Remedy Entertainment Oyj

OMXH:REMEDY

Earnings Call Transcript 2024-Q3

[Liisa Eloranta, executive]

Hello, everyone, and thank you for joining this Remedy Entertainment webcast. My name is Liisa Eloranta, and I run the Investor Relations at Remedy. Today, we will go through Remedy's business review for July-September 2024. With me here are Tero Virtala, Remedy's CEO; and Santtu Kallionpaa, Remedy's CFO. We will have a Q&A session after the presentation. Tero, the floor is yours.

[Tero Virtala, executive]

Welcome, everyone. All right. So, let's have a look at the third quarter highlights. In the third quarter, our revenue was EUR 17.9 million, which is over 2x more than last year in the comparison period. Our operating profit was EUR 2.4 million. Last year, in the third quarter, it was minus EUR 4.2 million. It's good to highlight that the big contributor to our third quarter numbers was a onetime payment that from our new partner, Annapurna, came in. So, this onetime payment from them will not repeat in the same amount in the upcoming quarters. But all-in-all, we have been building at Remedy basis for growing profitable business for a longer time. And when we look at our development in the past quarters and now the third quarter following, our trajectory is definitely pointing at the right direction. Also, cash flow from our operations was positive EUR 6.6 million.



Two important events in the quarter were the strategic partnership with Annapurna and convertible loan made with Tencent. As we discussed in our previous quarter info, we don't anymore have a need to significantly grow the organization. At the same time, our ways of working have all the time improving, which continued now in the third quarter. We have, during the third quarter, also reviewed our operations and costs, done some prioritizations, gotten more focus, and also some cost savings in our operations.



Overall, we can clearly see that with the people and partners we now have, how we work at the moment with the current size Remedy, we are getting more and better output than we have had in the past, which is, of course, great for our current games in development. After the reporting period, we also had big events. Alan Wake 2's second expansion, the Lake House was launched and the new Remedy game, FBC: Firebreak was announced. Then let's go through the status of our game and project portfolio. As said, in Alan Wake 2, second expansion, the Lake House was launched. FBC: Firebreak, the project previously known as code name Condor is now in full production. Control 2 continues in production readiness and is advancing step-by-step towards production phase. Max Payne 1 & 2 Remake is all the time making good progress in production phase.



Overall, throughout 2024, our game projects have been advancing at improving speed. Many of the developments we have done throughout Remedy during the past couple of years have now started to bear fruit. We are definitely not stopping here. The basis for creating great games more predictably and with a bit better velocity is stronger than it has ever been in the past. But we still need and have a good possibilities to improve, and we are focused to make these type of developments all the time happen. We will have even more development efficiency as we move forward. And with that, also more space for creativity in areas where it matters most for the players.



On the Alan Wake 2 front, we launched the second expansion, the Lake House. The first expansion, Night Springs was released back in June. Here, the development team went for a more lighthearted fan-pleasing episodic expansion, which featured versions of some of our fan favorite characters from Remedy's games. Now the second expansion, The Lake House is a more serious return to the Alan Wake 2 stone of survival horror featuring the playable character of Agent Estevez. There are strong connections to Remedy Universe and control franchise in this experience. And as I said, Remedy Connected Universe is strongly present. So let's now, at this point, have a look at the Lake House trailer.



[Presentation]



All right. A bit more on Alan Wake 2. So, at the end of the third quarter, Alan Wake 2 had recouped most of its development and marketing expenses, which means that the game has recouped more than 80% of its cost. Game did sell slightly more in quarter three than it did in the second quarter of the year. But as the recoupment was not yet fully full at the end of this quarter, the game did not yet generate royalties for us. With Epic Games, we have been preparing for this fourth quarter of the year, which normally is the year's biggest sales phase. And we will have a lot of activity around Alan Wake 2 in this quarter. We have the physical Deluxe Edition. We have the launch of the second DLC, second expansion, the Lake House, which just had a big anniversary update. They were all launched in October 22. We are supporting the very soon on November 7 to be launched PlayStation 5 Pro with an enhanced version of Alan Wake 2. Collectors Edition will launch in December. And overall, with Epic Games, we have good marketing activities planned for the end of the year.



