K e y w o r d s S t u d i o s P L C A n n u a l R e p o r t a n d A c c o u n t s 2 0 1 8 Strengthening our market leading position Annual Report and Accounts 2018 Support | Deliver | Evolve The video games industry represents the pinnacle of interactive digital content. At Keywords, we are using our passion for games, technology and media to create a global services platform for video games and beyond. Our vision is to be the world’s leading technical and creative services platform for the video games industry and beyond. Support | Deliver | Evolve Visit the website for further information www.keywordsstudios.com 2018 Highlights Contents Revenue (€m) Proforma Revenue1(€m) Strategic Report Highlights 1–33 1 2018 250.8 2018 265.4 At a Glance 2017 151.4 2017 220.7 2016 96.6 2016 112.8 €250.8m +66% (growth in 2018 on 2017) €265.4m +20% (growth in 2018 on 2017) Adjusted Profit Before Tax2 (€m) Adjusted Basic Earnings Per Share2 (c) Investment Summary Chairman’s Statement Our Culture Market Overview Our Business Model Our Strategy Chief Executive’s Review Financial and Operating Review KPIs Principal Risks and Uncertainties Governance Board of Directors 2018 2017 37.9 2018 47.75 Chairman’s Introduction 23.0 2017 31.18 Corporate Governance Directors’ Report 2 4 6 8 12 14 16 18 27 30 32 34–55 34 36 37 40 2016 14.9 2016 20.59 €37.9m +65% (growth in 2018 on 2017) 47.75c +53% (growth in 2018 on 2017) Statement of Directors’ Responsibilities 42 Audit Committee Report Directors’ Remuneration Report Report of the Nomination Committee 43 46 55 Financial Statements 56-104 56 Independent Auditor’s Report Dividend per share (p) 2018 2017 2016 1.61 1.46 1.33 1.61p +10% (growth in 2018 on 2017) Consolidated Statement of Comprehensive Income Consolidated Statement of Financial Position Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Company Statement of Financial Position Company Statement of Changes in Equity Company Statement of Cash Flows Notes Forming Part of the Consolidated and Company Financial Statements 60 61 62 63 64 65 66 67 Alternative Performance Measures The business uses a number of adjusted measures that are not defined or recognised under IFRS. For full definitions and explanations of these measures and a reconciliation to the most directly referenceable IFRS line item, please see pages 105 to 107. 1 Pro forma revenue includes the annualised sales of all acquisitions made in each year, in order to provide a better overview of the balance of the business at the end of each year. 2 Adjusted Earnings Per Share and Profit Before Tax are calculated before one-time costs of acquisitions and integration, share option charges, amortisation of intangibles, and foreign exchange movements. Supplementary Information Alternative Performance Measures 105-108 105 Company Information 108 Annual Report and Accounts 2018 1 At a Glance A global, integrated service provider The Group now has more than 50 studios strategically located in 40 cities worldwide providing full, integrated services by combining a presence that is local to our clients in key gaming clusters with lower cost production sites across four continents. Since the beginning of 2018, we have expanded further organically and by acquisitions, adding to our capabilities in regions where we have an existing presence, including Brighton, Los Angeles, Sao Paulo, Katowice, Ottawa and London. 6,000+ People on the payroll at peak time 50+ Providing services across more than 50 languages 23 Serving 23 out of the top 25 games companies measured by revenue 52 Studios in 21 countries Saint Jerome Orlando São Paulo See key on opposite page. 2 Keywords Studios plc Strategic ReportLos AngelesPortlandMontrealRio de JaneiroMexico CityRaleighOttawaQuebec CitySeattlePuneSingaporeBeijingNew DelhiManilaDalianShanghaiChengduTokyoTaipeiZhengzhouBarcelonaDublin (HQ)LiverpoolLondonHamburgMilanMadridRomeParisYogyakartaKatowiceKrakowBrightonVolgogradSt. PetersburgThe Hague Keywords Studios continues to build world-leading capabilities in services that video game and similar interactive content creators need. We stand shoulder-to-shoulder with our clients working as their external or co-development partner to provide dedicated outsourced or embedded services, providing access to our teams of experts where and when needed, so they don’t have to carry unnecessary fixed costs to cater for peaks in activity. Today we have breadth and depth in seven service lines. Revenue breakdown by service: Audio Player Support Engineering Multi-language voiceover recording, original language voice production, Hollywood production, music management, sound effects & related services. 365/24/7, multilingual support for gamers when games are in live operation, forum monitoring and moderation services & social media engagement on behalf of the game brand. Game development services including full game development, co-development, porting of games from one platform to another including remastering, tool development and consulting services on a work for hire basis. This also includes our proprietary software solutions for analytics, social media integration, procedural generation of art assets and player behaviour research consulting services 2018 2018 2018 €34.2m +66% (growth in 2018 on 2017) €35.9m +292% (growth in 2018 on 2017) €26.1m +632% (growth in 2018 on 2017) Art Creation Functional Testing Localization The creation of video game graphical art, including concept art, 2D and 3D art asset production & animation. Marketing services including game trailers, marketing art and materials. Quality assurance, including discovery and documentation of game defects and testing to verify the game’s compliance with hardware manufacturers’ and app stores’ specifications, as well as crowd based and focus Group testing solutions. Translation of in-game text, audio scripts, cultural and local adaption, accreditation, packaging and marketing materials in over 50 languages. Localization Testing Testing for out of context translations, truncations, overlaps, spelling, grammar, age rating issues, geopolitical and cultural sensitivities and console manufacturer compliance requirements in over 30 languages using native speakers. 2018 2018 2018 2018 €41.7m +59% €49.1m +64% €44.0m €19.8m +5% 0% (growth in 2018 on 2017) (growth in 2018 on 2017) (growth in 2018 on 2017) (growth in 2018 on 2017) Annual Report and Accounts 2018 3 Investment Summary A further strengthened offering from which to grow Keywords is better placed than ever to continue to capture share of our robustly growing market by deepening our relationships with clients that already trust us with their high value IP, having significantly extended our services and geographical reach during the year. 4 Keywords Studios plc Strategic Report We are a trusted partner to leading companies around the world, with a strong market position, providing services to 23 of the top 25 games companies and 9 of the top 10 mobile games publishers by revenue, including: Access to a dynamic growth market Keywords operates in a dynamic growth market but has minimal direct exposure to the successes or failures of individual game titles. Our focus on content means we are platform agnostic and well positioned to take advantage of the opportunities presented by mobile gaming, cloud streaming, next generation consoles and AR / VR. The increased sophistication of games and complexity of the video games market is driving demand for larger, professional, outsourced specialists, such as Keywords, in a highly fragmented supplier market. Outsourcing such work is attractive to developers and producers because it converts their fixed costs into variable costs, helps remove bottle-necks in capacity by providing access to talent as required and enables them to focus on their core competencies. Market leading position Keywords has a market leading position as the only global provider of fully integrated outsourced creative and technical services to the global video games industry. With an industry reputation for quality, reliability and flexibility, our scale and reputation mean we are well placed to take advantage of the trend for clients to move to more collaborative partnerships with fewer, larger suppliers. Strong growth record We continue to deliver strong Like-for-Like growth as we benefit from both the growth in our market and the trend towards greater outsourcing of our services. In addition, we have successfully acquired and integrated 37 acquisitions since IPO. The eight acquisitions we completed in 2018 bolstered our capabilities, particularly in engineering, data analytics, music and marketing services. In addition to extending our existing service lines to bring us even closer to our clients, we have continued to expand our geographical reach. Opportunity to grow further Having made strong progress in extending the Group’s client base, market penetration, geographic footprint and service lines, we now see significant potential for increased cross- pollination of our service lines and geographic locations, including taking advantage of our dual shore capabilities which enable us to be close to our customers and provide services from lower cost studios, as we increasingly become strategic partners to our clients. A strong business model Keywords’ flexible resourcing and charging model, with charges levied for time or output rather than a fixed price, combined with relatively low working capital and capital expenditure requirements support its ability to grow the business whilst also achieving strong cash conversion. Adjacent market potential Our expertise in providing outsourced solutions to the video games industry is already being sought after in adjacent markets such as film and television, and Keywords is well placed to deliver this. Annual Report and Accounts 2018 5 Chairman’s Statement International scale and flexibility across markets are key We are well placed to take advantage of the multiple opportunities afforded by our market as it grows in size and sophistication. Introduction 2018 was a year of good, and perhaps underappreciated, progress in which we delivered a 65% increase in Adjusted Profit Before Tax to €37.9m (2017: €23.0m) which was within the range of market expectations albeit it was held back by certain project deferrals into 2019 and, unusually for us, bad debts of approximately €1.6m relating to four clients entering insolvency processes, some of which were caused by the ‘Fortnite effect’ on the industry (as explained in more detail in the Chief Executive’s Review). The 53% increase in Adjusted Basic Earnings Per Share to 47.75c demonstrates how effectively the Company is deploying capital and managing its margins while growing so strongly. This performance was delivered while continuing to develop the Group’s strong positioning in the video games market and creating an even better balanced, more diversified business with the addition of several new services including marketing services, music management, sound effects and game and predictive analytics. We also significantly strengthened our relatively new engineering / game development services offering and invested in the expansion of studios which created an additional 930 work stations across Beijing, Chengdu, Katowice, Liverpool, London, Los Angeles, Manila, Milan, Montreal, Seattle and Tokyo. The businesses that have joined the Group through acquisitions have integrated well, embracing the dynamic and self-effacing Keywords culture. Like-for-Like revenue growth3 was 10.1%; without the expected drag in the year from the VMC acquisition, Like-for-Like revenue growth would have been 14.9%. However, we are pleased with the overall contribution from VMC which has been significantly earnings enhancing. The Like-for-Like growth reflected good performances across the business although Localization Testing revenues declined unexpectedly at the end of the year as a number of projects slipped into 2019. Multiple growth opportunities Overall, Keywords is well positioned to take advantage of the multiple opportunities we see as the video games industry is predicted to continue to grow strongly, at a CAGR of c.9% (source: Newzoo, October 2018), despite the short-term disruption caused by Fortnite last year, and the trend towards outsourcing continues as video games companies aim to avoid substantially increased fixed costs to handle peaks in activity levels. Having extended our service offering further during the year, many of our blue-chip games producer and developer clients now see us as an important and trusted business partner who can bring considerable value to their games’ development and creation process. Importantly, as cloud gaming and other subscription models emerge, we expect to see strong demand for our services to support the significant growth in content that these services will drive. Our strategic vision hasn’t changed since the flotation on AIM in July 2013, and pleasingly, we are significantly ahead of those early plans both in size and scope. We continue to see plenty of opportunity in the video games market to support our growth both organically and through selective acquisitions and the landscape remains fertile with a number of businesses expressing interest in joining us so they can participate in Keywords’ compelling partnering and growth model. Managing and funding growth Keywords’ ability to source, execute and integrate acquisitions effectively is a core skill and, as the Group expands, more of the management team are involved in these assimilation processes. We look for a strong cultural fit and focus on the people joining the Group, rather than just seeing it as acquiring businesses, so that we engender a partnership through which both parties work closely together to complement each other. 3 Calculated on the basis that the full year 2017 comparative included all of the 2017 and 2018 acquisitions, as if they had been owned for the same period in 2017 as they have been in 2018 and applying consistent foreign exchange rates in both years. 6 Keywords Studios plc Strategic Report We are also highly focused on maintaining the interest, drive and passion of those who join Keywords, to make sure that they are stimulated by new opportunities as part of a much larger organisation without losing their entrepreneurial drive. One of the ways in which we have done this is by strengthening the Group’s management team with the highly experienced people we bring in through our acquisitions; this, in combination with developing our existing team, in turn provides further bandwidth across the management team to support the ongoing growth of the business. The funding of our acquisitions is achieved both by cash generated organically and through bank facilities. We are continuously improving our profit-to-cash conversion, assisted by the streamlining of our banking arrangements around the Group and are working towards centralised cash pooling and regular draw- downs as standard within the treasury function. The increase in our bank facilities to up to €105m, which we secured during the year, gives us good headroom and demonstrates the strong support we enjoy from our banks for our growth strategy, given the strength of our financial performance and the recurring nature of many of the revenues. As we grow, we have continued to develop our business processes and strengthen our governance practices. We have had a particular focus in 2018 on developing our operating and financial systems in order to enhance the management information available and streamline our reporting processes further; this remains work in progress. We have also improved our governance procedures with the adoption of the Quoted Companies Association Corporate Governance Code, as outlined in further detail later in the Annual Report. Ensuring we have the best internal systems and controls, as well as more integrated and efficient processes with our clients, will remain a focus in 2019. the interim dividend of 0.53p per share will make a total dividend for the year ending 31 December 2018 of 1.61p per share. This reflects an increase of 10% compared to 1.46p for 2017 and is consistent with our progressive dividend policy whilst retaining sufficient resources to fund our future growth. Subject to shareholder approval at the Group’s AGM, the dividend will be paid on 21 June 2019, to shareholders on the register on 31 May 2019. People The progress of Keywords and its successful transition from being a small company with two service lines into what it is today is a credit not just to the top team, but to everyone throughout the organisation for their part in making it happen. On behalf of the Board, I would like to thank all of the team for their strong contributions. The whole executive team led by Andrew Day, our CEO, has worked impressively and performed well during the year. The team is operating in an industry that is not only fast growing but is a leading technological innovator in interactive technology; that Keywords is now a respected provider, not only of services, but also in technical innovation, shows how much we have become a key partner to our customers, despite most being many times our size. Current Trading and Outlook We have started 2019 promisingly. In a year in which the games industry is likely to see some changes with the arrival of games subscription and streaming services from new entrants like Apple and Google, we feel well placed to benefit from the likely increased demand for content. The considerable progress we made in 2018 has improved our quality of earnings and moved us higher up the value chain. Accordingly, as we continue to strengthen our market leadership and the breadth and scale of our service offering, we are well placed to take advantage of the multiple growth opportunities afforded by a market that is growing in size and sophistication. Dividend The Board is pleased to recommend a final dividend of 1.08p per share which, following Ross Graham Chairman 8 April 2019 Annual Report and Accounts 2018 7 Our Culture Pride in our people Our culture acts as the glue that binds all Keywordians around the world together – relaxed, professional and humble with a focus on doing the very best we can for each and every project entrusted to us. 8 Keywords Studios plc Strategic Report People that work at Keywords are passionate, talented, committed and resourceful. This culture creates an environment in which games-passionate individuals can work together with likeminded colleagues while enjoying the opportunity to work on most of the world’s leading games ahead of their releases. Working on around 250 games at any time in the year and more than 600 in total through the year, Keywords provides an excellent and sustainable variety of work, strong career progression and opportunities to work in many different locations. There is a common thread to the culture of Keywords. We recognise our role as professional services providers. We approach this humbly, doing the very best we can for our clients’ projects with the confidence borne out of our deep expertise. We value our people; we trust them and work to support their passion to perform the best service for each project and each client. We have an inclusive style of management and run a tight ship. Our priorities and areas of focus are summarised below: Our People • Training and development • Integration • Diversity • Career advancement • Equal opportunities Our Customers • Integrated efficient service • Customer satisfaction • Repeat business Annual Report and Accounts 2018 9 Our Culture continued We design our facilities as open plan to promote engagement and encourage knowledge sharing. At the core of our culture are our operating principles that we call the “Keywords Rule of 9”. The Keywords Rule of 9 1. Communication – We communicate openly and in a timely fashion. We do not hide things from colleagues or clients and we avoid office politics. 2. Project Focus – We focus on projects, delivering the best we can for the benefit of each and every product we touch. 3. Client Centricity – We act as an extension of the client’s organisation, moulding our processes and procedures to fit their requirements whilst sharing our knowledge of best practices. 4. Empowerment – We empower our people to perform to the best of their ability by providing them with the resources and environment to do their jobs and the tools to track and measure their performance. 5. Passion for Games – We are passionate about games and are proud of our role in helping to deploy them and we play an active role in the wider industry. 6. Client Intimacy – We love our clients (all of them) and want the best for them at all times. 7. Positivity – We have a “can do” attitude and rise to the challenge of solving our clients’ problems. 8. Flexibility – We recognise the importance of flexibility and actively embrace it despite the obvious challenges. Flexibility is why we exist at all. Without it, clients would perform those tasks we do, themselves. 9. Learning & Growing – We learn at every opportunity and grow ourselves through experience, training and tackling new challenges. 