Remedy Entertainment Oyj

OMXH:REMEDY

Earnings Call Transcript 2023-Q2

[Veli-Pekka Puolakanaho, executive]

Good afternoon, everyone, and thank you for joining Remedy's webcast. My name is Veli-Pekka Puolakanaho and I manage the Investor Relations at Remedy. Today, we will go through Remedy's half year review for the first half of 2023. With me are Tero Virtala, Remedy CEO; and Terhi Kauppi, Remedy CFO. We will have a Q&A session after the presentation.Tero, the floor is yours.

[Tero Virtala, executive]

All right, everyone. Thank you also on my behalf. So if we look at the second quarter highlights, our revenue was EUR 8.9 million. It was a decrease of 5% from the comparison period. Our operating profit, minus EUR 4.8 million. Cash flow, minus EUR 7 million. Overall, as we have been emphasizing during this whole year, this is an investment year and our numbers do reflect that. We have currently 5 games in development, 4 of them are co-financed by Remedy. This impacts our profitability now, but will increase the future potential for bigger profitable growth.It's also good to bear in mind that high quality of our games is of major importance to us. We know that quality will always eventually pay off. It affects each game sales opportunities, the value of the game brand and interest that partners overall have for Remedy. We also know that making high-quality games requires many right ingredients and actions throughout the game's long development cycle. But one key phase of ensuring the final quality is in the later phases of game production.In innovative and ambitious games like the ones we do, no one can beforehand say, estimate exactly how much work it takes to get the final quality in place. And making that quality happen is always in our hands as a developer, not in our partners' hands. We are the ones developing these games. And this fact is also reflected in our own investments. We do invest into our game projects during the whole development cycle. But overall, our investments are often skewed towards the later phases of the production.The game that we now have in the very late phase of production is, of course, Alan Wake 2. A big event for the second quarter was the start of Alan Wake 2's marketing campaign. And now, before we talk a bit more on that, let's watch the gameplay reveal trailer and remind everyone what Alan Wake 2 is about.[Presentation]All right. So the marketing campaign for Alan Wake 2 officially began in May. Together with our publishing partner, Epic Games, we have secured a good place in Sony's big PlayStation Showcase, and we came out with this gameplay reveal trailer that you just saw. Alan Wake 2 overall is our biggest game project ever, and the original game Alan Wake, launched 13 years ago. So it's fair to say that Alan Wake 2 has been in our minds for a long time.It's an ambitious game. Alan Wake 2 built strongly on the foundation of the original Alan Wake, but it also takes it significantly further. Now the first gameplay trailer that we gave out, gives one glimpse to the game, introducing Saga Anderson as the new playable co-protagonist. Marketing after the reveal trailer continued in June with behind the closed doors demo at the Los Angeles Summer Games Fest Play Days event. It was a 35-minute live demo and there was a lot of interest for that. In fact, every one of our 15 demo sessions was full and we needed to take more people than originally had been anticipated. This was naturally a change that we gladly welcomed. The audience also liked what they saw as Alan Wake 2 was selected as the singular most anticipated title in the event.Additionally, other PR and marketing activities have been carried out like we have selected European and Finnish outlets to whom we also showed the demo. There was good media coverage by big gaming medias like GameSpot, IGN and other high-profile medias and naturally some selected social media campaigns were being carried out. Now marketing campaign will of course continue also with new activities closer -- the closer we get towards the launch.And if we sort of talk about the reception that we had, first of all, the new playable character Saga Anderson was seen as a positive thing. Many guests that we had due to Alan Wake -- the first version of Alan Wake being launched already 13 years ago, many guests were new to series overall. But after watching the demo, the consensus was that newcomers will have no problem in jumping into Alan Wake 2. And this is also supported by the fact that in addition to Alan Wake, we have the new character as a playable one, Saga Anderson.Alan Wake, as I just mentioned, was selected as the singular most anticipated title. And as a clarification, this was just by more than 40 global media outlets and their professionals who had seen most of the games of the whole event. So, so far, the start of marketing campaign has been very promising. Marketing will naturally continue with new activities the more we go towards August, September, October. It's definitely going to be a busy and exciting fall also in the marketing front.Then when we look at the wider project portfolio, Alan Wake 2, as was mentioned, is in full production and progressing towards its October launch. In relation to Alan Wake, it's also good to mention that Alan Wake Remastered did not yet generate royalties in the second quarter. However, our plan with Alan Wake Remastered has all the time been that it's part of the wider Alan Wake 2 plan. Alan Wake Remastered in itself is a great game, but also a means to introduce the world of Alan Wake and build awareness for Alan Wake 2. As the marketing