentions not being released as actual returns and price

protection incurred Retention reserves wrongly carried forward

Simple transposition errors

Inappropriate low-price selling activity

Sales at low revenues per unit Particularly if soon after release Publisher moving inventory of poor-selling titles by mixing with

better titles at low prices Sales guys struggling to make targets at quarter end

Sales to European distributors at lower than US prices Affects European sales adversely

Sales to rental chains Low initial sale price augmented by rental income share Check the rental share is reflected

Weak consolidation activity by HQ

All territories’ results consolidated at HQ Forced into a standard spreadsheet

Scope for errors in Exchange rates used - $ counted as € “New” territories overlooked and not consolidated Simple addition errors if not computerised Deal format not reflected in standard spreadsheet

Too much human intervention Lack of continuity when someone leaves

So why should you audit?

A standard business practice Especially in the music and movie businesses Royalty auditing now accepted by publishers as a business

exercise An audit is a contractual right – enforce it

Good corporate governance When you suspect an error

Sell-through data doesn’t tie with royalty reports The math poses questions and you’re not getting answers When the publisher is uncooperative generally

For peace of mind It’s good to know you’re not being paranoid!

What do you need to do?

Make sure you have audit rights No, really…….you’d be surprised…….! Time expiration of audit rights Audits only permissible during certain months

Be organised Contracts (signed copies of originals) All royalty statements Amendments

Contractual, email or verbal amendments need noting Timely responses on questions during the audit

You audit, then what happens?

MF has always found inaccuracies Almost always in the developer’s favour

Two publisher approaches “You’re absolutely right, we’ll tighten up our systems and send a

cheque immediately” “So sue me”

A negotiating tactic to reduce the exposure and buy time Publisher will plan the “hit” into the next quarter in order to hide it Will not say, “Earnings lower than forecast due to errors in royalty

accounting”

Be prepared to go the distance

Summary

Royalty accounting is complex – a specialist area Little standardisation within or between publishers Numerous areas and scope for errors to be made Systems are lacking, not publishers’ integrity Review and question your royalty reports Audit as a matter of routine

It’s not personal, just good corporate governance Third party shareholders will expect it

As an absolute last resort, be prepared to sue

Media Forensics Ltd

Thank you for your attention We look forward to discussing individual

requirements at your convenience

Tim Christian Mobile + 44 (0) 7768 883808

Email tim.christian@mediaforensics.com Faye Sieracki

Mobile + 44 (0) 7971 966119Email faye.sieracki@mediaforensics.com