10 Keywords Studios plc Our People An average of 5,238 employees make up our highly diverse and multicultural team and are well balanced across our three regions; 2,056 in The Americas, 1,267 in Europe, 1,915 in Asia. The number and diversity of people and skills in our workforce allows us to be perfectly placed to deploy these skills across the industry to meet all of our customers’ needs. As the growing games industry continues to produce more content and as industries as diverse as retail, urban planning, advertising, education, architecture and automotive, adopt the use of game engines to make their content more interactive and engaging, we see the demand for the skills we offer increase. Our acquisition programme also brings fresh talent to the Group at all levels on a regular basis. We continue to be successful at integrating these new businesses and the talent they bring with them whilst providing opportunities for them to grow their careers across the Group and move between our various studios. This year we have added game programmers, game designers, software engineers, data scientists and machine learning specialists to our ever- growing Keywords family. We provide equal opportunities for all of our colleagues, demonstrated by our senior leadership team, which comprises four people from the original Keywords business, ten people from acquired entities as well as six externally hired employees. Strategic Report Real experiences “The value of the Company is the value of its employees, and you certainly can say that for Keywords. Every colleague is a friend and, at the same time, a talented professional always ready to help. When you couple this great environment with the best products of the video game industry, satisfaction and motivation are the natural outcome.” Riccardo QA & Support Co-Ordinator, Dublin Our Customers We are fortunate to be able to count most of the top global games developers as our customers. These companies expect the highest level of service and our diverse capabilities allow us to satisfy our customers’ needs every time. Increasingly, these customers prefer to outsource multiple services to one service provider and this is where we are uniquely positioned to meet expectations. We offer our clients flexible, scalable solutions that match their project requirements. Through our dedicated embedded services, we partner with our clients to provide the expertise of an in-house team and deliver flexible, in-house out-sourced solutions. Keywords Studios Extra Life 2018 Community involvement and supporting good causes – throughout our local studios staff support local charities and good causes. One activity that involved multiple sites was Extra Life 2018 – In 2018, Keywords staff participated in a 24-hour gaming marathon which supports Children’s Miracle Network Hospitals, raising over $10,000 for the cause. Joining the Keywords Family We are a highly acquisitive business and have some very strict criteria for our acquisition targets, by far the most important being cultural fit. Typically, if we think that there is a cultural misalignment then we won’t even open the dialogue with the Company. Once we set our sights on an acquisition there is a process that we follow during the due diligence phase and after closing the acquisition to ensure seamless integration of the new studio and most importantly the new people, to ensure that from day one, they feel like part of the Keywords family, while, at the same time, appreciating the history and richness that the new company brings. A mark of our integration success is that half our senior executive team joined us through acquired companies. Keywordians with their drive and talent make Keywords the global service provider that it is today, and it is essential for us that we continue to support our unique and diverse culture, which includes welcoming new faces and ensuring they feel just as supported and welcomed as their more established colleagues. Keywords Studios – Extra Life 2018 raised teams with 40+ members $10,736 3 9 40+ 187 over 187 hours played different locations in 5 countries games played through 16 live streams Annual Report and Accounts 2018 11 Market Overview Providing a global services platform to support the video games market Keywords operates in an exciting high growth market, with exposure to most of the world’s leading video games across all devices and all genres. Continued market growth The global games market for video games is fast moving and continually evolving. New gaming platforms, genres, monetisation models, distribution channels, and audiences keep coming. Not only this, but all manner of content providers are seeking to make their content more impactful and engaging. Interactive content is emerging everywhere and the lines between video games and e-learning, film and TV, simulation and e-retail are becoming increasingly blurred. Video games represent the most interactive of content types, and the tools, skills and production facilities needed to produce video games are now in demand from a much wider market. Keywords is hardware agnostic; rather our services support the production, the marketing and the support of the content itself in live operation. 12 Keywords Studios plc Content revenues in the global games market reached $134.9bn in 2018 and are forecast to increase to $174.0bn in 2021. (Source: NewZoo Global Games Market 2018). The mobile games segment continues to grow fastest, and the Chinese market is now larger than the US despite the hiccup in 2018 that saw Chinese authorities blocking the publication of new games for 9 months – a situation which now appears to be getting back to normal. The move towards ‘games as a service’ continues The move towards ‘games as a service’ continues and unlike the sale of one-time packaged product, this requires ongoing maintenance of the content, continually updating it with new worlds, characters, and items to purchase or win. The market for the provision of services to the games industry is evolving too. While the industry remains highly fragmented, customers are increasingly willing to outsource multiple services to proven providers of scale who can offer all of these under one umbrella, by way of strategic partnerships, as well as exploring more co-development, in which significant parts of, or even full games, are developed on behalf of game developers or game publishers. The trend towards increasing outsourcing at a more strategic level benefits Keywords as the largest and broadest provider, making it an increasingly attractive home for service providers with a narrower focus. Strategic Report A high growth global video games market Global market 2018 $134.9bn +10.8% (growth on 2017 – ($121.7bn)) YoY ($Bn) 2021 2020 2019 2018 174.0 160.5 148.1 134.9 c.9% CAGR (Source Newzoo, 2018) Cloud gaming is poised to expand the market on a scale not seen since the introduction of mobile gaming. Peter Warman, CEO Newzoo, November 2018 There are 2 billion people who play video games on the planet today. We’re not going to sell 2 billion consoles. Many of those people don’t own a television; many have never owned a PC. For many people on the planet, the phone is their compute device. It’s really about reaching a customer wherever they are, on the devices that they have. Phil Spencer, Microsoft’s Vice President of Gaming (March 2019) Cloud gaming / streaming and subscription platforms Streaming games, Netflix style, and subscription platforms are a hugely exciting prospect following the initial publicity in January regarding Microsoft’s streaming service, xCloud, the unveiling of Google’s Stadia gaming platform in March 2019 and Apple’s launch of its Arcade subscription-based games platform in March 2019. Presently, gaming can be costly for the user, with the requirement for high end gaming PCs, expensive consoles and high-end smartphones limiting the access to and uptake of some games. Streaming, and subscription services, have the potential to provide highly cost-effective distribution of content, making it available to more players, on more devices, in more countries, in more languages. All this requires more services; engineering to port games to new streaming platforms; localization into more languages; increased player support services; and of course, as the competition amongst these streaming platforms intensifies, demand for new content production is expected to grow just as it has done in film and TV with the likes of Netflix, Amazon, Apple, Disney, and Hulu. New generation consoles The current generation of PlayStation and Xbox games consoles first launched in 2013. Both companies are expected to launch completely new devices, with market rumours currently suggesting 2020 or 2021 are the most likely years for this. Unlike in the last console generation transition, in which publishers shifted very rapidly from content for the previous generation to new content for the current generation, this time we expect to see a different evolution thanks to the ‘games as a service’ model. We anticipate game publishers will want to continue to support existing content that is commercially successful while simultaneously producing new content that takes advantage of the power and features of the new consoles. We anticipate this doubling up will create added demand for our services. Augmented reality, virtual reality and mixed reality While VR in its first form didn’t catch on as some were expecting, the hardware providers are continuing to reduce the size of the headsets and uncouple them from the PC or console. As these advances continue, so we expect video game content providers to continually explore the possibilities for this most immersive of experiences. In the meantime, we continue to work extensively in the field not only with game content but more and more in non-game related content of an educational and experiential nature. Augmented Reality, as represented by a range of solutions either on existing devices like mobile phones or with specialised headsets such as the Microsoft’s HoloLens or Magic Leap One offers perhaps more immediate promise as seen with the early success of Pokémon Go but we don’t see this a major driver for the business in 2019. Annual Report and Accounts 2018 13 Our Business Model Creating value and growth through operational efficiency The video games industry represents the pinnacle of interactive digital content. At Keywords, we use our passion for games, technology and media to create a global services platform for video games and beyond. Our key strengths Global presence Provides access to the best talent and enables us to deliver projects across studios in multiple time zones, allowing seamless 24-hour turnarounds whilst remaining close to our customers. Flexible resource model Particularly true of our testing business, this allows us to scale up or down to meet demand, mirroring the seasonality of games production. Knowledge and expertise Our talented people have deep games- specific knowledge and experience, enabling them to add value to our clients’ games at all stages in the development lifecycle. Reputation for quality At the heart of our culture is our commitment to quality, reliability and integrating with our clients’ processes promoting long-term customer relationships. Financial strength Our strong financial performance and position gives our customers reassurance of resilience in their supply chain and is part of our attraction to businesses we acquire. Acquisition track record We have a strong track record in identifying acquisitions with a good fit with Keywords in terms of culture as well as expertise or geography and integrating them effectively to support their growth. 14 Keywords Studios plc Keywords’ presence in each stage of the games development cycle creates multiple opportunities for cross selling and revenue growth. #1 Pre-production • Concept art • Level design • Game design #6 New content for games • Game extensions • Level expansions • Art • Audio • Testing • Localization • Marketing • Issue patches #2 Early stage game development • Co-development • Programming • Art production • Cinematics / visual effects • Audio production • Original language voice production • Engineering • Development quality assurance • Game demo trailers • Music scoring • Sound design • Story writing • Motion capture #5 Ongoing live operations support • Customer support • Community management • Data analytics • Payments processing • Game analytics • Social integration • Customer retention • Payments processing • Promotions management Services offered by Keywords Services added by Keywords in 2018 –2019 Services not currently offered by Keywords Strategic Report Our Business Model is supported by our Strategic Pillars: Extending our range of services Selective acquisitions Organic growth and cross selling Growing market share Expanding geographic reach Introducing technology #3 Later stage game development • Functional testing • Text localization • Audio localization • Localization testing • Player research • Game porting • Music branding and strategy #4 Launch • Certification testing • Official game trailers • Soundtrack and merchandise • Marketing services • Customer acquisition Creating value for our stakeholders By working as their external development partner, we enable leading content creators and publishers to leverage our expertise and capacity across the lifecycle of interactive content. In so doing we enable our clients who are operating in complex and fast-moving environments to remain lean and agile, and to focus on creating and monetising the most engaging experiences. We are trusted and relied upon by many of the world’s leading video game companies to work alongside them during concept, development and live operations by leveraging the breadth and depth of our industry leading service lines every step of the way. Keywords’ presence in each stage of the games development cycle creates multiple opportunities for cross selling and revenue growth. Investors Consistent track record of delivering earnings and dividend growth. Opportunity to invest in the exciting video games market, without the risk of exposure to the successes or failures of individual game titles. Employees Keywords provides employees with an excellent and sustainable variety of work, good career advancement opportunities and, increasingly, opportunities to work in many different locations. Our customers can access a world class talent base without incurring any of the usual variable costs. Customers Our involvement across the video games cycle means that we can be a “one-stop-shop” for our global customers, meeting their requirements with a combination of on-demand and dedicated services facilitated through a wide geographic reach to talent and a flexible resource model. This allows our customers to outsource most aspects of game development enabling our customers to reduce the number of permanent staff that would otherwise be required to cater for peak activity, thereby converting fixed to variable costs and minimising their overall operating costs. Increase in Adjusted EPS since 20144 53.7% Customers using 3 or more services 99 up from 30 in 2014 Average number of employees 5,238 up from 978 in 2014 4 Before acquisition and integration expenses, share option charges, amortisation of intangibles, and foreign currency exchange. Annual Report and Accounts 2018 15 Our Strategy To be the world’s leading technical and creative services platform for the video games industry and beyond. Strategic Pillars Progress in 2018 Priorities in 2019 Measures of our Success Extending our range of services Selective acquisitions Organic growth and cross selling • Entered the marketing services arena with three acquisitions • With gaps in most of our services which can be filled with niche of video game trailer production companies. • Added music management capability for the first time enabling us to offer a service which is complementary to our voiced audio, game development and marketing services. • Landed a leading sound design and sound effects team and invested in studios to support them. • Welcomed a leading voice production company to the Group which also brings with it writing and motion capture management experience. • We are now offering video game analytics services and automated app testing for GDPR compliance. • Completed eight acquisitions during the year which added additional scale and expertise in our Engineering and Art services lines as well as in our Audio business. • These acquisitions are being integrated within the service lines as well as within the country and regional management structures and our global finance, accounting, HR and IT functions. services, we will continue to acquire and invest in 2019 in expanding our palette of services. investment in growth in 2019 and may come to form our eighth fully fledged service line during the year. 7 • Most notably, marketing services is likely to be the recipient of further Seven service lines, up from two in 2009, four in 2013 and six in 2016. • The Group’s acquisition programme continues to be an important feature and we anticipate that 2019 will yield a similar number and value of acquisitions as previous years. 4-10 • We are mindful of the integration challenges and therefore Between 4-10 acquisitions per year. acquisitions will likely be spread across geographies and across services lines to avoid management overstretch. €30m to €80m invested. • Like-for-Like revenue grew by 10.1% in 2018 or 14.9% • Our principal focus will remain on organic growth, as in previous years, Organic growth materially ahead of market growth. Like-for-Like excluding VMC. • While this growth was lower than the Group had targeted, we faced some considerable market related headwinds in 2018 and we remain hopeful of double-digit growth in 2019. and we expect to grow faster than the market for our services as we capture market share. In 2018, the number of clients buying three or more services from us increased once • A key measure of our success is how ‘relevant’ we are to our clients, again, to 99 from 93 in 2017. as evidenced by the growth in the number of our clients and also how many services each of our clients is using. Overall customer numbers increased by 31% to 846 compared to 646 in 2017. Growing market share • We continued to grow our service lines aiming to make them the “go to” providers for their respective sets of services. • We have considerable headroom in each of our service lines to continue to grow our market share. Expanding geographic reach Introducing technology • Opened our third location in Eastern Europe improving access • to important talent pools. Increased presence on the West Coast of the US, with operations in Hollywood and Burbank in Los Angeles, which again provide access to talent but also get us closer to the video game producers and publishers on the West Coast. • Grew our presence in the UK, given its reputation for creative and technical video game talent. • Continuous development of tools for internal use in making processes more efficient and in managing our businesses more effectively. • Our acquisitions of XLoc, Yokozuna Data, GetSocial and our investment in and exclusive commercialisation of AS Analyser provide access to technology solutions that can be provided as a service to clients. • We have much to do to grow all our service lines to the point Critical mass in each service line provides scale, increased flexibility, improved Localization Services has reached in being the “go to” provider. efficiencies and deeper expertise. • We will seek to add to our capabilities in marketing, in Engineering and in Audio as we have been doing over the last year, as well Achieving critical mass comes through organic growth, led by cross selling and as more in Player Support. new client acquisition activities, and can be accelerated by selective acquisitions • Our testing businesses have achieved critical mass in North America of similar businesses. but remain underweight in Europe and Asia and we will seek to rebalance this over the coming years. • Geographic reach has been a decreasing driver for us as we have now We have a good spread of talent across three continents, with about 39% of our people expanded our reach onto many of our key target regions and while in North America, 24% in Europe and 37% in Asia. we would like to have a presence in territories like Korea, and a wider base in Eastern Europe, these aren’t essential priorities for 2019. • Keywords will continue to develop and acquire software solutions Supporting internal innovation and tool development including our newly initiated to support the services we provide to game developers and Keywords Innovate programme. game publishers. • Keywords Ventures (which is described in more detail in the Chief Selective acquisitions of software solutions that complement our services. Executive’s Review) is also active in assessing technologies being Yokozuna Data was acquired in July 2018. GetSocial acquired in February 2019. developed for games or related markets where we believe we can add value in terms of modest financial support coupled with our Venture investments and associated commercial agreements such as the recent global market reach in games. investment in GDPR compliance testing solution, AS Analyser, by Keywords Ventures. We continue to pursue our proven strategy of growing organically and through acquisitions to extend the Group’s range of services, geographic reach and client base to achieve scale and become the “go to” services provider for each of our service lines. Where the Group can use its existing expertise, we continue to cross over into neighbouring markets such as film and television, e-learning and wider uses of interactive content more generally, generating synergies in a highly fragmented games service industry. Each year, we continue to become more diversified and better balanced as a business, with an expanding range of services and with further locations to offer our clients. We see many opportunities to extend our existing relationships and become a strategic partner to major games companies, both through providing additional services to existing customers and through providing dedicated outsourced services. 