We see that there is still a lot of potential audience for Alan Wake 2, and we have plenty of activities to reach them. Then another highly important topic that had a big milestone in this third quarter. The background being that early this year, in February 2024, we acquired all publishing, distribution, marketing and other rights for Control, codename Condor, now meaning FPC Firebreak, Control 2 and all future Control products from 505 Games. At the same time, in Alan Wake 2, we have a good partnership with Epic Games, but that is only for Alan Wake 2. We own all the sequel rights for Alan Wake, which is not a standard situation in games industry with big investments from a partner. To us, this positive situation means that we can freely decide on the longer-term future of Alan Wake.



We see major growth opportunities in mid- and long term for both of these franchises. And now we have had a chance to freely decide what is the model that would best support these games to grow and succeed, and Remedy to create maximum values, value with them. And a big consideration for the value creation and future model has related to the question, how do we aim to commercialize and publish our future games. This will directly affect on the share of revenues we can get and also on the investments we need to make. Also, we have considered what that right partnerships may then also open up possibilities as an example to reach new audiences. We have known that we do need financing to develop our current lineup of projects into great games that have this potential to succeed in a bigger way. We have also known and considered that the more we would go towards self-publishing, the more we would then need to invest ourselves both to development and publishing operations. So, this has been the background, which during the second and third quarter, we have evaluated.



We have been considering these different models and had a lot of discussions and negotiations with potential partners. Eventually, looking at the future, value creation potential that we see that these franchises have and our aim to be more in control in how Remedy games are commercialized, our goal became to find a way to get partnership and financing that would allow us to make great games and at the same time, move towards self-publishing. However, past year and this year, the economic climate hasn't been the easiest one overall for getting big financing and gaming industry especially has gone through hard times. Very fortunately for us, there was good interest from potential partners, both towards Remedy overall and Control as a franchise. In the end, in this third quarter, we were able to find and close a great partner and partnership with Annapurna Pictures with a good deal for both parties, and we were also able to close a financing agreement with Tencent, which I consider with good terms. Overall, I'm very happy with these results.



And then in relation to Annapurna, if we look at this partnership in a bit more detail. So, summarize the key terms of the deal where that there is a financing of the development of Control 2, and that is shared 50-50 between Annapurna and Remedy. Annapurna will get rights to take Control and Alan Wake into TV and film, and other audiovisual mediums. Revenue sharing-wise, we will get a greater share of revenue from the game side, Control 2 sales and Annapurna will get the greater share of revenues from TV and film. And we definitely see that there are a lot of benefits in this deal. First of all, it does allow us to move into self-publishing. It gives both parties good revenue opportunities on their main business for us in the games, for them in TV and film side, both parties still benefiting from both mediums. It allows us to focus fully on games, while at the same time, Control and Alan Wake now can grow also beyond games and reach new audiences. And definitely, it does secure a budget with which we can make a great Control 2 game.



Then with Tencent, we agreed on a convertible loan. It's an unsecured loan of EUR 50 million. It has an interest of 8% capitalized annually. The conversion is set at the fixed price of EUR 27.2 million. And this financing overhaul will support when Annapurna partnership provides us the financing to develop Control 2, this will support us in developing and fully realizing overhaul the games we have in development and supports us in that part, that's our part of the financing. And then also it provides financing for carrying out the commercial activities of our next self-published games like the marketing activities for Condor.



And when we look at this convertible loan agreement, I think when we look at the conversion price, which is over 60% higher than our share price was when the agreement was made, I think it signals a strong trust from Tencent side on Remedy's long-term vision and strategy. And then some questions that have been raised that what does this mean in practice to Remedy. Tencent currently owns 14.7% of Remedy. If they then decide to exercise the right in this loan agreement and they will increase their share -- their ownership, the ownership will rise approximately to 20%. Tencent has been a long-time investor in Remedy. They have been a minority owner already for a while, and I don't personally see their role changing with this convertible loan. We continue running our business as we have done so far.