campaign for Alan Wake 2 kicked off, more players will find Alan Wake Remastered. That was our plan and that was the expectation. And in fact, that has happened. The game has now reached breakeven after the reporting period in July.Now as Alan Wake 2 is now getting closer to launch, more developers will free-up from the project and move to our other projects. These other projects have been longer in the earlier development phases, on one hand, making sure that the groundwork is done well before moving to next phases in '23 and '24, but also on one hand that they are expecting now to get more people. And this fall, we are getting more people from Alan Wake 2 and other projects are ready to take them onboard.Control 2 out of the games continues in proof of concept stage. Condor, the spin-off of Control, service-based coop multiplayer game is also in proof of concept phase, but now quite close already to production readiness stage. With Vanguard, our free-to-play coop multiplayer game, we are aiming to complete this long proof of concept phase by the end of the year. Max Payne 1&2 remake is also in proof of concept stage. And one of those projects that will expand during '23 as we get people freeing up from Alan Wake 2. So overall, there has been progress with our projects and our projects are ready to take on more people as they are now freeing up from Alan Wake 2 and then move towards their next development phases.Okay. And then a few words on a highly important topic in a way, our people. The people, as we have so often emphasized, are at the heart of Remedy world-class talents that we have. We now have at the moment over 380 world-class talents, supported by better external development capabilities and good partners in that front. We are selectively still recruiting new talent. There are areas where it deems, strengthening are justified. However, it is good to note that this new recruitment needs are not anymore that big, that high as they used to be in the past years. We do still expect a slight increase in our total headcount due to the targeted recruitments to further strengthen our teams. And we are in a good position to successfully do that.On one hand, Remedy is a highly regarded employer in the industry. On the other hand, we also have very interesting game projects and roles for talented people. And thirdly, at the same time, there is uncertainty in the global economy and also among many gaming companies in the industry. Gaming companies overall have slowed down recruitments. So our position now to get those selected targeted recruitments is strong. But also in people front, as our recruitment needs are not as big as they used to be in the past years, even more focused than before goes to professional development, career progress of our people, leadership training, ways of improved working, how our teams work and develop the games and how we collaborate internally all the time better and better.All right. Then a few a few words also, in a way, on the wider context. I just want to remind everyone that where we come from, where we are at the moment and where we are aiming to go. We now have all the key elements in place to develop our road map of these current 5 games and succeed with them in the future. Reaching this point has been a long process. 6 years ago, we started the transformation to be able to develop longer engaging games on top of our unique strengths to make multiple of these games in parallel. And while doing this, also to gain a stronger position in the value chain, and therefore, eventually get more of the value created from our games.This has been a long transformation. We have faced our challenges. But we have been able to take these learnings and all the time improve. All this has taken time. And now, end of '22, we have reached our goal to have a strong organization and an ability to develop the games we have in our hands. We now have a high portfolio of 5 games. It consists of longer engaging single-player games, which are closer to the strengths that we have always had, but also 2 service-based multiplayer games that are building us capabilities that we can utilize in many of our future games.We have trusted partners in place for all of these 5 games, partners that are the right ones for these games. And overall, we have gained a stronger position in value chain. Out of the 5 game projects, 4 are based on Remedy owned brands. Remedy is a co-publisher in 3 of these. Max Payne is the only one owned by our partner, Rockstar, but it's a great match to our portfolio. We have a strong cash position, high potential games in development and ability to develop them.According to our strategy, we have in collaboration with our partners started to invest also more of our own money to these games to gain bigger benefits when we get these games into the markets. We are, therefore, currently in an investment phase. These investments are done to enable major growth opportunities in the future and even stronger position to benefit from this growth.With this strategy, we see that in the coming years, we have ability at the same time to develop new games and live operate existing ones. We can have game updates and game launches every year. We have longer engaging games which also gives a possibility to longer recurring revenue. There is a higher royalty upside with these games. And also, with the co-publishing arrangement, we have a direct involvement in game marketing and sales and also stronger ability to build, connect and serve our gaming communities.Having said that, I'll hand over to Terhi to talk a bit more on the financials.