16 Keywords Studios plc Strategic Report Extending our range of services Selective acquisitions Organic growth and cross selling of video game trailer production companies. • Added music management capability for the first time enabling us to offer a service which is complementary to our voiced audio, game development and marketing services. • Landed a leading sound design and sound effects team and invested in studios to support them. • Welcomed a leading voice production company to the Group which also brings with it writing and motion capture management experience. • We are now offering video game analytics services and automated app testing for GDPR compliance. • Completed eight acquisitions during the year which added additional scale and expertise in our Engineering and Art services lines as well as in our Audio business. • These acquisitions are being integrated within the service lines as well as within the country and regional management structures and our global finance, accounting, HR and IT functions. • Like-for-Like revenue grew by 10.1% in 2018 or 14.9% Like-for-Like excluding VMC. • While this growth was lower than the Group had targeted, we faced some considerable market related headwinds in 2018 and we remain hopeful of double-digit growth in 2019. Growing market share • We continued to grow our service lines aiming to make them the “go to” providers for their respective sets of services. • We have considerable headroom in each of our service lines to continue to grow our market share. Expanding geographic reach Introducing technology • Opened our third location in Eastern Europe improving access to important talent pools. • Increased presence on the West Coast of the US, with operations in Hollywood and Burbank in Los Angeles, which again provide access to talent but also get us closer to the video game producers and publishers on the West Coast. • Grew our presence in the UK, given its reputation for creative and technical video game talent. • Continuous development of tools for internal use in making processes more efficient and in managing our businesses more effectively. • Our acquisitions of XLoc, Yokozuna Data, GetSocial and our investment in and exclusive commercialisation of AS Analyser provide access to technology solutions that can be provided as a service to clients. Strategic Pillars Progress in 2018 Priorities in 2019 Measures of our Success • Entered the marketing services arena with three acquisitions • With gaps in most of our services which can be filled with niche services, we will continue to acquire and invest in 2019 in expanding our palette of services. • Most notably, marketing services is likely to be the recipient of further investment in growth in 2019 and may come to form our eighth fully fledged service line during the year. 7 Seven service lines, up from two in 2009, four in 2013 and six in 2016. • The Group’s acquisition programme continues to be an important feature and we anticipate that 2019 will yield a similar number and value of acquisitions as previous years. • We are mindful of the integration challenges and therefore acquisitions will likely be spread across geographies and across services lines to avoid management overstretch. 4-10 Between 4-10 acquisitions per year. €30m to €80m invested. • Our principal focus will remain on organic growth, as in previous years, and we expect to grow faster than the market for our services as we capture market share. • A key measure of our success is how ‘relevant’ we are to our clients, as evidenced by the growth in the number of our clients and also how many services each of our clients is using. • We have much to do to grow all our service lines to the point Localization Services has reached in being the “go to” provider. • We will seek to add to our capabilities in marketing, in Engineering and in Audio as we have been doing over the last year, as well as more in Player Support. • Our testing businesses have achieved critical mass in North America but remain underweight in Europe and Asia and we will seek to rebalance this over the coming years. • Geographic reach has been a decreasing driver for us as we have now expanded our reach onto many of our key target regions and while we would like to have a presence in territories like Korea, and a wider base in Eastern Europe, these aren’t essential priorities for 2019. Organic growth materially ahead of market growth. In 2018, the number of clients buying three or more services from us increased once again, to 99 from 93 in 2017. Overall customer numbers increased by 31% to 846 compared to 646 in 2017. Critical mass in each service line provides scale, increased flexibility, improved efficiencies and deeper expertise. Achieving critical mass comes through organic growth, led by cross selling and new client acquisition activities, and can be accelerated by selective acquisitions of similar businesses. We have a good spread of talent across three continents, with about 39% of our people in North America, 24% in Europe and 37% in Asia. • Keywords will continue to develop and acquire software solutions to support the services we provide to game developers and game publishers. • Keywords Ventures (which is described in more detail in the Chief Executive’s Review) is also active in assessing technologies being developed for games or related markets where we believe we can add value in terms of modest financial support coupled with our global market reach in games. Supporting internal innovation and tool development including our newly initiated Keywords Innovate programme. Selective acquisitions of software solutions that complement our services. Yokozuna Data was acquired in July 2018. GetSocial acquired in February 2019. Venture investments and associated commercial agreements such as the recent investment in GDPR compliance testing solution, AS Analyser, by Keywords Ventures. Annual Report and Accounts 2018 17 Chief Executive’s Review A strong performance 18 Keywords Studios plc Strategic Report Well placed to benefit from the growth in content that will be driven by streaming games and next generation consoles The Group produced another good performance during the year, albeit its growth was slightly held back by the anticipated low growth of VMC combined with the ‘Fortnite effect’ and, late in the year, certain unforeseen project delays and cancellations (both explained in more detail in the organic growth and investment section of this review). Despite these reverses, the underlying performance of all but one of the seven service lines has been strong. The exception was Localization Testing where we were particularly impacted by delays at the tail end of 2018 some of which we are now working on in 2019. Overall, we continued to increase our share of the growing video games market, with customers attracted by our ability to flexibly deliver high quality services, across an increased and unrivalled range of services and geographies. The addition of music management and sound effects, marketing services and data analytics through acquisitions in the year will further extend relationships with our clients. Delivering on our strategy Our strategy of building the world’s leading technical and creative services platform for the video games market and beyond continues to yield rapid, synergistic growth. Operating globally across the lifecycle of video games, we continue to benefit from the major structural drivers of a growing industry, combined with a trend towards the outsourcing of services to create, test, market, internationalise and support interactive content. The video games services market remains highly fragmented despite the scale and global nature of the major video games publishers and developers. We continue to believe that the services provision market needs to consolidate further in order to support the needs of game publishers and developers who are grappling with the challenges of producing ever extending content whilst meeting demands for higher quality. This includes the provision and support of this content in more markets, ENGINEERING Starting with the acquisition of GameSim in May 2017, our Engineering Services Line now comprises 7 companies in 8 locations. Possibly better described as game development services, we collaborate with our clients to deliver richer definition for their video gaming titles, learning applications or visualisation and simulation experiences. We provide a range of services from the creation of complete games; the co-development of games alongside our clients in which we assume responsibility for a part of the game; ongoing live support in which we continue to add features, expansions, new items, new characters to the game; the porting of games from one platform to another or from one hardware generation to another, with or without remastering of the content; troubleshooting services; and the provision of teams to work alongside our clients as an extension to their teams. across more devices and delivered in a range of formats – which looks set to extend to cloud-based delivery in 2019 and beyond. The ability and flexibility to extend team sizes and to turn to specialists who are available as needed is essential for publishers looking to satisfy these demands rapidly, thus making outsourced and embedded services ever more attractive. Annual Report and Accounts 2018 19 Chief Executive’s Review continued Acquisitions since early 2018 Year Art Creation Software Engineering Audio Functional Testing Localization Localization Testing Customer Support 2018 Fire Without Smoke The TrailerFarm Snowed In Studio Gobo Electric Square Yokozuna Data Maximal Cord Laced Blindlight 2019 Sunny Side Up GetSocial MUSIC SERVICES With the acquisition of Cord and Laced in April 2018, we entered the whole field of music services. Taking the expertise developed by Cord over many years of working with advertising agencies and directly with major brands in advising, sourcing, commissioning and managing music, including all licencing issues, we have started to introduce these specialised services to the games industry. Early successes in 2018 have included managing all the music requirements for a much-anticipated upcoming new game. Laced is a record label which specialises in helping game companies maximise returns from their investment in music by licencing it back and publishing albums of game music. One of the highlights of 2018 for Laced was the sell-out of its 4-album collection of music from the video game, Doom. During 2018 we successfully acquired and integrated eight companies, investing €33.1m in cash (gross) and €27.3m in deferred cash and in shares. These businesses extended our services into new areas such as marketing services, music management and predictive analytics and significantly strengthened our existing service lines including a considerable scaling up of our newer Engineering Service line. In particular, our entry into the design and production of trailers used to promote games has added a new pillar for growth through the acquisition of Fire Without Smoke and The TrailerFarm. In the first few days of 2019, we also completed the acquisition of our third company in marketing services, Sunny Side Up, and we hope to add further scale to this activity to turn it into our eighth service line. We added Snowed In and, more substantially, Studio Gobo and Electric Square to our Engineering Service line which had been significantly enhanced by the acquisition of Sperasoft in the last weeks of 2017. Following these acquisitions, this service line generates annualised revenues of c. €35.8m, demonstrating that we have been able to build a service line of scale that is now the fourth largest of our seven service lines, in a very short space of time. We are continuing to review further acquisitions in this area of our business while we further integrate the six studios that currently comprise the service line. Our recent acquisitions of Yokozuna Data and GetSocial have brought back-end gaming platforms and underlying analytics to the Group to help games companies keep gamers in their game for longer and improve their monetisation of the games. Whilst these acquisitions are not currently earnings enhancing, we believe that they can be developed into valuable additional technologies and services for clients and, therefore, additional revenue generators. In our Audio Service Line, we extended our service offering outside our traditional localised voice-over services, a field in which we lead the video games industry, to music management, sound effects and sound design and original language voice production through the acquisition of Cord and Laced, the hiring of a complete team in SoundLab and the acquisition of Blindlight. This broadened scope of services has already led to synergies and cross selling successes within the service line and with other service lines. The Group has now fully integrated VMC, which was acquired in October 2017 for $66.4m (€57.9m). This very thorough integration exercise across four service lines and five studio locations was completed ahead of schedule. As a result, VMC has contributed significantly to the Group’s achievement of a 15.1% operating margin, despite the pre-acquisition operating margin of VMC having been about 9%. Although initially a drag on revenue growth (as expected), it has given us the benefits of real scale in certain service lines in North America, where we are seeing growing demand, and it is significantly earnings enhancing. Keywords Ventures In July 2018, we launched Keywords Ventures (“KWV”) to make modest investments in companies with innovative technologies and services that will benefit our clients and where we can help commercialise those products and services through access to our global platform, relationships and funding. We would not expect our annual investment in KWV to exceed 5% of our annual spend on acquisitions. Our first investment was for £300,000, in a Series A funding for up to a 45% shareholding in a pre-revenue company, AppSecTest Ltd, which has created AS Analyser, a cloud based automatic testing solution that analyses apps and mobile games for compliance with the GDPR, and which launched in late 2018. 20 Keywords Studios plc Strategic Report Organic growth and investment We have continued to deliver organic growth, having achieved a 10.1% increase in Like-for-Like revenue at constant exchange rates in 2018. During 2018, our Like-for-Like revenue growth on this basis was negatively affected by two principal factors including the contribution from VMC where revenue declined in the year, as anticipated, and due to what we have labelled as the ‘Fortnite effect’. The phenomenally successful Fortnite game attracted some 200 million players during the course of the year and in so doing disrupted other games which we support, although we ourselves now do a considerable amount of work on Fortnite. In some of those cases, the competitive effect and loss of player base was material enough for clients to reduce their spending on supporting games, to terminate games and, while it may not be the only contributing factor, a few companies ceased trading altogether (or went into insolvency processes), including Telltale and Starbreeze. Localization was the service line most affected by the ‘Fortnite Effect’. The drag on the Group’s revenue growth by VMC primarily affected Functional Testing, Player Support and, to a lesser extent, Localization Testing. However, having now fully integrated VMC, we expect it to contribute to revenue growth and good margins in those divisions incrementally during 2019. Due to these impacts, the headline growth per service line in some instances masks the underlying trends but we have attempted to provide those underlying trends, alongside the reported numbers, in the service line review section below. We continue to make good progress in cross selling our services into our client base. For the 12-month period under review we increased the number of clients using three or more of our services to 99 clients in 2018 from 93 clients in 2017. The investment programmes in the existing businesses that we began in late 2017 were successfully completed in 2018 and resulted in increased capacity to support the organic growth of the business. The additional work stations created are being well utilised already and have helped to support our organic growth during the year. We expect to further increase our available work space in certain locations in 2019 but anticipate the level of investment returning to the ordinary course of business, in contrast to 2017 to 2018 when the demand pressures for space came together in many geographies and service lines. While we successfully consolidated some locations during the year, the results of organic and acquisition led expansion meant we finished the year with 52 operating units in 21 countries up from 42 and 20 respectively in 2017. Service line review Revenue Mix €’000 Art Creation Engineering Audio Functional Testing Localization Localization Testing Player Support Total Year ended 31-Dec-18 Year ended 31-Dec-18 Year ended 31-Dec-17 Year ended 31-Dec-17 41,688 26,161 34,190 49,128 43,983 19,751 35,904 250,805 16.6% 10.4% 13.6% 19.6% 17.6% 7.9% 14.3% 100% 26,193 3,572 20,657 30,033 41,959 19,848 9,168 151,430 17.3% 2.4% 13.6% 19.8% 27.7% 13.1% 6.1% 100 % As the Group made a number of acquisitions during the year, the following table also provides an overview of revenues on a Pro Forma basis, which includes the annualised sales of all acquisitions made in each year, in order to provide a better overview of the size and balance of the business at the end of each year. The service line commentary which follows reports on the statutory revenues unless otherwise stated. Proforma Revenue Mix €’000 Year ended 31-Dec-18 Year ended 31-Dec-18 Year ended 31-Dec-17 Year ended 31-Dec-17 Art Creation Engineering Audio Functional Testing Localization Localization Testing Player Support Total 43,978 35,803 36,897 49,128 43,984 19,751 35,904 265,445 16.6% 13.5% 13.9% 18.5% 16.6% 7.4% 13.5% 100% 36,239 17,059 24,573 48,183 43,323 22,717 28,626 220,720 16.4% 7.7% 11.1% 21.8% 19.6% 10.3% 13.0% 100% GAMES SCIENCES Since the beginning of 2018, Keywords has added meaningfully to its activities in the field of player behaviour analysis capabilities. All of which translate into helping our clients make better games, target the most appropriate new players, retain players for longer and monetise their games better. Player Research, our first business in this field acquired in October 2016 was complemented with the acquisition of Tokyo-based predictive analytics and machine learning business, Yokozuna Data in July 2018. In February 2019, GetSocial joined the Group, bringing with it a software platform for mobile games providing all the social media features and supporting analytics to player-led customer acquisition, social sharing, rewarding and push notifications to mobile game developers. As games continue to transition to a service model from a product model, the use of sophisticated game sciences to understand player behaviour and to facilitate and automate in-game actions will become increasingly valuable to our clients. Annual Report and Accounts 2018 21 Chief Executive’s Review continued Service line review Headed by Ashley Liu, based in Beijing, Art Creation services revenue grew 59.2% to €41.7m (2017: €26.2.m) reflecting full year contributions from the 2017 acquisitions, SPOV, Red Hot and part of Sperasoft, and, since May and September 2018, the contributions from the acquisitions of Fire Without Smoke and The TrailerFarm respectively. On a Like-for-Like basis, Art Creation grew by 11.9% year-on-year, having benefited from our investment in expanded capacity in late 2017 and into 2018 which enabled it to meet more of the demand for its services. In addition, increasing integration across a greater number of studios in the art service line has enabled us to take on and deliver work that we would not otherwise have been able to service. During the year we added marketing services, including the production of game trailers and marketing art and materials, to the range of services Art Creation is able to offer through the acquisitions of Fire Without Smoke and The TrailerFarm. Just after the year end, Sunny Side Up, another game trailer and marketing services business joined the Group through acquisition. We are continuing to review other acquisition opportunities in this area and may establish a separate services line to house these activities once it reaches the requisite scale. The Engineering services line which only started in 2017 has grown to represent around 13.5% of Group revenues on a proforma basis in 2018. Principally due to acquisitions made in the year its revenues grew seven-fold to €26.2m (2017: €3.6m) reflecting full year contributions from Gamesim, d3t and Sperasoft which were acquired during 2017, while Snowed In, and Studio Gobo and Electric Square have contributed since July and August 2018, respectively. Jamie Campbell, formerly CEO of d3t, assumed responsibility for this service line in July 2018. On a Like-for-Like basis, revenues grew by 23.3%. We now have a 333-strong team which is currently working on some very high-profile titles for some leading game developers and publishers and we were able to announce projects we had delivered in 2018 including significant work on Shenmue I & II for Sega; Assassin’s Creed Odyssey, Rainbow Six: Siege, and For Honor for Ubisoft; and Miami Street for Microsoft. While this service line is more project based and exhibits a lumpier revenue profile than the rest of the Keywords business, it is important for the Group as it is highly valued by our customers and ensures we are even more integrated with their development life cycles, often at an earlier stage. It is also expected to see significant demand as customers increasingly port games content to cloud gaming platforms for streaming. We are, therefore, actively assessing further acquisition opportunities in this area and as we build its scale, we expect to achieve smoother and more predictable revenues for this service line. Art Creation Engineering 16.6% of Group revenue for the year 10.4% of Group revenue for the year 22 Keywords Studios plc Led by Andrea Ballista, based in Milan, Italy, our Audio business extended its services offering into sound design, music management and original language voice recording (principally in Hollywood) during 2018 and these new services are showing good promise in their own right, in addition to bringing cross selling benefits to the Group. Games music is a niche but growing market and one example of our success in this area is that our games music record label, Laced Records, saw strong forward orders for its four-vinyl album of the music from Doom. As another example, Cord managed all the music elements for a highly anticipated upcoming game, in which it arranged the composition of music and the licensing of previously published tracks on behalf of the developer. Our audio studio in Tokyo, which we opened in 2017, had a good first full year of operations and has benefitted from a recently strengthened team in preparation for an even busier 2019, and our new, larger studios in London are enabling us to meet the strong demand for their services. Audio revenues increased by 65% to €34.2m (2017: €20.7m) including full year contributions from our 2017 acquisitions in Paris (La Marque Rose, Around the Word, Dune Sound and AsRec) and of Lola, and contributions from Cord and Laced, and Blindlight since they were acquired in April and June 2018 respectively. On a Like-for-Like basis, revenues in our Audio service line grew by 9.8%. This was achieved despite the collapse of two companies which were important clients for the service line and certain unexpected delays and scale backs in projects, all of which can in part be attributed to the ‘Fortnite effect’. It reflects the benefits of our previous investments in our Audio service line, including new studios in Tokyo and London. Our search for suitable premises in which to co-locate our four voice recording businesses in Paris is continuing but our continued focus on ensuring the premises are suitable and good value means it is taking longer than previously envisaged to achieve this goal. In the meantime, these businesses are operating well from their existing studio locations under common management and reporting. Audio 13.6% of Group revenue for the year Strategic Report Our Functional Testing service line grew by 64% to €49.1m (2017: €30.0m), including a full year’s contribution from VMC which was acquired in October 2017. The service line also grew by 6.4% on a Like-for- Like basis despite the anticipated drag from the inclusion of c.52% of VMC revenues (at the time of acquisition) falling within Functional Testing. Excluding VMC, we estimate that this Like-for-Like growth would have been 26.5% as our functional testing business in North America has become the “go to” provider. Our Localization activities increased revenues by 5% to €44.0m (2017: €42.0m). Like-for-Like revenues grew by 3.5% despite suffering a significant impact from clients reducing support for some of their games, which we believe was in large part due to the ‘Fortnite effect’. In particular, one client who was the top ranked client by revenue for this service line in 2017 reduced its spend substantially compared to the prior year and our expectations, leaving the Localization service line to make up a c.