And then the decision on self-publishing. Since 2017, we have step-by-step strengthened our position in the industry value chain. Now with the decision and supporting arrangements that we have done in this third quarter, we can take the next big step and start self-publishing our games. When self-publishing is done successfully, it will provide a basis for bigger value creation. We are in full command on how our games are commercialized. Share of the game sales revenues that comes to us is higher than it would be with the other models publishing by partner or co-publishing. Self-publishing definitely does require more from us in terms of financing and publishing capabilities. But with publishing, we already have an existing core team ready for that, and we keep on building that further.



And then after the reporting period, big event was when in October 17 we announced a new Remedy game, FBC Firebreak. We have, of course, closely followed both the player and media reception, and it's very fair to say that the initial reaction to game has been positive. It's a good start, which I'm happy about. Internally at Remedy, it's also been important that all this was for the first time, fully-managed by our internal publishing team. A lot of publicly visible but also unseen preparative work was done to build the basis for successful reveal. So, in addition to good reveal for FBC Firebreak, this was also a good start to our path towards self-publishing.



Short summary on FBC Firebreak. So, it's a 3-player cooperative first-person shooter. It's an experience set in the control universe. It will be self-published by Remedy in '25. It launches on PC via Steam and Epic Game Store, and it will also launch on consoles, Xbox Series X and S, and PlayStation 5. Also, good to say that it will launch day 1 on PC Game Pass and Game Pass Ultimate and under the PlayStation Plus game catalog available for Extra and Premium members. And being on Game Pass and PlayStation Plus subscription services day 1 has obvious benefits for us. One is that, yes, there are some payments related to the game being available in these services. The second is that being available on these services means that we will have quite a large player base from the start, which is obviously important for a multiplayer game for many reasons.



We can also reach a much wider audience way beyond our normal fan base, which is great for FBC Firebreak and good for Remedy overall. And then also with the larger player base, naturally, the chances for higher additional sales potential grow as well. So, let's end my part to FBC Firebreak reveal trailer.



[Presentation]

[Santtu Kallionpaa, executive]

All right. Good afternoon. Then we are moving to the financial update. And before that, I will briefly introduce myself. So, my name is Santtu Kallionpää, and I have joined Remedy as CFO in October. Before Remedy, I have been working at Fazer and Fiskars in several finance leadership positions, latest one being the Head of Finance for Fazer's Confectionery business for the past 4 years. I've been working on building growth and optimizing performance in international consumer markets and B2B. Also, large-scale investment projects are part of what I have been doing in the past. Personally, I have also had passion for computer and video games since 1980s, and I'm very excited to be part of the Remedy team. And now let's move to the financial update. And let's start from revenue. So, in third quarter of 2024, our revenue was EUR 17.9 million. Development fees were EUR 17 million, which is 2.5x the amount in the comparison period. The significant amount of development fees was due to Control 2 and Max Payne 1 and 2 remake. The development fees related to Control 2 include a onetime payment related to the development work done before the start of the agreement with Annapurna. Because of this onetime element, it's good to note that this is not the new normal level of the development fees.



When looking back at our historical revenues, the revenue levels have been on a higher year-on-year level throughout this year, even though there is variation between quarters depending on the timing of the development fee payments. This quarter, our royalty income was mainly owned by game sales of Control and older Alan Wake titles. And as Tero mentioned earlier, Alan Wake 2 hasn't yet built its recoup and thus didn't yet generate royalties to us. The operating profit of the third quarter was positive EUR 2.4 million, which is EUR 7.9 million more than in the comparison period. Operating profit margin was 13.4%. The profit was impacted positively by the onetime payment of Control 2 related development fees. On the other hand, the profit included a EUR 3.4 million onetime depreciation from the activated assets of Control franchise products as Remedy entered into a strategic partnership agreement with Annapurna.