[Terhi Kauppi, executive]

Thank you, Tero, and good afternoon to everyone also on my behalf.So let's go through the financials a little bit more in detail. So quarter 2, our revenue decreased EUR 0.5 million from comparison period. And in percentages, that was 5.3%, ending up to a revenue level of EUR 8.9 million. Out of that, development fees were 89% and royalties 11%. The decrease in royalties was 52%, and that's EUR 1 million due to Control game. And like mentioned, Alan Wake Remastered did not yet -- failed to recoup, and thus, did not yet generate royalties for us. Our development fees grew by 7%. We received development fees from all of our projects in development phase and their amounts vary from comparison period based on projects in different phases.And when looking at historically, and reminding again, there has been and there will be quarterly variation in revenues, and thus, also in profitability. The level of royalties has been low for quite a while now due to Control being old game and lack of new major releases. And we are in an investment phase and that is reflected in the profitability. For quarter 2, the EBIT was negative by EUR 4.8 million and that's minus 54% of revenue. The decrease in profitability was due to a bit lower level of revenue, but also due to higher outsourcing, staff and other operating expenses as well as lower level of capitalization. We are now, as planned action, financing a lot to share ourselves during project development phase to ensure higher future revenue shares.When looking at the first half together, our revenue was EUR 15.8 million and the decrease was 28.3% from comparison period. And the decrease mainly was due to timing of the project milestones and related revenue recognition, but also again lower level of Control royalties. And here, out of total first half revenue, the development fees were 91% and royalties 9%. And yes, the investment phase is reflected in the profitability also for the first half.Here, for the first half of this year, the EBIT was negative by EUR 10.4 million and that's minus 66% of revenue. Whereas in comparison period, we had a slightly positive EBIT of EUR 0.4 million. Decrease for the first half in profitability was due to clearly lower level of revenue, but also due to higher expense level and lower level of capitalizations. And for transparency reasons, we also present here the unaudited amount of expenses, because in IFRS, we need to net the expenses with the capitalizations.And when looking at these numbers, we see that the external work performed was on a slightly lower level than in comparison period, EUR 4.7 million versus EUR 4.9 million in comparison period. And the IFRS format unaudited amounts are EUR 4.1 million versus EUR 3.5 million. And the difference is due to capitalizations of external development costs. In personnel expenses, we had a 10% increase due to increase of about 9% in personnel to 347 people from 318 people. Our capitalizations were on 37% lower level than in comparison period and mainly due to project Condor's lower level of external development work.Our operating cash flow was negative by EUR 7 million in quarter 2, and in comparison period, it was negative by EUR 8.3 million. The total cash level was EUR 39 million, which is still strong, although there has been about EUR 17 million reduction in liquid funds during the first half of this year. And in addition to pure bank account balances, we have now about EUR 10 million in liquid instruments like interest funds.And yes, the current profitability level is impacted by increased investments to product development and by composition of revenue, i.e., we bear more on risk in development and we have had lower level of royalties. But overall, we see possibilities for our top-line growth and improved profitability in the long run. And that in mind, we make appropriately wise decisions, although in shorter term, this impacts our numbers. But with still a strong cash position, we build up the bases for long-term success.And we have a balanced portfolio of projects. We have a sub-contracting type agreement with Rockstar Games for Max Payne. We are working with pack of 5 games and Epic in a model where Remedy owns the IP publishing partner funds the development partly, and we share game sales profits. And we have co-publishing deals with projects, Condor and Control 2 as well as Vanguard, and these are IPs owned by Remedy.And here is the same portfolio described by the type they generate revenue for us, especially taking the timeline in account as we are in investing phase. The higher we move up in the picture, the more there are models where the profitability of game project is depending on game sales rather than development fees received from publishing partner. And if you look at the pluses and minuses related to development phase, you see that in partner IP sub-contracting type project, we usually have margin already during the development phase, but in other models, not.So please, Tero, you can continue from here.