€6m deficit. The service line management team led by Mathieu Lachance, who is based in Montreal, Canada, have done well in integrating the VMC business, having consolidated their facilities, improved the processes in the business and implemented common tools such that there is now no discernible difference between what was VMC and what is the larger Keywords team today. We expect the functional testing activities of VMC to grow at the same rate as the underlying service line in 2019 and beyond. The VMC brand along with that of Babel has been replaced by the Keywords name to reflect this complete integration. Enzyme Testing labs continues to have its own branding for now, although this may be rebranded during 2019. During the year, the Localization service line, led by Fabio Minazzi in Milan, continued to invest in new functionality and the scalability of our proprietary “BPS” operating platform and worked with our suppliers of translation memory systems to increase the robustness of these solutions to support the ever-increasing workloads we are putting through them. We have continued to explore machine translation solutions and while we have found few opportunities for the use of this technology in video games localization so far, we will none-the-less be more active in building this capability into our workflows during 2019. Our XLOC globalization content management product progressed further in 2018 and we recently launched XLOC 6.2 with more developer file formats supported and new user interfaces, including in both Chinese and Japanese, making it the only product of this kind available for Asian developers. Our Localization Testing operations maintained revenues at €19.8m (2017: €19.8m) helped by the full year contribution from VMC. On a Like-for-Like-basis however, its revenues declined by 10.6%. This performance in part reflects VMC’s inclusion (if VMC were excluded, Like-for-Like sales would have declined 8.7%), but the key impact was from some important titles, that were expected to come in for testing in the last two months of the year, being delayed to Q1 2019. Consequentially, the service line has started strongly in the first months of 2019. In addition, we anticipate that longer sales cycles, as we have concentrated more effort on multi service line strategic client relationships, should bear fruit in 2019 and the management team, led by Thomas Barth from Dublin, Ireland, are continuing to focus on quality and cost efficiencies. In line with this focus, they are exploring the option of establishing a localization testing operation in Katowice, Poland, leveraging the management, personnel and facilities infrastructure created there by the Player Support Group to access the local, high calibre, yet good value talent. Revenues for this service line, which benefitted significantly from a full year contribution from VMC, almost quadrupled to €35.9m (2017: €9.2m). The VMC business reduced the Like-for-Like growth of the business, as expected. Without VMC Like-for-Like growth would have been 94.1%, rather than 30.8% including the effect of VMC. This excellent underlying performance led by Frederic Arens, who moved from Montreal to our Tokyo studio during the year, was driven by organic expansion, including the opening of a new support centre in Katowice, Poland, making use of the nearby presence of Sperasoft in Krakow. This facility now employs 200 people having commenced in June 2018. Our Manila operation has also continued to grow strongly and now has 700 employees, double the number in the prior year. Player support is planning for a year of consolidation in 2019, after the exceptional growth in 2018. The Player Support operations assumed from VMC are being stabilised, although some further attrition is expected in 2019, and we expect it to return to growth by next year. Functional Testing Localization Localization Testing Player Support 19.6% of Group revenue for the year 17.6% of Group revenue for the year 7.9% of Group revenue for the year 14.3% of Group revenue for the year Annual Report and Accounts 2018 23 MARKETING SERVICES Fire Without Smoke (FWS), The TrailerFarm and Sunny Side Up make up our marketing services business which is currently housed within our Art Services Line. Our activities here are primarily the production of marketing trailers to support the launch of games, promote the addition of expansion content, introduce new characters, and support community outreach. In addition, we also provide marketing consultancy services, key art production (such as billboard advertising) and e-Sports marketing materials. The combination of creative and technical services represented by this activity sits well within the Keywords family while also expanding our contacts within our clients to include the marketing departments for the first time. Chief Executive’s Review continued Managing growth and developing our people In July 2018, we strengthened the senior management team with the promotions of Igor Efremov, previously with Sperasoft, and Jamie Campbell, previously with d3t, to the roles of Chief Commercial Officer and Service Line Director, Engineering respectively. In addition, we appointed Andrew Brown, whose background is in marketing at Danone, Coca Cola, Johnson & Johnson and Activision, to the role of Chief Marketing Officer. The Group employed an average of 5,238 people in 2018 (2017: 3,167). Of these around 1,100 are flexibly resourced positions, most notably in our testing businesses, which enables us to scale up and down with the demands of the projects. Across our three regions of the Americas, Europe and Asia, we employed an average of 2,056, 1,267 and 1,915 respectively. By function, these 5,238 positions break down in to 1,199 artists, 333 engineers / software developers, 1,615 testers and test engineers, 1,113 player support agents, 165 internal linguists, 100 audio engineers, and 255 project managers and supervisors. We also have 458 people in our support functions, including in finance / accounting, HR, IT, facilities, administration, and general management. Our increasingly broad and deep pool of highly experienced and games-passionate co-workers provide a tremendous resource that our clients can access as needed in order to get their content developed, localised, marketed and supported in live operations, in a flexible and cost- efficient manner across the globe and in appropriate time zones. While we continue to develop our own tools to improve productivity and to use best of breed solutions where we can in our business, talent remains by far our most important asset. There is always more to do in investing in our people, but we continue to make improvements with training, benefit schemes, career planning and we monitor ourselves in line with our policies of non-discrimination, to ensure we are providing equal opportunities. We are particularly proud and protective of our culture. It acts as the glue that binds our co-workers around the world together. Empowered, relaxed, professional and humble with a focus on doing the very best we can for each project entrusted to us, this culture creates an environment in which games- passionate individuals can work as an extension of our client’s organisations together with like-minded colleagues, while enjoying the opportunity to collaborate on most of the world’s leading games ahead of their release. We are an increasingly attractive employer for many in the wider games industry, as we offer the opportunity for individuals to work on around 250 leading games at any time or over 600 throughout the year, giving them an excellent and sustainable variety of work as well as good career advancement and opportunities to work in many different locations. We are proud of and aim to develop and retain our home-grown talent, but we are equally proud that a healthy proportion of our colleagues have, and will, go on to work in games publishing and development within our clients’ organisations, creating a Keywords’ alumnus which is helpful to both us and the games industry in general. Our acquisition programme also brings fresh talent to the Group at all levels and we continue to be successful at integrating our businesses, including providing opportunities for our staff and colleagues to move between our various studios and the countries in which we operate. Our senior leadership team, which comprises four people from the original Keywords business, ten people from acquired entities as well as six externally hired employees is itself testament to the opportunities provided across the Group and our ability to complement the leadership team with talented individuals from acquired companies. We continue to see demand for our services from outside of the games industry due to the specific expertise we have in interactive content development, testing and support. Working on different forms of content can help to further expand the horizons of our colleagues as they get the opportunity to tackle challenges in new but related fields such as film and TV, retail, education, automotive, advertising, architecture, urban planning, theme parks and interactive experiences. In time, we intend to more proactively target expansion into some of these adjacent market sectors, building on the experience we are already gaining. 24 Keywords Studios plc Strategic Report Current video games market trends Bursting onto the scene in the last months of 2018 has been the promise of streaming of video games or cloud-based gaming. While earlier attempts from companies like OnLive and Gaikai stalled in the earlier part of this decade, Google has now entered the market with its newly launched Stadia streaming service and Microsoft has indicated its plans for its games streaming project, codenamed xCloud, to provide streaming access to over 3,000 current Xbox titles, supported by its Azure cloud infrastructure of 54 data centres serving 140 countries. Apple also announced in March 2019 its Arcade subscription-based gaming service which, although not a streaming platform per se, does provider gamers with access to many games through this new subscription platform. The promise of these subscription platforms providing easy, mostly device independent access, to play video games anywhere in the world is compelling and, if successful, will be a major opportunity for new entrants (such as Google and Apple) and for potentially new monetisation models. As the music and film and TV industries have experienced when moving towards streaming services, we expect to see an increased demand for content as these streaming platforms compete to become the “Netflix of games” and endeavour to host the most and the best content to attract and retain their player bases. While we can’t rule out some short-term disruption from this development, we believe that Keywords is well placed to benefit from this trend as games are repurposed to run well on the new streaming platforms and new content is created that best fits their capabilities. Keywords started working on a number of projects directly related to video game streaming in the second half of 2018 and we have further increased our exposure in the first months of this year, with a number of services being provided and discussions ongoing with existing and potential clients about how we might support future projects. Few industry observers expect these developments in cloud-based gaming to displace the video game consoles and PCs, on which so many games are played, in the short term. This is expected to change as internet bandwidth improves around the world and latency issues are overcome. The current generation of Sony and Microsoft devices launched in November 2013 have been refreshed since but there is now speculation over a new generation of Xbox and PlayStation consoles which could launch over the next two years. This would represent another milestone for the games industry and one from which we believe Keywords is well placed to benefit. At the time of the last launch, there was a sudden switch of investment by publishers and developers away from the previous generation of games. This time, given that games as a service is such a feature of games now, we expect to see the current generation of games continue to be supported while new games are developed that take advantage of the enhanced capabilities of the new consoles. The mobile games sector continues to grow faster than other platform types, with much of this growth originating in Asia. Keywords is proud to be supporting many of the world’s leading mobile games and, as the quality, complexity and scale of individual mobile games grows, this benefits Keywords as the skills, scale and global reach of all its services from development to player support become more relevant to them. MagicLeap released their much-anticipated augmented reality headset for use commercially in August, albeit it was restricted to the US. Microsoft have confirmed that their HoloLens 2 augmented reality headset will be launched later this year but augmented reality, much like virtual reality, is showing signs of slower adoption in the games industry than many had thought a few years ago. Keywords does work extensively on VR content (games and non-games) as well as AR but we don’t anticipate these being major growth drivers in 2019. eSports continues to develop strongly, and we increased our exposure to this market in a small way through our entry into marketing services with the acquisitions of Fire Without Smoke, The TrailerFarm and Sunny Side Up. We continue to seek out ways in which we can participate in this segment in a more meaningful manner. The astounding success of Fortnite and, to a lesser extent, Player Unknown Battleground (“PUBG”), has been a disruptor in the market in 2018, helping to attract new video gamers to the market while also outcompeting other games. While we expect the success of both to continue, we think the market is more settled now with Fortnite, PUBG and more latterly, Apex Legends, an integral part of it. Also, of note has been Epic Games (publisher of Fortnite) move into providing the market with a lower cost route of getting games to market than the established platforms such as Steam. If game developers and publishers reduce their costs of distribution and increase their margins as a result, this may translate into higher spend on content creation, marketing and support which will benefit Keywords. Annual Report and Accounts 2018 25 Chief Executive’s Review continued Service provider market The service provider market remains highly fragmented and, in addition to the continued growth in our end market driving demand, we continue to see a trend to outsourcing across all our service lines, with Art Creation, Functional Testing and Engineering likely to benefit more given the high proportion of this type of work that remains in house. In addition, we hope to further increase market share and benefit from our larger scale as we further consolidate our market. Outlook We have had an encouraging start to 2019, with trading for the first quarter being in line with our expectations. Some important new business wins, including in the game streaming space, and good overall demand for our services across the Group give us confidence in the outcome for the full year. We expect 2019 to be lighter in capital expenditure than 2018, although we won’t hesitate to invest in growth and enabling technologies as the opportunities arise and as we see the business requiring more space, people, tools, and systems. Whilst we are listed in the UK, only a relatively small proportion of our business is in the UK where we now employ a total of 317 people. As a highly international diversified business that operates in a very global market we, therefore, do not expect Brexit to have a material impact on the business. Our acquisition program is continuing at pace, with a particular focus on building up our marketing, engineering and audio services. Having completed the acquisition of Sunny Side Up in early January, we announced in February 2019 that we had acquired GetSocial, which brings to the Group leading edge technology which drives user engagement, retention, acquisition and monetisation through social interactions of players within the game. We are actively reviewing a healthy pipeline of acquisition opportunities from which we will continue to be selective, with many businesses excited about the strong platform Keywords could potentially provide for their services and people. Our Keywords Ventures arm has an active pipeline of investment opportunities in areas that would benefit our video game client base and beyond. The application of artificial intelligence and machine learning to the video games space is interesting and a number of these opportunities lie in this general arena. We see potential to leverage the latest technologies and big data expertise to provide services to our clients which help them better understand and influence player behaviour, so they can attract players more cost effectively, retain them for longer and better monetise players while, at the same time, fine tuning and improving the game experience for players. As a more diversified, better balanced business with significantly expanded range of services to offer our clients, we look forward to developing our relationships with our clients through increased integration of services, the development of more strategic client relationships, across multiple services, and through the provision of dedicated outsourced or embedded services. Andrew Day Group Chief Executive Officer 8 April 2019 26 Keywords Studios plc Strategic Report Financial and Operating Review Strong results driven by good organic growth complemented by acquisitions Group performance 2018 has seen the Group deliver another year of significant increases in revenue, profit and underlying cash generation driven by good organic growth, substantially complemented by acquisitions which have further extended its service offering, market penetration and geographic reach. Revenue Revenue for 2018 was up 66% at €250.8m (2017: €151.4m). Overall six of the seven service lines grew, with Engineering and Player Support being particularly strong. This growth was generated through a combination of both organic and acquisitive growth. On a constant currency basis, revenue grew to €258.6m (2017: €151.4m). The Like-for-Like revenue growth rate was 10.1% for the year, down from 15% in 2017 due to the onboarding of the VMC business. Excluding VMC, the Like-for-Like revenue growth rate, was 14.9%, which was in line with our expectations and a strong growth rate from a larger base. Gross margin Gross profit for the year was €95.8m (2017: €55.1m). The gross margin percentage increased to 38.2% (2017: 36.4%). EBITDA EBITDA for the year was €34.3m (2017: €21.9m). Adjusted EBITDA is a measure of operating profit used by the Board, which excludes depreciation, amortisation, share option expenses and one-time costs related to acquisitions. For 2018, Adjusted EBITDA increased 66% to €43.7m compared with €26.3m for 2017. As a percentage of revenue, Adjusted EBITDA has been maintained at 17.4% compared to 17.4% for 2017. Adjusted Operating Costs, which excludes depreciation, increased by €23.2m to €52m (2017: €28.8m) mainly as a result of the acquisitions made in 2017 and during the year. The continued additional investment in strengthening Keywords’ management to successfully manage the growth of the Group also contributed. These costs increased from 19.0% to 20.7% of revenue. Net finance costs During 2018, there was a net finance cost of €0.5m compared to a cost of €4.4m in 2017 primarily due to the impact of foreign exchange gains of €0.8m (2017: loss of €3.6m). The foreign exchange movements were largely due to the effect of translating net current assets held in foreign currencies. The interest expense of €0.5m (2017: €0.3m) related partly to the syndicated revolving credit facility (“RCF”) of up to €105m over a three-year period of which €40m was drawn down at the year end. Profit before taxation Profit before tax for the year was €22.1m (2017: €12.0m). Adjusted Profit Before Tax is used by the Board to measure the more meaningful underlying profit generation of the Group. This measure adds back one-time expenses, including acquisition and integration expenses of €5.6m (2017: €3.0m), share option charges of €4.1m (2017: €1.4m), foreign currency exchange gains of €0.8m (2017: loss of €3.6m), and amortisation of intangibles of €6.9m (2017: €3.0m) to the statutory profit before tax. As a result, Adjusted Profit Before Tax for 2018 increased by 65% to €37.9m compared with €23.0m in 2017. Annual Report and Accounts 2018 27 Financial and Operating Review continued Revenue mix Revenues increased across six of our seven lines of business in 2018, staying constant in Localization Testing, resulting in our seven service lines accounting for the following proportion of Group sales