The rest of the activated assets related to the products will be depreciated by default after the games launch according to Remedy's intangible assets accounting policy. As an additional note, the last balance related to Alan Wake Remastered was depreciated during the third quarter, meaning that the balance sheet doesn't contain any more activated development expenses related to the project. Year-to-date, our revenue has increased from the previous years, driven by strong third quarter. Year-to-date revenues have increased by 65 percentage, ending up to EUR 39 million. Royalties increased by 42 percentage and development fees by 68 percentage. Looking year-to-date operating profit, it has improved driven by revenue growth. For year-to-date, the operating profit was EUR 2.9 million negative and minus 7.4 percentage of revenue. There is a clear improvement compared to previous year.



Here, we can see the analysis of unnetted amounts of expenses and capitalization for transparency. In the third quarter, external work expenses were EUR 5 million and on slightly higher level than in the comparison period when they were EUR 4.9 million. Personnel expenses decreased year-on-year by 4.8 percentage, while the increase in our employee amount was about 4 percentage from 348 to 363. The difference in personnel expenses in relation to employee amount growth was driven by 2 reasons. Firstly, we had lower amount of expenses recognized from option programs. This was due to option program 2021 vesting and thus, cost recognition of the program ending during the previous quarter. Secondly, the third quarter is annually the lightest in personnel expenses as it's the highest season for summer holidays. Holidays are recognized as expense already when they are accrued.



Capitalized development expenses were 24 percentage higher level than in comparison period. The growth is visible already from the first quarter of this year, and it is due to higher share of capitalized expenses related to FPC Firebreak and Control 2 game projects. The capitalization percentages were raised as we purchased the publishing rights for Control franchise during the first quarter. Regarding Control 2, the percentage was recalculated again as we entered into agreement with Annapurna, and this reflects a lower amount of capitalized expenses when comparing to previous quarters this year. Then cash flow. So, for fourth quarter in a row, our operating cash flow remained positive. In the reporting period, the operating cash flow was EUR 6.6 million positive as in comparison period, it was negative by minus EUR 5.1 million.



Operating cash flow was affected by the onetime payment of Control 2 development fees. We also received a bigger amount of development fees related to Max Payne 1 and 2 remake and Control 2 than in the comparison period. The outgoing payment amount was nearly at the same level as in the comparison period. In the third quarter, our total cash level was EUR 31.2 million, increasing EUR 5 million from the previous quarter. Currently, we have EUR 10 million in cash management investments. Regarding purchasing back the Control franchise rights from 505 Games, we have now paid 2 installments, and we have 1 left. The cash flow effect of the payment has been and will be smaller than the liability due to agreement-based amounts netted from the payments. 



Then still looking at the longer time period, current year-to-date profitability level is impacted by the level of our own investments to game development, which have increased during the last years. We have entered in a strategic partnership for developing Control 2 and will self-publish FPC Fire Break. And I think that's all from financials, and Tero will now continue about the outlook.

[Tero Virtala, executive]

Thank you. So, outlook, in a bigger picture, it's unchanged. We expect revenue to increase from the previous year and operating profit to improve. We have announced earlier that revenue growth rate and EBIT improvement this year, they are meaningfully dependent on the choice and evaluation that we have had between the different publishing model. Now when we have made and announced the decision to self-publish both Control 2 and FPC Fire Break, it does mean that these projects are generating less development fees in the short-term, but bring a greater value in the long-term than would have been the case. these projects are generating less development fees in the short term, but bring a greater value in the long term than would have been the case had we chosen for one of these projects a fully in a way or a publishing partnership deal or a co-publishing deal with bigger short-term investments from a partner. But we see that for the longer-term, this is a better choice. And now therefore, with this choice, we see that our revenue stays in the same guidance as it has been. It will increase and EBIT will improve, but we did clarify that the EBIT remains negative still throughout this whole year.

[Liisa Eloranta, executive]

That was all from our part. Now it's time for the Q&A. Related to the outlook, have you assumed any royalties from Alan Wake 2 in your 2024 outlook?