[Tero Virtala, executive]

Thank you. So just to shortly recap on our outlook. So outlook stays unchanged. So we expect our revenue to decline from previous year and the negative operating result. And before we jump into questions, just a reminder that our long-term objectives remain the same. The objective is that by the end of '25, we have created several successful games and at least one major hit game, this meaning a game that reaches the global top-selling chart and then keep on succeeding also after reaching it.We have the unique creative skills and we can create worlds, characters, stories that really build powerful brands. We will own at least 3 expanding game brands, all with long-term hit potential. We also will have commercial capabilities so that we can ourselves select the right commercial model for each of our future games, whether in some games it could be self-financing, self-publishing or if it's working with publishing partners with the specific model. Great people also continue to be a key focus for us. We aim to be the most attractive gaming industry employer in Europe. And as has been said, in the long term, we aim to reach each of these objectives, while having a long-term profitable and growing business in which we are managing our risks well.But that's it on the presentation side. I guess, now it's time for questions and answers.

[Veli-Pekka Puolakanaho, executive]

Yes. Thank you, Tero. Thank you, Terhi. [Operator Instructions] And actually, there are a few questions already there. So Terhi, how much intangible assets in game development versus game engine expenses? Can you break that a little bit?

[Terhi Kauppi, executive]

Yes. I would say that overall, the capitalization of game projects is based on the future expected returns for that project. So they are based on a project business cases. And yes, surely some of the work performance for the projects also include work for the game engine, but that cannot be directly separated.

[Veli-Pekka Puolakanaho, executive]

Then there's a question, was Alan Wake 2 total budget increased or bigger than initially expected? And how do we view the prospects of game revenue potential versus total budget compared to what Control has achieved?

[Tero Virtala, executive]

Yes. Alan Wake 2 development budget has increased during the development. It was end of '21 when we evaluated the game with the big ambitious game, big game. We saw a lot of potential, certain innovation that we wanted to realize and they would have required more work. And it was at that point evaluated with our partner, Epic, that making the game bigger than originally was planned made sense. And we decided then to increase the game size and the bot set. And at that point, it was also decided that Epic is bearing significant part of the cost, but we are also ourselves investing into the game.And was there another part of the question?

[Veli-Pekka Puolakanaho, executive]

How do you view the prospects of game's revenue potential versus total budget compared to what Control has achieved?

[Tero Virtala, executive]

Well, I think Control was definitely a great achievement for us. It was, in a way, done with a very manageable AAA budget. At the same time, it was also justified that it was done with a smaller budget because it was a first installment of a completely new brand, which in itself then always includes quite a lot of risk. And we were able to do it, in a way, the breakeven point was lower. And after that when the game has continued to sell, it has been a success and a very profitable one both for us and for our partner 505 Games.Now Alan Wake 2 has a bigger budget. It does need to sell more. But in comparison to most other AAA games, our budgets are still very manageable and clearly kind of like on the lower end of the really big budget games that there are in the market. And together with our partner, Epic Games, we do see that the business case for a high-quality game is still kind of like very reachable, a good business case, and that's where we are aiming. And both us and our partner, Epic, are confident that Alan Wake has the potential to become a good success.

[Veli-Pekka Puolakanaho, executive]

Are you still confident in one game launch per year after Alan Wake 2? And could this goal push the firm and the employees too hard and lead to rushed releases?