in the year on a statutory and pro forma basis*: Revenue mix % Art Creation Engineering Audio Functional Testing Localization Localization Testing Customer Support Total Revenue Year ended 31-Dec-18 % Revenue Year ended 31-Dec-17 % Proforma* revenue for the Year ended 31-Dec-18 % 16.6 10.4 13.6 19.6 17.6 7.9 14.3 17.3 2.4 13.6 19.8 27.7 13.1 6.1 16.6 13.5 13.9 18.5 16.6 7.4 13.5 100.0 100.0 100.0 * Pro forma includes the annualised sales of all acquisitions made in 2018 in order to give a better overview of the balance of the business at the start of 2019. Total pro forma revenue for 2018 on this basis was €265.4m (2017: €220.7m). Following acquisitions made in late 2017 and through 2018, the proportion of the Group’s revenues denominated in US Dollars is running at around 49%, while those in Euros and Canadian Dollars are around 22% and 16% respectively. The UK has grown in importance to the Group as a result of our investments in the more technical and creative areas of our business, resulting in annualised revenues denominated in Sterling of approximately 9%. Taxation The Group’s effective tax rate has decreased again in 2018. We continue to make steady progress in making better use of our Ireland- based operational headquarters in contracting and treasury management such that we expect our effective tax rate to continue to reduce despite our exposure to higher tax jurisdictions in most of the territories we operate in. The Group’s adjusted effective tax rate, based on the Adjusted measure of Profit Before Taxation in the period (as set out in the financial overview above), was 19.0% (2017: 20.5%). Basic earnings per share Basic earnings per share based on the statutory profit after tax was 23.16c (2017: 12.37c). Adjusted Basic Earnings Per Share for the year, before one-time costs of acquisitions and integration, share option charges, amortisation of intangibles, and foreign exchange movements, increased by 53% to 47.8c compared with 31.2c for 2017. The Group made eight acquisitions to strengthen the business during the year with a related net cash outflow on consideration payments of €24.1m, and an additional €4.5m in acquisition and integration cash outlay. Investment in fixed assets amounted to €9.4m (2017: €3.8m) reflecting the ongoing costs of IT across larger staff numbers and the cost of further increasing the capacity of the Montreal, Tokyo and Manila studios, and improvements to both the Dublin and London studios. Additionally, there were ongoing purchases of games, development and testing equipment. Following the investment of €24.1m net cash consideration for acquisitions in 2018, cash and cash equivalents increased to €39.9m from €30.4m. The loans and borrowings were €40.3m at 31 December 2018 (2017: €19.3m) having utilised €40m of its €75m revolving credit facility, giving a net debt position of €0.4m (2017: €11.1m net cash). Cash flow and debt The Group generated operating cash flow of €32.2m for the year, up from €16.7m in 2017. During the year the Group also received multi media tax credits (“MMTCs”) in Quebec of €10.9m (2017: €3.4m). MMTCs in relation to VMC for the years 2015 to 2017 were collected in 2018 and the total MMTC accrual amounted to €9.2m as at 31 December 2018 (2017: €10.0m). Capital Structure and Group Financing The Keywords Group funds itself primarily through cash generation and a syndicated revolving credit facility. The bank debt facility is a €75m RCF, with an option to increase this to €105m. The Keywords Group had €40m drawn from the RCF at year-end 2018. The RCF matures in June 2021 and has an option to extend it for up to a further 2 years. As at 31 December 2018, the Group had available cash balances and undrawn facilities which, aggregated, were c.€75M. These available funds and ongoing cash generation from activities provide appropriate operational headroom and available funding for strategic purposes. Key Financial Covenants The majority of Group borrowings are subject to financial covenants that are calculated in accordance with the facility agreement: • Leverage: A maximum Total Net • Borrowings to Adjusted EBITDA ratio of 3 times; and Interest Cover: A minimum Adjusted Operating Profit to Net Finance Costs ratio of 4 times. The Group’s performance against these covenants in the current and comparative year is set out below: Covenant Leverage Maximum 3.0 Interest Cover Minimum 4.0 2018 Times 0.19 2017 Times -0.47 40.29 40 Foreign exchange Keywords does not hedge foreign currency profit and loss translation exposures. The effect on the Group’s results of movements in exchange rates and the foreign gains and losses incurred during the year mainly relate to the effect of translating net current assets held in foreign currencies. 28 Keywords Studios plc Strategic Report Dividend The Group has a progressive dividend policy, subject to the retention of funds needed to fund future growth of the Group’s business and its strategic aims. This was identified by the Board in August 2018 and legal advice was obtained. It is important to make clear that no party has been or is in a worse position as a result of these oversights. Following the interim dividend payment of 0.53p per share in October 2018, the Board has recommended a final dividend of 1.08p per share, which will make the total dividend for the year ending 31 December 2018 1.61p per share, a 10% increase over 2017. Subject to shareholder approval at the Annual General Meeting, the final dividend will be paid on 21 June 2019 to all shareholders on the register at 31 May 2019 and the shares will trade ex-dividend on 30 May 2019. The cash cost of the final proposed dividend will be an estimated €0.8m, subject to currency fluctuations. Review of distributable reserves and rectification of prior dividends The Board has identified technical breaches in respect of certain interim and final dividends having been declared and paid otherwise than in accordance with the requirements of the Companies Act 2006 (the “Act”). The Company has previously declared final dividends and certain interim dividends relating to the financial years 2014 to 2016 without having had sufficient distributable reserves in the holding company as required by the Companies Act 2016 due to a failure to make the necessary upstream distributions from subsidiaries to the Company despite such reserves being available. This was recognised during 2017 and a major distribution exercise was undertaken to rectify the problem. In addition to the above, no interim accounts were filed at Companies House prior to the payment of interim dividends previously paid by the Company in the years 2013 to 2018. The Company is seeking authority to release all relevant parties from any potential liability via a specific shareholder resolution to be put to the shareholders at the 2019 AGM. Accordingly, the appropriate resolution, if passed, will authorise the Company to enter into deeds of release to put all relevant parties in the position in which they were always intended to be had the relevant dividends been made in accordance with the Act. Full details, including the form of the deeds of the release, will be included in the circular and notice of the 2019 AGM to be sent to shareholders. For the avoidance of doubt, procedures are now in place to ensure that this does not happen again in the future. Events after the reporting period On 3 January 2019, we announced that the Group acquired Sunny Side Up Creative Inc in Canada for a total consideration of CAD 5.9m comprised of an initial cash consideration of CAD 4.75m on completion and the issue of 60,179 ordinary shares in Keywords. Sunny Side Up generated Adjusted EBITDA of CAD 1.2m in the year to September 2018. On 21 February 2019, we announced that the Group acquired GetSocial B.V. in the Netherlands for a total consideration of €0.2m. David Broderick Chief Financial Officer 8 April 2018 Annual Report and Accounts 2018 29 KPIs FINANCIAL KPIs We monitor our financial performance against a number of different benchmarks and these are set in agreement with the Board. Like-for-Like Revenue Growth 10.1% Revenue Growth 66% Gross Margin 38.2% Adjusted Operating Costs as a % of Sales 20.7% 2018 10.1% 2018 66% 2018 38.2% 2018 20.7% 2017 15.1% 2017 57% 2017 36.4% 2017 19.0% Quantifies the growth in revenue to external customers. The Board believes this to be a consistent measure of trading performance. The Board monitors the overhead to ensure the operating costs of the Group are in line with the level of business being generated. Calculated increase in sales year on year. Sales revenue from contracts with customers less cost of sales. Administration expenses, before non-operating costs including share option costs, costs of acquisitions and integration, amortisation, depreciation, and including bank charges, as a percentage of revenues. Reasons for choice Due to the number of acquisitions the Group makes and because it integrates them quickly, this provides the most meaningful measure of underlying revenue growth. How we calculate Calculated by adjusting the prior year revenues comparison, by adding pre-acquisition revenues for the corresponding period of ownership, as presented in the current year results, and applying consistent foreign exchange rates in both years. Outlook The Group expects to achieve like for like growth materially ahead of market growth. The Group expects FY19 to be another year of revenue growth and development. The Group expects to keep margins in line with previous years. The Group will continue to seek to control these closely and in line with the level of business being generated. 30 Keywords Studios plc Strategic Report Adjusted operating profit margin 15.1% Adjusted Operating Cash Conversion 87% Growth in Adjusted EPS ROCE 53% 19.4% 2018 2017 15.1% 2018 87% 2018 53% 2018 19.4% 15.2% 2017 84% 2017 51% 2017 15.8% The Board believes this to be a consistent measure of trading performance, aligned with the interests of our shareholders. Measures cash generation and our capacity to pay dividends and service debt. Reports the underlying profit generated on a per share basis, demonstrating the value being created for shareholders. Also links to the Group’s dividend policy and gives an indication of our ability to pay dividends from underlying profit. Provides an indication of how we are performing relative to our peers and against our cost of capital. Operating profit before foreign exchange gains or losses, amortisation, any one time expenses and the cost of employee share option awards. Adjusted Free Cashflow as a percentage of the Adjusted Profit Before Tax. The Adjusted Profit After Tax comprises the Adjusted Profit Before Tax, less the tax expense as reported on the Consolidated Statement of Comprehensive Income. The Adjusted Earnings Per Share comprises the Adjusted profit after tax over the non-diluted weighted average number of shares, as reported on note 8. ROCE is the continuing Adjusted Profit Before Tax as a percentage of total capital employed, which are both adjusted as if all the acquisitions made during each year were made at the start of that year. The calculation is described in more detail on pages 106 and 107. The Group expects to keep margins in line with previous years. Cash generation and working capital management will remain a key focus in FY19. The Group expects that FY19 will be another year of growth in Adjusted Earnings Per Share. The achievement of returns on capital employed in excess of the Group’s cost of capital will continue to be key in order to ensure the efficient generation of cash to fund organic growth, acquisitions and dividend growth. Annual Report and Accounts 2018 31 Extending our range of services Selective acquisitions Organic growth and cross selling Growing market share Expanding geographic reach Introducing technology Principal Risks and Uncertainties The principal risks associated with the Group’s strategy can be divided into: General business risks for any international company; Industry-related risks; and Those specific to the Keywords Group and its strategy. The principal risks to which the Group is exposed are set out below, together with details of their potential impact; the likelihood of occurrence (on a scale of 1 to 3, with 1 being the most likely); an indication of whether the trend in the risk exposure is increasing, decreasing or broadly unchanged; and the actions taken to mitigate the risk. Links to Strategic Pillars: Extending our range of services Selective acquisitions Organic growth and cross selling Growing market share Expanding geographic reach Introducing technology Trend Increase No change Decrease Internal risks Likelihood Actions Trend Acquisition risks Failure to deliver services Cross contamination 3 3 2 Keywords has an active acquisition strategy to reinforce its global growth. Managing such acquisitions successfully and embedding the Keywords culture is a crucial ingredient of success, and as Keywords continues to make larger acquisitions, the risk associated is heightened. Failure to do so will have adverse consequences such as management distraction, disposal and reduced profit. Since IPO, the Company has involved a broader number of senior managers in the acquisition and integration process, building on the considerable experience that exists at Board level thus providing further bandwidth to identify, execute and integrate acquisitions. Most of Keywords’ services are of a time-critical nature with delays or service delivery failures potentially impacting the development or launch plans for games. Timely delivery and the resourcing flexibility to enable delivery to tight deadlines has been an integral part of the Company’s modus operandi, and Keywords’ approach to project management is applied across the Group. With the expansion of the Group, measures are being taken to assess ongoing delivery performance beyond the regular project post-mortems that are routinely conducted. As the Group succeeds in delivering multiple services to the same clients, so the risk of failure in one service line contaminating the relationship with the client across the other service lines increases. Whilst the introduction of co-development adds to this risk in some respects, it also helps to mitigate it. Adhering to Keywords’ strong standards of delivery and efficient communication across service lines is key to managing this risk External risks Likelihood Actions Trend Exposure to large clients 3 The Company’s client base principally comprises global game companies whose revenues are in the billions and hundreds of millions of dollars. Our top five clients account for 25.6% (2017: 29%) of the Company’s revenues. These companies have exacting standards and demand a high quality of service. Any failure in this regard or breakdown in the relationships at the top level could cause considerable damage to the business. The potential impact is partially mitigated through the Company’s highly flexible resource base and its expansion continues to reduce its exposure to any single large client. 32 Keywords Studios plc Strategic Report Introducing technology External risks Likelihood Actions Trend Financial performance – failure to meet expectations Sudden business interruption Breaches to Technology and information security Global political risk and uncertainty 2 3 2 3 Keywords floated on AIM in July 2013 with an expressed set of objectives of growing the business organically and by acquisition. Should the Company lose the confidence of investors, the Company’s rating will suffer and this in turn will affect its ability to raise money for or place shares to pay for acquisitions. However, the Company makes every effort to communicate regularly with investors via announcements and face-to-face contact and this effective communication of the continued opportunities for growth in the sector, how it continues to execute on its stated strategy and successfully integrate the businesses it acquires should continue to maintain the confidence of its investors. Keywords is a global business and needs to minimise business interruptions and be able to continue servicing customers. This threat could be internal such as a major failure in its IT systems but also external such as the Group experienced and managed during the 2011 Tokyo earthquake and tsunami. The Group’s multiple, full-service, delivery hubs provide for a good level of contingency and, supported by a solid business continuity plan and comprehensive insurance, the effects of such disasters can be managed. The Company uses various third party and proprietary tools and technologies for process control and productivity purposes. Continued investment in these tools is important to ensure the Group’s effectiveness. New technologies for automated testing, machine translation and crowdsourcing, could pose a threat to the Group in the long-term. The Company participates directly and with clients in various pilot programmes for new technologies to keep abreast of the state of the art and we have a technology innovation initiative called Keywords Innovate which distils ideas from across the Group to develop technologies that can support our services. This is further underpinned through the formation of Keywords Ventures which is focused on new, emerging technologies that may impact the Group in the future. The industry requires the highest standards of security within a company offering services such as Keywords. Cyber security breaches may lead to piracy, disruption of clients’ marketing plans, loss of competitive edge and could result in compensation claims. Keywords maintains physical and data security policies and procedures which are regularly audited by its larger clients. We operate and own assets in a large number of geographic regions and countries, and, as a result, we are exposed to a wide range of political, economic, regulatory, social and tax environments. Policies or laws in the countries in which we do business may change in a manner that may be adverse for us, even those with stable political environments e.g. many governments have sought additional sources of revenue by increasing rates of taxation. However the diversification and spread of activities geographically mitigates the risk of disruption in any one location and the tax strategy adopted is designed for improved efficiency and we eschew aggressive or artificial practices. Brexit The Board has assessed the risk of Brexit on Keywords and concluded that for now, this does not constitute a risk for the Group as its UK operations are small relative to the rest of the Group. Financial risks Likelihood Actions Trend Inadequate financial and operational controls Failure to manage human resources / talent effectively Non-compliance with legal and ethical standards 3 2 2 As a business like Keywords grows rapidly, global financial controls and regular audits need to be in place to ensure smooth, timely and accurate reporting to satisfy the relevant accounting bodies to local branches as well as the Board. Failure to accurately report or forecast financial results through error or fraud would damage the Group’s reputation. Therefore, the Group has invested and continues to invest in its financial reporting functions to facilitate strong reporting and management control as it grows. The Group intends to appoint a new Global Internal Audit Manager was appointed in 2019 to further drive improvements. Keywords management structure has been fundamental to the Group’s success, enabled by embedding a Group culture that binds the teams together, with a common set of standards. In addition, special emphasis is placed on workplace harmony and the prevention of any forms of discrimination, harassment, or malpractice in the workplace recognising that any sense of dissatisfaction can be very disruptive. As a separate dimension, failure to attract, retain or develop high quality entrepreneurial management across the business could impact on the attainment of strategic objectives. The Group is focused on these areas with the implementation of globally managed service lines, management development and remuneration programmes, incorporating long and short-term incentives. Regular staff surveys are undertaken. A material failure to comply with applicable legal and ethical standards could result in penalties, costs, reputational harm and damage to relationships with suppliers and customers. The Group promotes a culture of “Doing the right Thing” in all activities. Business conduct guidelines are in place and are supported by more detailed policies and procedures where needed. Annual Report and Accounts 2018 33 Board of Directors: Biographies Ross Graham (71) Independent Non-Executive Director and Chairman Andrew Day (55) Group Chief Executive Officer David Broderick (44) Chief Financial Officer David Reeves (72) Senior Independent Non-Executive Director Length of service with the Group (as at 8 April 2019): 5 years Length of service with the Group (as at 8 April 2019): 10 years Length of service with the Group (as at 8 April 2019): 3 years Length of service with the Group (as at 8 April 2019): 5 years Experience: Ross has extensive executive and Non-Executive experience in the technology sector. From being a partner in Arthur Young from 1981 to 1987, he joined Misys PLC, a global software business as Finance Director upon its flotation, latterly becoming Corporate Development Director; throughout he played a key role in developing and implementing the very successful Misys acquisition strategy. Since retiring from Misys, Ross has held a number of Non-Executive directorships including those at Psion PLC from 2005 until 2012 (when it was successfully sold to Motorola Solutions Inc.), at Wolfson Microelectronics PLC from 2004 to 2013 (prior to its sale to Cirrus Logic Inc.), and several others. His experience in these companies has included being Senior Independent Director, Chairman of the Audit Committee and Chairman of the Remuneration Committee. Ross was appointed Director and Chairman of Keywords shortly prior to its flotation in July 2013. With his wealth of experience and Chairing skills, Ross creates the environment for dynamic Board discussion. He has helped elevate the governance processes without destroying the entrepreneurial essence of Keywords. 