My Royalty Report Says I Owe How Much

My Royalty Report Says I Owe How Much?

The hard part’s done. . . right? w You’ve pitched the product and beat the competition w Negotiated the deal § Developed the game n w w 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! w Royalty accounting has become a major undertaking, complicated by n The growth of the industry l l l n n Non-standard publishing and development deals Standard royalty reporting formats by publisher l n More data to capture Millions of dollars, millions of units, dozens of territories Online and mobile gaming So squeezing non-standard data into standard reports Merger, acquisition and bankruptcy of developers and publishers alike l Legacy accounting systems forced into an Excel spreadsheet

Publishers aren’t thieves! w Almost all the publishers MF audits strive to do well n n n 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 w There are exceptions n n 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 w 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 § § § Royalty report § § § 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. 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 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? w “Do the math” n Publishers’ staff do make mistakes l l l n n $$ 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 l Especially if you’ve seen the products in store or on the web

What can you do? w “Do even more math” n Divide gross revenues by gross units to get gross revenue per unit l n Net sales units and revenues as a % of gross l n New full price release should be minimum $30 Top titles net sales usually > 85% of gross sales Manufacturing costs l l PC CD < $1. 50 Videogame <$9. 00 w 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 w Generally, revenue reporting is accurate n n Sales invoicing systems for sales to retail are the most robust Online and mobile gaming – different challenges w Errors and omissions of non-routine sales n n n Rental income from Blockbuster and others Sales in new territories, missed off report Sub-licence, OEM and bundle activity not captured

Overstated deductions w Deductions may include n n n Manufacturing (cost of goods) Distribution Marketing and MDF w Standard costs applied at the start of the deal n n n 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 w Always seek support for marketing and MDF spend

Transposition errors w Not all publishers’ systems are “joined-up” n i. e. sales and other data sources feeding directly into the royalty report w Royalty report compiled by taking numbers from different reports and sources w Human error can and will happen n And errors can go both ways!

Overstated bad debt provisions w Again, publisher will always be conservative n i. e. they will over-provide initially, say, a “standard” 2. 5% w Most publishers have actual bad debt of 1. 0% – 1. 5% w A minimum of an extra 1% of revenue is being retained by the publisher, which goes straight to their bottom line w A 1 m unit seller will have revenues of say $25 m n n 1% over-retention is $250 k A 15% royalty would mean you are owed $37, 500 w Only an audit would expose this over-statement

Retentions wrongly calculated and held w Provisions for returns and price protection n n i. e. a “standard” percentage of net revenues Usually 10% - 20%, released 3 – 12 months later w Beware n n n Retentions at different rates to the contract Retentions not being released as actual returns and price protection incurred Retention reserves wrongly carried forward l Simple transposition errors

Inappropriate low-price selling activity w Sales at low revenues per unit n n n 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 l l n Sales to European distributors at lower than US prices Affects European sales adversely Sales to rental chains l l Low initial sale price augmented by rental income share Check the rental share is reflected

Weak consolidation activity by HQ w All territories’ results consolidated at HQ n Forced into a standard spreadsheet w Scope for errors in n n Exchange rates used - $ counted as € “New” territories overlooked and not consolidated Simple addition errors if not computerised Deal format not reflected in standard spreadsheet w Too much human intervention n Lack of continuity when someone leaves

So why should you audit? w A standard business practice n n n 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 w Good corporate governance w When you suspect an error n n n 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 w For peace of mind n It’s good to know you’re not being paranoid!

What do you need to do? w Make sure you have audit rights n n n No, really……. you’d be surprised……. ! Time expiration of audit rights Audits only permissible during certain months w Be organised n n Contracts (signed copies of originals) All royalty statements Amendments l Contractual, email or verbal amendments need noting Timely responses on questions during the audit

You audit, then what happens? w MF has always found inaccuracies n Almost always in the developer’s favour w Two publisher approaches n n “You’re absolutely right, we’ll tighten up our systems and send a cheque immediately” “So sue me” l l l 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” w Be prepared to go the distance

Summary w w w 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 n n It’s not personal, just good corporate governance Third party shareholders will expect it w 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 966119 Email faye. sieracki@mediaforensics. com