[Santtu Kallionpaa, executive]

We haven't specified it exactly and we cannot open it.

[Liisa Eloranta, executive]

Can you say anything about how meaningful those B2B deals for FPC Fire Break are in terms of revenue and which one is more important in those deals? Is it access to large player base right away in the game launch or the risk-free revenue?

[Santtu Kallionpaa, executive]

We cannot specify exactly the amounts. Overall, as I said in my part of the presentation, there are several benefits that we get from here. Our long-term aim is to build much bigger successes than we have done so far. And we see that we have these franchises in our hand. So, at the same time, when we, of course, do expect these games to succeed when we launch them and start being profitable to us. We are also considering what's the best way to create this longer-term bigger successes and get the company into real profitable growth path. So, in that sense, we are aiming to find a balanced model that when we make a deal that it would support us both in the short-term, bringing us good revenue, but also building a strong basis for the long-term success.



So of course, in a way, always the financial component that is in the game, that's a way valued. But then at the same time, especially for multiplayer game, ensuring that the game has large enough player base from the start. So, everyone will enjoy the game no matter in a way what region they come from, at what time of the day, in what day they come, that has a value. We also do see that when this game is set in the control universe, they always have this in a way cross-sell and cross-promotion possibility. So with this type of subscription services, we are likely to reach audiences that are not part of our traditional fan base, expanding the audiences. All these are important to us.

[Liisa Eloranta, executive]

Do you have resources to move Control 2 into full production before the launch of FPC Fire Break?

[Santtu Kallionpaa, executive]

We haven't specified now the exact schedules that when are we moving to production with Control 2. But we are, of course, managing our portfolio of games and portfolio of projects, and we have our plans in ready, and they are made in a way that we can make it happen.

[Liisa Eloranta, executive]

Then related to Control 2, has the development budget changed?

[Santtu Kallionpaa, executive]

In relation to Control 2, the development budget is, as we have said earlier, we have mentioned that the initial development budget is approximately EUR 50 million.

[Liisa Eloranta, executive]

Related to Alan Wake 2, when do you expect it to recover all of its development and marketing expenses? And how many copies of the game is being sold?

[Santtu Kallionpaa, executive]

With Epic, we haven't released the exact sales numbers since last February when it was 1.3 million copies that had been sold. And we have said that the game hasn't yet recouped. It's not far away, of course, based on what we have said from that. But still at the moment, it didn't yet generate royalties for us. We know that this fourth quarter of the year is always the biggest sales season of the year with Epic games. We have put a lot of effort to being able to be visible with the game to audiences and to reach new audiences. And now is the, in a way, the next couple of months a bit over -- next couple of months are the time to try to reach these audiences and reach good sales.

[Liisa Eloranta, executive]

Then do you have any data on cross purchasing between remedies games? So how many players that have played or purchase control have purchased games in the Alan Wake franchise, for example?

[Santtu Kallionpaa, executive]

Well, internally, we have that data, but we haven't shared it publicly.

[Liisa Eloranta, executive]

Then a future question. Will there be dividends in the future?

[Santtu Kallionpaa, executive]

We won't speculate that at the moment. That will be then in due time, the Board's decision, what's right for the company value generation and for all its shareholders.

[Liisa Eloranta, executive]

In relation to FBC Fire Break, how does it differ post release from your other games in terms of team size and resources needed?

[Santtu Kallionpaa, executive]

Well, it is a multiplayer game. We are not making a massive live operations game where players would be demanded to spend more money to enjoy the game. I think we are building with the learnings that many of these type of co-op games have had success in the recent couple of years, but it definitely does have a longer-term and stronger support than traditional single-player games have.

[Liisa Eloranta, executive]

I think that's it for the questions. Thank you for the call. We'll be back with the next earnings webcast, which is our financial statements released January, December 2024 and February 12, 2025. Also, don't forget our Capital Markets Day, which will be held in Helsinki on November 19. A formal invitation regarding that will follow soon. That's all for now. Have a great rest of the week, everyone.