34 Keywords Studios plc Experience: Andrew has a background in technology, manufacturing and business services through corporate development and general management roles within both publicly quoted and private companies. Andrew started his career in 1983 at Rothmans International PLC in production management. From 1986 to 1993 he had responsibility for corporate development activities at Britannia Security Group PLC, TIP Europe PLC and Brent International PLC before holding the position of Divisional Managing Director at Brent International PLC for six years. Andrew was Chief Executive Officer of interactive retail software developer, Unipower Solutions and Head of Retail and CPG for EMEA, a NYSE-listed advanced analytics business, FICO, before joining Keywords as its Chief Executive Officer in April 2009. Experience: David Broderick is the Chief Financial Officer. He joined the Group, and was appointed to the Board, in October 2016. Prior to joining Keywords he was the Chief Financial Officer of Dublin-based Arconics, a high-growth aviation software company. In 2013 David joined Stobart Air (formerly Aer Arann) as the Finance Director of the European regional airline during a period of significant growth. Before this he spent eight years at Ryanair Holdings plc, Europe’s largest low-cost airline, the latter six years of which he was the Head of Investor relations and oversaw the Group’s Inflight Sales Unit’s finances and operations. He is a qualified certified accountant, with extensive experience of capital markets and financial management in an international environment. Experience: David has over 30 years global experience in management roles within multinational companies. He began his career with ICI in the UK and then moved to RJ Reynolds Nabisco where he worked from 1979 to 1991, becoming the worldwide Marketing Director in the USA in 1989. In 1991, David served as the General Manager and Vice President of Marketing in Tokyo for Mitsubishi Shoji JV Technology Company before moving into the Computer game Industry, opening and setting up the PlayStation Company in Germany, Switzerland and Austria. He was appointed Executive Vice President in 1999 and President and CEO of Sony Computer Entertainment (Europe) in 2003 where he remained until 2009. David now runs his own Management Consultancy practice as well as being on the Board of three major Charities in the UK. He brings a global knowledge of growing multinational Companies, experience of the video game industry, Corporate Governance and an understanding of working with companies to develop global strategies in Europe, Asia, North America and LATAM. He was appointed to the Board of Keywords Studios Limited on 29 May 2013. Governance Giorgio Guastalla (50) Non-Executive Director Georges Fornay (62) Independent Non-Executive Director Charlotta Ginman (53) Independent Non-Executive Director and Chairman of the Audit Committee Length of service with the Group (as at 8 April 2019): 20 years Length of service with the Group (as at 8 April 2019): 2 years Length of service with the Group (as at 8 April 2019): 2 years Experience: Giorgio Guastalla is co-founder of Keywords. Prior to establishing Keywords in Ireland in 1998, Giorgio held various positions in marketing and IT at Brent International PLC based in the US, Spain, the UK and France. In 2002 Giorgio founded Italicatessen Ltd, a company operating in the food sector. Giorgio was CEO of Keywords until 2009 before concentrating on his other business interests and moving to a Non-Executive Director role at Keywords Studios. With over twenty years’ experience in the industry, Giorgio brings a wealth of understanding and knowledge to Keywords. Experience: A fellow of the Institute of Chartered Accountants in England and Wales, Charlotta is Chair of the Audit Committee. She is a Non- Executive Director and Chair of the Audit Committee of Polar Capital Technology Trust PLC, Pacific Asset Trust PLC and Motif Bio PLC. She is also a Non-Executive Director of Consort Medical PLC and Unicorn AIM VCT PLC. Charlotta has held senior positions in the investment banking and technology / telecom sectors. As three out of Charlotta’s six Non- Executive directorships are with quoted investment companies that involve less time commitment than trading companies, Charlotta is able to devote sufficient time to all of her appointments. Charlotta was appointed a Director of Keywords in September 2017. Experience: Georges has over 30 years’ experience in the technology and video games sectors and currently sits on the board of France’s second largest Independent games publisher, Focus Home Interactive, which is listed on the Alternext. Georges worked in senior management at Sony Computer Entertainment from 1995 to 2011, including as CEO of the French and Swiss divisions and culminating as the Senior Vice President from 2004-2011. During this time he oversaw the launch of the PlayStation Portable and PlayStation 3. Prior to this, Georges spent nine years at Commodore, the last five years of which were as CEO of Commodore France PC Manufacturing and Distribution. Georges has also held significant industry-wide roles including four years as President of SELL, France’s Union of Entertainment Software Publishers, where he was responsible for representing and advocating the industry’s and its 31 members’ interests to the government. Georges was appointed a Director of Keywords in September 2017. Committee Membership Audit Committee Nomination Committee Remuneration Committee Disclosure Committee None Annual Report and Accounts 2018 35 Chairman’s Introduction The Board is committed to the highest standards of corporate governance Dear Shareholders As Chairman of the Board of Directors of Keywords Group plc, I am pleased to introduce the Group’s corporate governance report. The corporate governance statement provides an insight into how the Board operated during the year and the key issues considered. The Board is committed to the highest standards of corporate governance. Our approach to governance is set by the Board and our Executive Directors ensure that the approach is effectively implemented across the business. Effective and robust governance remains central to the ongoing success of the Group. It is my responsibility to ensure that the Group has both sound corporate governance and an effective Board. As Chairman of the Company, my responsibilities include leading the Board effectively, overseeing the Group’s corporate governance model, communicating with shareholders and ensuring that good information flows freely between the Executive and Non-Executive Directors in a timely manner. The Directors of the Company recognise the value of good corporate governance in every part of its business. The Company has adopted the Quoted Companies Alliance Corporate Governance Code (“QCA Code”), which we believe is the most appropriate for a company the size and stage of development as Keywords. 36 Keywords Studios plc The Board will provide annual updates on our compliance with the QCA Code. During the year, the following changes were made to the Group’s key corporate governance arrangements: • Appointment of ONE Advisory Limited (“Company Secretary”) as Keywords’ Company Secretary in June 2018 • First Board Performance Evaluation conducted • Formation of Nominations Committee • Appointment of David Reeves as Senior Independent Director The Board considers that the Group complies with the QCA Code in all applicable respects. An explanatory report of how we have applied the QCA Code guidance, and disclosures of any areas of non-compliance, can be found on our website at: www. keywordsstudios.com. The Board understands that the application of the QCA Code supports the Group’s medium to long-term success whilst simultaneously managing risks and provides an underlying framework of commitment and transparent communications with stakeholders. The main Group-wide governance documents are our Core Values and the Code of Conduct, which set out the values and standards that we expect of our employees. These documents, together with our policies, govern how we conduct our business and set the standards that drive performance. Compliance training helps to enforce this. Board oversight, reviews and audits form part of the monitoring and supervision process. Risk processes are embedded and reviewed by the Board on an ongoing basis across the business. The important governance developments at Keywords over the last year are outlined below. My ambitions for the composition of the Board are to maintain, and where applicable, broaden the range of expertise, experience and diversity. The Board continues to ensure that effective succession plans are in place. I encourage all shareholders to attend the AGM, which will be held at MHP, 6 Agar Street, London, WC2N 4HN on 20 May 2019. This event provides an excellent opportunity to meet the Executive and Independent Non-Executive Directors. Ross Graham Chairman 8 April 2019 Governance Corporate Governance Strategy A description of the Company’s strategy, business model and supporting strategic pillars, along with key strengths can be found in the strategic report on pages 14-17. Internal controls and risk management The Company’s principal risks, along with key challenges in the execution of the Company’s strategy, can be found in the Strategic Report on page 32-33. The Board is responsible for the monitoring of financial performance against budget and forecast and the formulation of the Group’s risk appetite including the identification, assessment and monitoring of the Group’s principal risks. The Audit Committee has been delegated responsibility for the oversight of the Company’s risk management and internal controls and procedures, as well as determining the adequacy and efficiency of internal control and risk management systems. The Board continuously monitors and upgrades its internal control procedures and risk management mechanisms and conducts regular reviews, when it assesses both for effectiveness. This process enables the Board to determine if the risk exposure has changed during the year and these disclosures are included in the Annual Report. In setting and implementing the Company’s strategies, the Board, having identified the risks, seeks to limit the extent of the Company’s exposure to them having regard to both its risk tolerance and risk appetite. The Directors believe that the Group has internal control systems in place appropriate to the size and nature of the business. The key elements are: • Group Board Meetings, at a minimum of eight times per year, with reports from and discussions with senior executives on performance and key risk areas in the business; • Monthly financial reporting, for the Group and for each subsidiary, of actual performance compared to budget and the prior year; • Annual budget setting; • Annual strategy conference with top management team; and • A defined organisational structure with appropriate delegation of authority. Further information on the Company’s approach to risk management and internal controls can be also found in the Audit Committee Report on page 43. The Board The Board, as a whole, is responsible for the overall management of the Group and for its strategic direction, including approval of the Group’s strategy, its annual business plans and budgets, the interim and full year financial statements and reports, any dividend proposals, the accounting policies, major capital projects, any investments or disposals, its succession plans and the monitoring of financial performance against budget and forecast and the formulation of the Group’s risk appetite including the identification, assessment and monitoring of Keywords’ principal risks. Director biographies and committee memberships are set out on pages 34-35. The Board comprises the CEO, Andrew Day, the CFO, David Broderick, 1 Non-Independent Non-Executive Director, Giorgio Guastalla, and 4 Independent Non-Executive Directors, Georges Fornay, Charlotta Ginman, Ross Graham and David Reeves. David Reeves is the Company’s Senior Independent Director (“SID”), and Ross Graham is the Company’s Chairman. Letters of appointment of all Directors are available for inspection at the Company’s registered office during normal business hours. The Executive Directors work full time for the Company. All the Non-Executive Directors are expected to dedicate at least 30 days per annum to the Company, rising to 40 days if they also chair a Committee, and the Chair is expected to dedicate 60 days per annum. The Company has adopted a policy whereby all members of the Board are subject to re-election at each AGM. The Board is satisfied that it has a suitable balance between independence, on the one hand, and knowledge of the Company, on the other, and that no individual or group may dominate the Board’s decisions. The Non-Executive Directors have both a breadth and depth of skills and experience to fulfil their roles. The Company believes that the current balance of skills in the Board as a whole reflects a very broad range of personal, commercial and professional experience, and notes the range of financial and managerial skills. All Directors are encouraged to use their independent judgement and to challenge all matters, whether strategic or operational, enabling the Board to discharge its duties and responsibilities effectively. The Board meets a minimum of 8 times a year and a calendar of meetings and principal matters to be discussed are agreed at the beginning of each year. In order to be efficient, the Directors meet formally and informally both in person and by telephone. Board and Committee document authors are made aware of proposed monthly deadlines through the calendar of meetings assembled at the beginning of the year. Board papers are collated by the Company Secretary, compiled into a Board / Committee Pack, and circulated at least one week before meetings, allowing time for full consideration and necessary clarifications before the meetings. The Board also utilizes a fully-functioning Board Portal, which ensures the provision of timely and efficient distribution of Board and Committee papers as well as an effective means of Communication for the Board. Management supply the Board with appropriate and timely information and the Directors are free to seek any further information they consider necessary. Annual Report and Accounts 2018 37 Corporate Governance continued Senior Independent Director David Reeves acts as the Senior Independent Director (“SID”) to the Company, serving as a sounding board to the Chairman and acting as an intermediary for the other directors. The SID is also available to shareholders and other Non-Executive directors to address any concerns or issues they feel have not been adequately dealt with through the usual channels of communication. Audit Committee The Audit Committee is responsible for assisting the Board in fulfilling its financial and risk responsibilities. The Audit Committee oversees the financial reporting, risk management and internal control procedures. The Audit Committee advises the Board on the appointment and removal of the external auditor and discusses the nature, scope and results of the audit with the auditors. The Audit Committee reviews the extent of non-audit services provided by the auditors and reviews with them their independence and objectivity. Remuneration Committee The Remuneration Committee is responsible for determining the remuneration of the Chairman, Executive Directors, the Company Secretary and senior executives of Keywords. The Remuneration Committee is responsible for making recommendations to the Board of Directors’ and senior executives’ remuneration. Non-Executive Directors’ remuneration and conditions are considered and agreed by the Board. Financial packages for Executive Directors are established by reference to those prevailing in the employment market for executives of equivalent status both in terms of level of responsibility of the position and their achievement of recognized job qualifications and skills. The Committee will also have regard to the terms, which may be required to attract an equivalent experienced executive to join the Board from another company. Nominations Committee The Nominations Committee monitors and reviews the structure, size and composition (including the skills, knowledge and experience) required of the Board compared to its current position and makes recommendations to the Board with regard to any recommended changes. The Nominations Committee also gives full consideration to succession planning for directors and other senior executives in the course of its work, taking into account the challenges and opportunities facing the company, and what skills and expertise are therefore needed on the Board in the future. The role and responsibilities of the Nominations Committee can be found in the Nominations Committee Report on page 55. Disclosure Committee The Disclosure Committee has been established to assist in the design, implementation and evaluation of the Company’s disclosure controls and procedures. The first Disclosure Committee meeting is scheduled for the first half of 2019. Terms of reference of all Keywords’ Committees are available to view on the Company’s website at: www.keywordsstudios.com. The table below sets out attendance statistics for each Director at Board, and where relevant, Committee meetings held during the financial year. Director Ross Graham Andrew Day David Broderick Giorgio Guastalla Georges Fornay Charlotta Ginman David Reeves * Appointed to Audit Committee in June 2018. Board 10 meetings held Audit Committee 6 meetings held Remuneration Committee 3 meetings held Nomination Committee 4 meetings held 10 10 10 10 10 10 10 6 – – – 4* 6 6 3 – – – – 3 3 4 4 – – – 4 4 The Non-Executive Directors meet without the presence of the Executive Directors during the year, and also maintain ongoing communications with Executives between formal Board meetings. Meetings are open and constructive, with every Director participating fully. Senior management can also be invited to meetings, providing the Board with a thorough overview of the Company. In addition to their general Board responsibilities, Non-Executive Directors are encouraged to be involved in specific workshops or meetings, in line with their individual areas of expertise. The Board is kept abreast of developments of governance and AIM regulations. The Company Secretary provides updates on governance issues, and the Company’s Nomad provides annual Board AIM Rules refresher training as well as the initial training as part of a new Director’s on-boarding. The Board shall review annually the appropriateness and opportunity for continuing professional development, whether formal or informal. 38 Keywords Studios plc Governance Advisors The Board has regular contact with its advisors to ensure that it is aware of changes in corporate governance procedures and requirements and that the Group is, at all times, compliant with applicable rules and regulations. The Company holds appropriate insurance cover in respect of possible legal action against its Directors. The Company’s Nomad supports the Board’s development, specifically providing guidance on corporate governance and other regulatory matters, as required. Keywords’ Company Secretary is responsible for ensuring that Board procedures are followed and that the Company complies with all applicable rules, regulations and obligations governing its operation, as well as helping the Chairman to maintain excellent standards of corporate governance. The Company Secretary also provides Board support through assistance with shareholder meetings and MAR compliance. The Company has also enlisted the support of Mercer-Kepler, who provides advice in relation to remuneration. Additional information can be found in the Company’s Remuneration Report on page 46. All Directors may receive independent professional advice at Keywords’ expense, if necessary, for the performance of their duties. Board Performance Evaluation Details of the Company’s Board Performance Evaluation for the year can be found in the Report of the Nomination Committee on page 55. Culture The Board recognises that its decisions regarding strategy and risk may impact the corporate culture of the Company as a whole and that this will impact the performance of the Company. The Board is also aware that the tone and culture set by the Board can have an impact on the Company as a whole and on the way that employees behave. The corporate governance arrangements that the Board has adopted are designed to ensure that the Company delivers long term value to its shareholders and that shareholders are able to express their views and expectations for the Company in a manner that encourages open dialogue with the Board. A large part of the Company’s activities are centred upon an open and respectful dialogue with employees, clients and other stakeholders. Therefore, the importance of sound ethical values and behaviours is crucial to the ability of the Company to successfully achieve its corporate objectives. The Board places great importance on this aspect of corporate life and seeks to ensure that this flows through all that the Company does. The Directors consider that the Company has an open culture facilitating comprehensive dialogue and feedback, which enables positive and constructive challenge. The Company operates in a manner that encourages an open and respectful dialogue with employees, customers and other stakeholders and the Board considers that sound ethical values and behaviours are crucial to the ability of the Company to achieve its corporate objectives. The Board places great importance on this aspect of corporate life and seeks to ensure that this flows through all that the Company does. The Directors believe that the Company has an open culture facilitating comprehensive dialogue and feedback and enabling positive and constructive challenge. Further information on the Company’s culture can be found in the Strategic Report pages 8-11. Annual Report and Accounts 2018 39 Directors’ Report The Directors present the Annual Report together with both the audited consolidated financial statements and the parent company (Keywords Studios PLC) financial statements for the year ended 31 December 2018. Disclaimer The purpose of this Annual Report & Financial Statements is to provide information to the members of the Company. The Annual Report & Financial Statements have been prepared for, and only for, the members of the Company, as a body, and no other persons. The Company, its Directors and employees, agents or advisers do not accept or