[Tero Virtala, executive]

Well, that is our plan at the moment and that's where we have been developing primarily to have that ability. And in that front, nothing has changed. Now would we boost the firm to rushed releases in order to set it in stone that we'll have one game per year, definitely not. So we cannot have -- no matter if we would have one game launch per year, it's still not that much. And the high quality of our games not just affects the potential of that individual game, but the value of the overall game and the opportunities that we have for spin-offs and sequels for that game, our value and interest in the eyes of our future publishing partners. So we don't rush releases if they jeopardize the quality.But then the other aspect is that, currently our plan is to have one game launch per year. But now, of course, we are eyeing the situation all the time and evaluating; is the game, in a way, the next game progressing in the time and quality that we want to release it exactly in that timeline currently it is. But as an example, when we launched Control in 2019, we had an early idea to move that team earlier to the next project. But Control ended up being so successful that the business opportunities that presented in 2020 and still in 2021, in a way, made all the sense that we get the team longer with Control, which in a sense, pushed then the future releases of the next games, but I think it was a very justified call. And that's also when we have more games, a positive, in a way, situation where we may end up at some point. But at the moment, we are, in a way, planning to have one game launch per year. And at the moment, we are on track to do that.

[Veli-Pekka Puolakanaho, executive]

Next question relates to Vanguard and Condor. In a market where players tend to play biggest online games, how will Remedy cooperative multiplayer games differentiate themselves?

[Tero Virtala, executive]

Well, I can't yet reveal too much. That's always, in a way, part of then the marketing campaign once they -- when they start that we are utilizing. But what we have already said, I think the question in itself is very relevant, because in a way, it is quite a biased market in that sense and polarized market, in a way, the biggest and most successful games take a big part of the market. And in order to be able to enter into that space, one needs to have a high-quality games, but the game also needs to be unique. It does need to stand out and differentiate. And that is definitely in our mind when we build our games.And I guess, it's understandable and fair to say that we are building games, also the multiplayer online games, partly utilizing the strength that Remedy has in the world building, in the characters, in the narrative and story side. Of course, applying these to multiplayer service-based games is different, but that is one angle where we believe and are now in the games in development seeing that we can bring something new into the genres.

[Veli-Pekka Puolakanaho, executive]

Then a question for Terhi. Will Q3 and Q4 be more cost-heavy on goods of costs sold and operating expenses since you released a game or how we should think about the costs?

[Terhi Kauppi, executive]

The short answer is, not really, because our operating costs are consisting of staff expenses, external development costs and then other operating expenses and they do not directly vary according to the game launches. The marketing campaigns are organized and primarily beared by publishing partners.

[Veli-Pekka Puolakanaho, executive]

How should we think about the length of the full production stage for Vanguard and Condor? Is it fair assumption? Is it fair to assume a shorter duration from the start of full production to launch than for AAA games like Alan Wake 2?

[Tero Virtala, executive]

I wouldn't centralize in that way, because all these games, they are unique projects. Vanguard has been long in development. And it's mainly been for OPs and that it's something very new to us. It's a massive game, free-to-play, service-based, really long-lasting game. We have been learning on the way, in a way, there have been changes that we have been making for the team. So now, in a way, it has been progressing better and better all the time, but it's still, in a way -- there is still a lot of development to be done before we one day are able to launch it.Naturally, overall, for this type of service-based games, the difference does come in the production that the game is never ready. So one day, it is possible that it will then, in a way, have its beta phase launches, early stage launches. And in that sense, it doesn't need to be perfected on every single angle like a tradition of AAA or single-play game needs to be. So that is true in that sense. Condor on one hand, kind of like, it is a co-op multiplayer service-based game, but it's more contained. It's not kind of like as big and as complex for us to make as a free-to-play game like Vanguard.

[Veli-Pekka Puolakanaho, executive]

Can you give any comment on Alan Wake 2 pre-sale figures?

[Tero Virtala, executive]

At the moment, in a way, no, we cannot give anything concrete on that. And that's of course also based on the agreement that we have with our partner, Epic Games. Pre-sales overall, what can be said is that during the past years, the tendency has even more been that pre-sales are one part of the marketing campaign and pre-sales are very much focused in the last weeks before the launch of the game. But overall, in a way, on marketing front, I can say, as was said in the presentation that the early reception and what we have seen, it has been very promising.