assume responsibility to any other person to whom this document is shown or into whose hands it may come and any such responsibility or liability is expressly disclaimed. The Annual Report & Financial Statements contain certain forward-looking statements with respect to the operations, performance and financial condition of the Group. By their nature, these statements involve uncertainty since future events and circumstances can cause results and developments to differ materially from those anticipated. The forward-looking statements reflect knowledge and information available at the date of preparation of this Annual Report & Financial Statements and the Company undertakes no obligation to update these forward- looking statements. Nothing in this Annual Report & Financial Statements should be construed as a profit forecast. Dividends The results for the year are set out on page 60. Dividends paid and proposed are set out on page 78. The Board is proposing a final dividend 1.08p per share following the payment of an interim dividend of 0.53p per share in October 2018. Directors and changes to the Board The Directors of the Company during the year were Ross Graham, Andrew Day, David Reeves, Giorgio Guastalla, Georges Fornay, Charlotta Ginman and David Broderick. Details of members of the Board at 31 December 2018 are set out on pages 34 and 35. Going concern In view of the Group’s resources, cash at 31 December 2018 of €40m, cash flow from operations in 2018 of €32.2m, and the overall financial condition of the Group, the Directors have reasonable expectation that the Group has adequate resources to continue in operation for the foreseeable future. For this reason, the Directors continue to adopt the going concern basis in preparing the financial statements. Political donations No political donations were made in the year. Directors and their interests A list of Directors, their interests in the ordinary share capital of the Company, their interests in its long-term performance share plan and details of their options over the ordinary share capital of the Company are given in the Directors’ Remuneration Report on pages 46 to 54. No Director had a material interest in any significant contract, other than a service contract or contract for services, with the Company or any of its operating companies at any time during the year. Significant shareholdings At 31 December 2018, the Company had been notified, in accordance with the Disclosure and Transparency Rules, of the following interests in its ordinary share capital*: Name P.E.Q Holdings Octopus Investments Andrew Day Oberweiss Asset Management Canaccord Genuity Wealth management T Rowe Price Global Investments Franklin Templeton Kames Capital * As recorded in the Company’s share register. Shares 4,000,736 3,650,758 3,296,573 2,944,000 2,820,855 2,788,693 2,695,000 2,247,262 % 6.3 5.7 5.2 4.6 4.4 4.4 4.2 3.5 Future developments Important events since the financial year end are described on page 29 of the Strategic Report and future developments are described in the strategy section of the Strategic Report on pages to 16 and 17. People and organisation Keywords is, and always has been, dependent on the quality and commitment of its entire staff to provide and maintain the high levels of services expected by the Groups’ clients. Keywords average number of employees was 5,238 during 2018. This permanent headcount is supplemented with employees on short-term contracts as activity changes throughout the year. 40 Keywords Studios plc Governance The Group continues to give full and fair consideration to applications for employment made by disabled persons, having regard to their respective aptitudes and abilities. The policy includes, where practicable, the continued employment of those who may become disabled during their employment and the provision of training and career development and promotion, where appropriate. The Group has continued its policy of employee involvement by making information available to employees on matters of concern to them. Many employees are stakeholders in the Company through participation in share option schemes and a long-term performance share plan. The Group has not disclosed further details on employment of disabled persons or employee involvement as it has fewer than 250 employees within the UK. Corporate responsibility Keywords seeks to be a socially responsible Group which has a positive impact on the communities in which operates. By the nature of the business, we employ a diverse workforce, with many nationalities. No discrimination is tolerated and we endeavour to give all employees the opportunity to develop their capabilities. We provide an excellent working environment, the latest technology and appropriate training. Website publication The Directors are responsible for ensuring the Annual Report and Financial Statements are made available on a website. Financial statements are published on the Group’s websites in accordance with legislation in the United Kingdom governing the preparation and dissemination of financial statements, which may vary from legislation in other jurisdictions. The maintenance and integrity of the Group’s websites is the responsibility of the Directors. The Directors’ responsibility also extends to the ongoing integrity of the financial statements contained therein. By order of the board David Broderick, FCCA Chief Financial Officer 8 April 2019 Annual Report and Accounts 2018 41 Statement of Directors’ Responsibilities The Directors are responsible for preparing the Annual Report & Financial Statements. Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Group and Company financial statements in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union (“EU”). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and the Group and of the profit or loss of the Group for that period. The Directors are also required to prepare financial statements in accordance with the rules of the London Stock Exchange for companies trading securities on the Alternative Investment Market. In preparing these financial statements the Directors are required to: • Select suitable accounting policies and then apply them consistently; • Make judgements and estimates that are reasonable and prudent; • State whether IFRS as adopted by the EU have been followed, subject to any material departures disclosed and explained in the Group and Company financial statements respectively; and • Prepare the financial statements on a going concern basis, unless it is inappropriate to presume that the Company will continue in business. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and to enable them to ensure that the financial statements and the Directors’ remuneration report comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The Directors as at the date of this report, whose names and functions are listed in the Board of Directors on pages 34 and 35, confirm that: • So far as the Director is aware, there is no relevant audit information of which the Company’s auditors are unaware; and • The Director has taken all the steps that he or she ought to have taken as a Director in order to make himself / herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 418 of the Companies Act 2006. Website publication The Directors are responsible for ensuring the Annual Report and Financial Statements are made available on a website. Financial statements are published on the Group’s websites in accordance with legislation in the United Kingdom governing the preparation and dissemination of financial statements, which may vary from legislation in other jurisdictions. The maintenance and integrity of the Group’s websites is the responsibility of the Directors. The Directors’ responsibility also extends to the ongoing integrity of the financial statements contained therein. By order of the Board Liam O’Donoghue Company Secretary 8 April 2019 42 Keywords Studios plc Governance Audit Committee Report Introduction from the Chair As Chair, I am pleased to present the Audit Committee report for the year ended 31 December 2018. This report details the work of the Committee over the past year, fulfilling our responsibilities to provide effective governance over the Group’s financial activities. Committee Composition The Committee members, apart from myself, are Ross Graham, David Reeves and Georges Fornay who joined the Committee during the year. The Audit Committee, as a whole, has competence relevant to the video games industry, both Ross Graham and I are Chartered Accountants and I also chair the Audit Committee for other public companies. More information about the Committee members can be found on pages 34 and 35. internal control framework including financial systems roll out risk assurance treasury taxation The Committee met 6 times during the financial year, and discussions included the following key items: • • • • • accounting policies • financial results • alternative performance measures • • asset Impairment (including goodwill) • going concern review • internal audit function • engagement and review of performance of external auditors • • cyber risk, data protection and disaster recovery plans • whistleblowing, tax evasion, anti-bribery / corruption and modern slavery policies • review of audit and non audit services and fees review of Audit Committee terms of reference treatment of special items Committee Role and Responsibilities The Committee has written Terms of Reference, which are available to view on the website, www.keywordsstudios.com. The Terms of Reference clearly define the Committee’s responsibilities and duties. In addition to the Terms of Reference, the Committee has developed an annual agenda which corresponds with the meeting schedule, to ensure all key responsibilities are completed and managed. Significant Issues Considered by the Audit Committee During the Year Internal Control and Risk Assurance Framework The Audit Committee has been actively reviewing and challenging the upgrades that have taken place during the year to the Company’s internal control and risk assurance framework ensuring that following its rapid expansion, the Company operates within a fit for purpose framework. The Committee is pleased to see the progress made in the global automated financial systems roll-out, allowing eventually a fully integrated automated reporting system to operate seamlessly across the Group, replacing manual consolidation processes that are both labour intensive and prone to human error. The recruitment of a treasury team in Dublin during the year with a cash pooling platform being introduced will allow better control of Group cash and the optimisation of cash management. During the year the Audit Committee has introduced a regular review of the Company’s main risks on behalf of the Board, ensuring key risks are top of mind and relevant and mitigation plans are in place where possible and, over time, the Company proposes to adopt a similar framework right through the organisation. Internal Audit To complement the above efforts, the Audit Committee has commenced working closely with management to recruit an Internal Audit Manager in 2019. They will be tasked with establishing an internal audit function, to embrace all aspects of operating and financial efficiency, and will report to the Audit Committee chair. Annual Report and Accounts 2018 43 Audit Committee Report continued Key Accounting Issues During the year and as part of the year end procedures, the Committee considered the following key financial and internal control matters in relation to the Group’s financial statements and disclosures with input from both management and the external auditor: • Revenue recognition • Functional reference currency • Business combinations • The valuation of intangible assets • Leases • Financial instruments • Alternative performance measures • Segmental reporting (if relevant) • Application and impact of new standards IFRS 9 (financial instruments), IFRS 15 (revenue recognition) and IFRS 16 • Taxation • Going concern For further detail on these, see notes 2 and 3. Financial Reporting Council The Company received a letter from the Financial Reporting Council’s (FRC) in November 2018, which raised questions on certain aspects of its annual report and accounts for the year ended 31 December 2017. The Company responded fully to the matters raised in the FRC’s letter, enabling it to conclude its enquiry. The principal changes to the Company’s annual report and accounts for the year ended 31 December 2018 resulting from the FRC’s enquiry were as follows: • • Revising the tax reconciliation in note 7 so that it starts from the weighted average statutory tax rate that applies in the jurisdictions Improvements to the level of detail included in the strategic report, including added analysis on movements in working capital; in which the Group pays tax; and Improving the disclosure of critical accounting estimates and judgements in note 3. • In addition, the FRC highlighted to the Company that it the payment of dividends in 2016 and 2017 were not supported by the correct Relevant Accounts, as required under UK company law. Further information on this and how the issue has been addressed can be found on page 78. The FRC’s enquiry did not result in any change to reported profit or net assets. Scope and limitations of the FRC’s review The Company recognises that the FRC’s review was based on a review of its annual report and accounts for the year ended 31 December 2017 and did not benefit from detailed knowledge of the Company’s business or an understanding of the underlying transactions entered into. The FRC’s review provides no assurance that the Company’s annual report and accounts are correct in all material respects; the FRC’s role is not to verify the information provided but to consider compliance with reporting requirements. The FRC’s letters are written on the basis that it (and its officers, employees and agents) accepts no liability for reliance on them by the Company or any third party, including but not limited to investors and shareholders. Annual Report and Financial Statements The Board has asked the Committee to confirm that in its opinion the Annual Report as a whole can be taken as fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s financial position, performance, business model and strategy. In doing so the Committee has given consideration to: • The way the Strategic Reports (including the Chairman’s Statement and Reports of the CEO and CFO) presents the Group – its business, financial and business model and the metrics management uses to measure performance • whether suitable accounting policies have been adopted and have challenged the robustness of significant management judgements and estimates reflected in the financial results the comprehensive control framework around the production of the Annual Report, including the verification processes in place to deal with the factual content; the extensive levels of review that are undertaken in the production process, by both management and advisers the Group’s internal control environment • • • In 2018, the Company became aware that certain interim dividends paid during the period 2013 to 2018 had been made otherwise than in accordance with the Companies Act 2006 because interim accounts had not been prepared and filed at Companies House prior to payment. Additionally, the Company also became aware of a technical issue relating to the levels of distributable reserves and the payment of the interim dividend to the shareholders in October 2016, as explained in more detail in the director’s report. The Committee was fully involved in resolving the matter and oversaw the thorough review by management into the historical issues and the administrative steps taken to rectify the issues. As a result of the work performed, the Committee has concluded that the Annual Report for the year ended 31 December 2018, taken as a whole, is fair, balanced and understandable and provides the information necessary for Shareholders to assess the Group’s performance, business model and strategy, and it has reported on these findings to the Board. 44 Keywords Studios plc Governance Whistleblowing During the year, the Audit Committee reviewed and approved the whistleblowing policy and accompanying process the Company has rolled out globally. The policy allows employees wherever they are to raise any concerns they may have about possible financial or other irregularities confidentially. The Group is committed to the highest level of integrity and accountability and the prevention of bribery and corruption. External Auditor BDO, the Company’s current auditor, was first appointed on 29 May 2013. This is the first year John O’Callaghan is acting as audit partner following Teresa Morahan having stepped down as audit partner after five years. The Audit The scope of the annual audit was agreed in advance with the Committee with a focus on areas of audit risk and the appropriate level of audit materiality. The Committee also had discussions with the auditor on fees, internal controls, accounting policies and areas of critical accounting estimates and judgements. The Auditors reported to the Audit Committee on the results of the audit work and highlighted any issue which the audit work had discovered, or the Committee had previously identified as significant or material in the context of the Financial Statements. There were no adverse matters brought to the Audit Committee’s attention in respect of the 2018 audit, which were material or significant or which should be brought to Shareholders’ attention. Effectiveness The Audit Committee monitored and evaluated the effectiveness of the Auditors under the terms of their appointment based on an assessment of their performance, qualification, knowledge, expertise and resources. The Auditors’ effectiveness was also considered along with other factors such as audit planning and interpretations of accounting standards and separate discussions with Management (without the auditor present) and with the auditors (without Management present). The Chair of the Audit Committee also had discussions with the audit partner outside the formal meetings throughout the year. The Committee was satisfied that the audit was effective and that BDO continues to demonstrate the skills and experience needed to fulfill its duties effectively. Independence In order to fulfil the Committee’s responsibility regarding independence of the Auditor, the Committee reviewed the senior staffing of the audit, the Auditor’s arrangements concerning any conflicts of interest, the extent of any non-audit services, the Auditor’s independence statement and any other issues that may affect the Auditor’s independence. The Committee was satisfied that the auditor remains independent. Non–audit services The Audit Committee’s established during the year a policy on the provision of non-audit services by the Auditors. The policy is produced in line with the FRC ethical standards and any non-audit services are required to be pre-approved by the Audit Committee. During the year BDO provided non-audit services to the Company of €23,000, as per the note 5. Charlotta Ginman, FCA Chair of the Audit Committee 8 April 2019 Annual Report and Accounts 2018 45 Directors’ Remuneration Report Dear fellow Shareholders, As Chairman of the Remuneration Committee, it is my pleasure to present the Directors’ Remuneration Report for the period ended 31 December 2018. Keywords Studios PLC has chosen to apply the Corporate Governance Code for Small and Mid-size Quoted Companies published by the Quoted Companies Alliance. Although the Company is currently AIM quoted, the Board recognises the importance of shareholder transparency and standards of governance. Therefore, this report contains all the information required to be disclosed as an AIM quoted Company and also contains some additional information that would be applicable were the Company listed on the London Stock Exchange main market, and includes: • The Directors’ Remuneration Policy; and • Our annual report on remuneration, detailing director remuneration in 2018 and that set for 2019. It is my hope that you find this a clear and comprehensive report and I look forward to hearing the views of our investors on the information presented here over the coming months. We will carefully monitor emerging practice in this area as well as guidance from investor representative groups. We operate a simple Executive Director remuneration structure made up of base salary and pension, a bonus plan and a long-term incentive plan (“LTIP”) which provides a clear link between pay and our key strategic priorities. The Remuneration Committee intends to keep its approach to remuneration under regular review for continued appropriateness taking account of regulatory requirements and corporate governance best practices as applicable to the Company over time. To this end, it is relevant to note our decision made in 2018 to change the LTIP performance condition for 2019 awards. Dr David Reeves Chairman, Remuneration Committee 8 April 2019 46 Keywords Studios plc Governance Section 1: Directors’ Remuneration Policy Policy and principles The Remuneration Committee determines the Company’s policy on the structure of the remuneration for Executive Directors and Senior Management Team (“SMT”) and is responsible for governing the remuneration policy for the broader employee population. The objectives of this policy are to: • Reward Executive Directors and the SMT in a manner that ensures that they are properly incentivised and motivated to perform in the best interests of shareholders. • Provide a level of remuneration required to attract and motivate high-calibre Executive Directors and SMT members. • Encourage value creation through consistent and transparent alignment of incentive arrangements with the agreed company strategy over the long term. • Ensure the total remuneration packages awarded to Executive Directors and SMT members, comprising both performance-related and non-performance-related remuneration, are designed to motivate the individual, align interests with shareholders and comply with corporate governance best practices. The Board and the Remuneration Committee believe the foregoing objectives are best achieved by a remuneration structure whereby: • Basic pay is set at a below-median level albeit sufficient for the challenges and pressures of the role. • Annual bonuses are