[Veli-Pekka Puolakanaho, executive]

Are you seeing a possibility for a delay in the release of Alan Wake 2?

[Tero Virtala, executive]

At the moment, we are heading to the October launch. But now, in a way, if one asks on any developer of AAA game that do you see a possibility for delay, if one would say that there is absolutely no possibility, they would be lying. It's always a race to the finish line, in a way, we have to get the game to the highest quality that we can make. That's in a way what promises what provides, in a way, big long-term potential. Always in this big and complex games, there are still at that phase, a lot of parks left, there is a lot of optimization, a lot of [ polish ] work to be done, balancing that the story is delivered in the right way. We have different platforms. The performance needs to be optimized.So overall, there is nothing individual that couldn't be done. There is still just a lot of work to be done. And at the moment, we are tracking well towards the October launch. There is, in a way, nothing that's at the moment in the vision that would prevent that. But if that question is asked from a game developer, it's really hard to say that there wouldn't be a possibility for that in any future scenario. Fortunately, we are not at the moment seeing that. And we know well what we are doing.

[Veli-Pekka Puolakanaho, executive]

How much do you expect depreciations to increase as a result of Alan Wake Remastered? And will these depreciations impact mostly 2023 and 2024?

[Terhi Kauppi, executive]

The first part, how much, that we cannot comment. We are not splitting our depreciations by project currently out. And yes, well, what years will they impact? Well, first, we need to make sure that the game has recouped and started to generate royalties for us. So it's difficult to estimate. But starting from '20 or onwards, I would say, generally.

[Veli-Pekka Puolakanaho, executive]

Then a couple of questions on Condor and Vanguard. Are you planning to have both Condor and Vanguard in full production simultaneously?

[Tero Virtala, executive]

We cannot comment at the moment on the -- in a way, on the exacts of the production schedules because those would then also indicate quite well the planned launch dates.

[Veli-Pekka Puolakanaho, executive]

Then another question regarding resourcing. How many employees are required to support Condor and Vanguard when they go live? Do we have the personnel to support these multiplayer games and also develop new games simultaneously?

[Tero Virtala, executive]

Well, without saying the exact numbers that we have in our plans, Condor requires less people. Do we then have personnel to support the multiplayer games and develop new games simultaneously? We have been building a structure and organization that can do that in the future. Do we at the moment have all these people and all these partners in place? Of course, not yet because we are not yet in that phase. But then, in a way, I would say that I would also welcome the scenario that wouldn't have all these people because then it would indicate that one of these games would have been such a massive success that it makes sense us to focus more on that individual game maybe instead of starting something new. But at the moment, what we have in our plans every single game, we see has a big possibility. In a way, we are making, I would say, realistic business plans for our games, in a way, not over optimistic. And what these games require we see that the structure and organization is developing to a direction where we can have personnel for that.

[Veli-Pekka Puolakanaho, executive]

There's a lot of games coming to the market in this quarter. Are you worried about the crowded launch window for Alan Wake 2?

[Tero Virtala, executive]

Well, it is crowded. But then at the same time, in a way, if we are launching games in September, October, early November timeframe, we knew that that has been an evaluation that we have been doing with our partner Epic Games. Now it's also that, in a way, making the game launch date public has, in a way, nowadays become more and more delayed. As has been said, that some of the industry's biggest games, in a way, the launch dates being released only a few months before their launch. But definitely, we at the moment see that we have a launch opportunity and launch window in October. With our partner, Epic, we are naturally all the time evaluating and we don't actually believe that not all the games have yet even made public their launch dates. And at the moment, we are progressing with the current one. And if changes, one date for one of our games would need to be done, those are then in our publishers hands as well.

[Veli-Pekka Puolakanaho, executive]

Good. That's all the questions. One final remark for us and then also the game team making Alan Wake that Alan Wake looks amazing.

[Tero Virtala, executive]

Thank you. It's becoming a great game.

[Veli-Pekka Puolakanaho, executive]

Thank you. I think that was all the questions for today. Thank you for the call and the questions. We will be back with the next earnings webinar on October 31. That's all for now. Thank you, everyone, and have a great weekend.