set at modest levels with a maximum of 30% of salary on the premise that an annual bonus doesn’t influence the behaviour or commitment of a senior executive (this does not apply to sales executives). • Long-term incentives are the means by which executives can earn significant rewards if, but only if, shareholders likewise have obtained a good return. Remuneration components for Executive Directors and SMT (the ‘Executives’) Various remuneration components are combined to ensure an appropriate and balanced remuneration package which reflects the size and complexity of the Group, the Executive’s experience, responsibility and position in the Company as well as market practice. For this, the Remuneration Committee takes into account the performance of the individual, comparisons with peer companies and, where considered appropriate, reports from external independent consultants. The remuneration package comprises the following elements: • Fixed remuneration (basic salary and, for some Executives, pension); • Performance-based remuneration (annual bonus and LTIP): Purpose and link to Strategy Operation Opportunity Performance measures Base salary To attract and retain talented Executives to deliver the Group’s strategy, by ensuring base salaries and the implied total package are competitive in relevant talent markets, while not overpaying. Pension and Benefits To provide an appropriate structure and level of post- retirement benefit for Executives in a cost-efficient manner that reflects local market norms in the relevant jurisdiction. Base salaries are reviewed by the Committee annually, and benchmarked periodically against comparable roles at comparable companies of similar size and complexity. Salaries are set on a case-by- case basis to reflect the role, the experience and qualifications of the individual, and are targeted at below market median. n/a Base salary increases for the Executives take into account personal performance, Company performance, significant changes in responsibilities, the average increase awarded to the wider workforce, and competitive market practice. At the discretion of the Remuneration Committee, the Executives may participate in a pension scheme facilitated by the Company. The Company also provides access to Group Benefit schemes where appropriate by Region which may include moderate contribution towards private health insurance, death in service and other Group based benefits. n/a The Company provides access to pension schemes based on local legal requirements or where expected by local labour markets. Contributions meet the minimum requirements or are of a modest level. Basic additional benefits may also be provided where available and where considered the norm for managerial positions in similar businesses. Annual Report and Accounts 2018 47 Directors’ Remuneration Report continued Purpose and link to Strategy Operation Opportunity Performance measures Annual Bonus To provide a modest award where individual and company performance have been at or above expected levels. Executives are eligible to participate in an annual bonus scheme. Up to a maximum of 30% of salary (excluding sales plans where the maxima may vary). The Remuneration Committee reviews targets and the weighting of performance measures each year. The Company also offers commission arrangements for Executives in sales roles. LTIP awards are granted as a number of shares. LTIP To incentivise delivery against total shareholder return targets and align the interests of Executives and shareholders in growing the value of the Group over the long-term. LTIP grants are made annually in the form of conditional awards of shares or nil-cost share options which vest subject to performance conditions measured over three years. Once vested, awards may be exercised for a period of up to 7 years from grant. Malus provisions apply in certain circumstances. The portion of bonus earned in any one year depends on the Remuneration Committee’s assessment of each individual’s performance and the overall performance of the Company against predetermined turnover and profitability targets for the year. Performance targets are typically weighted 80% on the Company’s financial performance and 20% on personal performance (however, if the Company’s financial performance is considered to be unsatisfactory, the element based on personal performance is likely to be foregone). Vesting of the LTIP is subject to continued employment during the performance period and the achievement of performance conditions based on Total Shareholder Return (“TSR”). The Committee has the power of discretion to adjust the outcome in exceptional circumstances so that it is a fair reflection of the underlying performance of the Group. Further details, including the performance targets attached to the LTIP in respect of each year will be disclosed in the relevant Implementation Report on Remuneration (subject to these being considered not to be commercially sensitive). Malus policy For any awards granted since 2016, malus may be applied to LTIP awards in cases of fraud, dishonesty or deceit, gross misconduct or material financial misstatement in the audited financial results of the Group. The Remuneration Committee may determine that an Award is cancelled in its entirety or be reduced to the extent they see fit. Use of Discretion The Remuneration Committee may apply its discretion when agreeing remuneration outcomes, to help ensure that the implementation of our remuneration policy is consistent with underlying Company performance and is equitable to all parties. 48 Keywords Studios plc Governance Executive Director service contracts In accordance with general market practice, each of the Executive Directors has a rolling service contract. The following table shows the date of the service contract for each executive director served during the year: Executive director Andrew Day David Broderick Position Date of appointment Date of service agreement CEO CFO 1 Apr 2009 3 Oct 2016 21 Jun 2013 8 Sep 2016 Notice period 6 months 6 months Remuneration for the wider workforce The remuneration policy for other employees is based on principles consistent with those that are applied to Executive remuneration, with the common objective of driving financial performance and the achievement of strategic objectives and contributing to the long-term success of the Group. Remuneration supports our ability to attract, motivate and retain skilled and dedicated individuals whose contribution continues to be a key factor in the Company’s success. Annual salary reviews take into account Company performance, local pay and market conditions plus salary levels for similar roles in comparable companies. Some employees below Executive level are eligible to participate in annual bonus schemes; opportunities and performance measures may vary by organisational level, geographical region and an individual’s role. An annual survey is conducted to ensure gender equality as it relates to employee compensation. The Company performs equal pay and gender pay gap analyses across all its locations. In particular, the Board of Directors discussed the results of the latest analyses in August 2018 and are satisfied that there is equal pay given location and role. LTIP programmes are used for senior permanent members of staff, in which approximately 10% of the workforce participate. The focus of the LTIP is to retain talent and create long-term shareholder value consistent with fulfilment of the Company’s long-term strategic goals. External appointments held by Executives Executives may not accept any external appointment without the consent of the Board. Consideration of shareholder views The Remuneration Committee will take into consideration all shareholder views during the year and at the annual general meeting each year as well as guidance from shareholder representative bodies more broadly, in shaping the Company’s implementation of its Remuneration Policy as well as future changes to the Policy. Leaver treatment Fair treatment will be extended to departing executives. The Group’s policy on termination payments is to consider the circumstances on a case-by-case basis, taking into account the relevant contractual terms in the Executive’s service contract and the circumstances of termination. Executives who resign or are dismissed for cause are, by default, not eligible for an annual bonus if they have left or are under notice at date of payment and forfeit all unvested LTIP shares. At the Remuneration Committee’s discretion good leavers (normally including such circumstances as retirement, death, disability and redundancy) may be allowed to exercise a proportion of unvested LTIPs post-termination when, or to the extent that, the underlying LTIPs meet the performance criteria for vesting. On a change of control, unvested LTIP awards may be exercised at the time of the event subject to achievement of any performance conditions. Annual Report and Accounts 2018 49 Directors’ Remuneration Report continued Pay for performance scenario analysis The charts that follow provide an estimate of the potential future reward opportunities for the Executive Directors, and the potential split between the different elements of remuneration under three different performance scenarios: ‘Maximum’, ‘On target’ and ‘Minimum’. These charts illustrate how performance-orientated and long-term the Company’s remuneration arrangements are, with the majority of the remuneration opportunity being delivered only under a ‘Maximum’ scenario. We have also included a bar showing the value of the actual package in 2018. Potential reward opportunities are based on the Remuneration Policy, applied to 2019 base salaries and incentive opportunities. Note that the LTIP awards granted in a year will not normally vest until the third anniversary of the date of grant, and the projected value excludes the impact of share price movement. CEO Actual 2018 Minimum 2019 Scenarios On Target Maximum CFO Actual 2018 Minimum 2019 Scenarios On Target Maximum 200 400 600 800 1000 (€’000) 200 400 600 (€’000) Fixed pay Bonus LTIP Pension Assumptions: ‘Actual 2018’: Fixed remuneration (2018 base salary, pension), bonus granted in 2018 and LTIP vesting in 2018. ‘Minimum’: Fixed remuneration only (2019 base salary, pension), being the only element of Executive Directors remuneration not linked to performance. ‘On Target’: Fixed remuneration as above, plus target bonus (18% of base salary) and threshold LTIP vesting (10% of maximum) at the 3-month average share price to 31 December 2018. ‘Maximum’: Fixed remuneration, plus maximum bonus (30% of salary) and full vesting of proposed 2019 LTIP awards at 3-month average share price to 31 December 2018. Non-Executive Director fee policy Non-Executive Directors receive fees for attendance at board meetings and its sub-committees. The Company does not operate any pension scheme for Non-Executive Directors nor do they participate in any variable pay plan. Any reasonable business expenses (including tax thereon) may be reimbursed. 50 Keywords Studios plc Governance Section 2: Implementation of the Remuneration Policy in 2018 The Remuneration Committee The members of the Remuneration Committee in 2018 were David Reeves (Committee Chairman), Charlotta Ginman (joined at 24 October 2017) and Ross Graham. The members are all Independent Non-Executive Directors. In the year ended 31 December 2018, the Remuneration Committee met on three occasions. All three members of the Committee attended the committee meetings throughout the year together with, on occasion, the CEO, the CFO, the COO the Global HR Director, all at the request of the Committee Chairman. The Company Chairman and the Chairman of the Remuneration Committee also met with key investors on several occasions in 2018 to obtain input and feedback on Executive and Company-wide remuneration. The remit of the Committee is to determine and agree with the Board the framework for the remuneration of the Company Chairman (Ross Graham is not involved in related discussions), Executive Directors, Company Secretary and other members of the Senior Management of the Group, and also oversee the remuneration policy for the wider workforce. No Director is involved in any discussion or decision about his or her own remuneration. Mercer-Kepler supports the Remuneration Committee on remuneration related matters and is a member of the Remuneration Consultants’ Group and, as such, voluntarily operates under the Code of Conduct in relation to Executive remuneration consulting in the UK. Mercer-Kepler does not have any other association with the Company and is considered independent by the Committee. Directors’ emoluments The remuneration for the Directors of the Company for the period year ended 31 December 2018 is detailed in the table below: Andrew Day David Broderick Ross Graham David Reeves Giorgio Guastalla Georges Fornay Charlotta Ginman Salary or fees € 230,195 158,227 76,293 68,300 50,552 55,299 68,300 2018 2017 Bonus € Pension € LTIP1 € Total € Salary or fees € Bonus € Pension € LTIP € Total € 21,036 14,460 – – – – – 911 7,850 – – – – – – 252,142 208,925 141,830 – 180,537 69,244 76,293 – 64,468 68,300 – 48,691 50,552 – 17,603 55,299 – 21,742 68,300 – 62,677 43,050 – – – – – – 3,587 – – – – – 3,587 – – – – – – – – 271,602 188,467 69,244 64,468 48,691 17,603 21,742 681,818 1. Based on 3-month average share price to 31 December 2018. 707,165 35,496 8,761 – 751,422 572,503 105,727 Annual bonus outcome for 2018 During 2018, the Executive Directors participated in the annual bonus scheme, and were eligible to earn awards of up to 30% of salary, subject to the attainment of specific targets set for each individual. The portion of bonus earned in the year was dependent on Company performance (weighted 80%) against turnover and profitability targets for the year and on the Remuneration Committee’s discretionary assessment of each individual’s performance (weighted 20%). The table below summarises the bonus earned by the Executive Directors for the year: Director Andrew Day David Broderick Maximum Opportunity Bonus for 2018 30% of salary 30% of salary 7.5% of salary=£18,624 7.5% of salary=€14,460 Annual Report and Accounts 2018 51 Directors’ Remuneration Report continued Long-term incentives vesting in 2018 In June 2015, the CEO was granted an award of 35,000 shares under the LTIP the vesting of which was based on the Company’s TSR performance versus the Numis Smaller Companies (excluding Investment Trusts) Index over the 3-year period ending on 1 June 2018. One-third of the award vests for achieving Index TSR+10%, two-thirds vests at Index TSR+20%, with full vesting for Index TSR+30% over three years. The Company’s TSR performance over this period significantly outperformed that of the Index (by c.920%) resulting in full vesting of these awards on 1 June 2018. TSR over the 3-year performance period 2015-2018 LTIP NSCI ex. Inv Trusts: 29% Full vesting (Index +30%) Keywords: 952% Other long-term incentives outstanding during 2018 LTIP awards granted to the Executive Directors in May 2016 and May 2017 remained outstanding during 2018. The full vesting of these awards requires Keywords TSR to outperform the Numis Smaller Companies (excluding Investment Trusts) Index over the 3-year period by 45%. Based on performance up to 31 December 2018 when the share price was £11.92, these awards would fully vest (see chart below). Long-term incentives granted during 2018 In May 2018, the Executive Directors were granted awards under the LTIP the vesting of which is based on the Company’s TSR performance versus the Numis Smaller Companies (excluding Investment Trusts) Index over the 3-year period ending on 18 May 2021. During 2018, and prior to the grant of these awards, the Remuneration Committee reviewed the TSR condition set for LTIP awards and determined, given the significant increase in the Company’s share price since the 2017 LTIP awards, that the performance level required for full vesting of future LTIP awards would be set at a 20% outperformance of the benchmark. Therefore, for the 2018 awards, threshold vesting (10% of the award) will vest for TSR in line with the Index and full vesting will be earned for exceeding the Index TSR by 20% over the performance period. The number of shares granted to the CEO and CFO was 50,000 and 25,000 respectively. Based on performance up to 31 December 2018 when the share price was £11.92, these awards would not vest (see chart below). TSR performance up to 31 December 2018 Keywords: 317% 2016-2019 LTIP NSCI ex. Inv Trusts: 23% 2017-2020 LTIP NSCI ex. Inv Trusts: 4% Keywords: 36% 2018-2021 LTIP NSCI ex. Inv Trusts: -12% Keywords: -39% 52 Keywords Studios plc Governance TSR performance The charts below show (i) the Company’s TSR since listing versus the FTSE Small Cap and Numis Smaller Companies indices, and (ii) the shareholder value created each financial year based on share price growth and dividends paid. Value of £100 invested in July 2013 Shareholder value created each year £m 1200 1000 800 600 400 200 0 11 Jul 2013 31 Dec 2013 31 Dec 2014 31 Dec 2015 31 Dec 2016 31 Dec 2017 31 Dec 2018 Keywords FTSE Small Cap Numis Small Cap 600 400 200 0 -200 -400 2013 2014 2015 2016 2017 2018 Shareholder value created each year is based on the increase in share price plus dividends paid over each financial year multiplied by the shares outstanding at the start of each year Implementation of the Remuneration Policy in 2019 Salary With effect from 1 March 2019, salary increases of 16% and 5% have been awarded to the CEO and CFO, such that their salaries will be £240,000 and €168,695 respectively. The Remuneration Committee consider the increases to be appropriate given the very material rise in the size and complexity of the business during 2018. Even after the salary increases, the Executive Directors still have base salaries in the bottom quartile for a company of equivalent size, consistent with the Company’s Remuneration Policy. Annual Bonus The Executive Directors will be eligible to earn annual bonuses of up to 30% of salary in line with previous years. LTIP The Remuneration Committee intends to make awards under the LTIP to the Executive Directors in line with previous years to the CEO and CFO respectively. The Remuneration Committee considered the TSR benchmark for the LTIP awards and concluded that from 2019, awards will vest based on the Company’s TSR performance versus the FTSE Small Cap Index (previously the Numis Smaller Companies (excluding Investment Trusts) Index) over a 3-year period, it being considered a more visible and accessible representative index of similar companies. Threshold vesting (10% of the award) will vest for TSR in line with the Index and full vesting will be earned for exceeding the Index TSR by 20% over the performance period. Non-Executive Directors’ remuneration The Board has reviewed the Non-Executive Director fee structure and has agreed a specific fee card based on the roles and responsibilities of the directors (see table below) to take effect 1 March 2019. The Committee reviewed the Chairman fee during 2018 and approved an increase from £69,244 to £90,000 in line with the increased scale of the business and after considering relevant internal and external benchmarks. The Board considers this revised fee structure to be more appropriate given the material rise in the size and visibility of the Company. Role Board Chairman Senior Independent Director fee Non-Executive Director basic fee Additional fees: Chairman of the Audit Committee Chairman of the Remuneration Committee Member of: Audit Committee Remuneration Committee Total Ross Graham* David Reeves Giorgio Guastalla Charlotta Ginman Georges Fornay £90,000 £5,000 £48,000 £48,000 £48,000 £48,000 £12,000 £3,000 £12,000 £3,000 £3,000 £90,000 £68,000 £48,000 £63,000 £51,000 *Ross Graham receives no additional fees on top of his Board Chairman fee for his membership of the sub-committees Annual Report and Accounts 2018 53 Directors’ Remuneration Report continued Directors’ interest in shares The interests of each person who was a Director of the Company (together with interests held by his or her connected persons) were: Giorgio Guastalla 1 Andrew Day Ross Graham David Reeves Georges Fornay Charlotta Ginman At 31 Dec 18 At 31 Dec 17 3,600,662 3,296,573 58,440 32,400 5,142 1,733 3,600,662 3,296,573 58,440 32,440 3,142 1,071 6,994,950 6,992,288 1 Giorgio Guastalla’s indirect shareholding arises out of his 90% holding in P.E.Q. Holdings Limited. The outstanding LTIP and Option awards held by each Executive Director of the Company are as follows. LTIP Andrew Day David Broderick Number at 31 Dec 17 Number granted during the year Number vesting during the year Number lapsed during the year Number at 31 Dec 18 Vesting date Current vesting expectation** 86,593 35,000 60,000 52,000 – 30,000 30,000 – 293,593 – – – – 50,000 – – 25,000 75,000 – 35,000 – – – – – – 35,000 – – – – – – – – – 12 Jul 2016* 86,593 35,000 01 Jun 2018* 60,000 10 May 2019 52,000 15 May 2020 50,000 18 May 2021 30,000 03 Oct 2019 30,000 15 May 2020 25,000 18 May 2021 368,593 100% 100% 0% 100% 100% 0% *Awards have vested **Vesting expectation (% of award) is based on the achievement of the TSR performance condition up to 31 December 2018 The awards in the table above vesting in 2019 and 2020 were granted subject to the Company’s TSR performance versus the Numis Smaller Companies (excluding Investment Trusts) Index over a 3-year period with a 4-year exercise window and continuous employment; threshold vesting (10% of the award) will vest for TSR in line with the Index and full vesting will be earned for exceeding the Index TSR by 45% over the performance period. The awards in the table above vesting in 2021 were granted subject to the TSR condition as described in the Section above “Long-term incentives granted during 2018” being the same criteria save that full vesting applies for exceeding the same Index by 20% (previously 45%). Share Option Plan Andrew Day Number at 31 Dec 17 Number granted during the year Number exercised during the year Number lapsed during the year Number at 31 Dec 18 21,167 21,167 21,168 63,502 – – – – – – – – – – – – 21,167 21,167 21,168 63,502 Vesting date 12 Jul 2015 12 Jul 2016 12 Jul 2017 Executive Directors no longer receive awards under the Share Option Plan. Awards of options in the table above have all vested and shall lapse the day before the seventh anniversary of the Date of Grant (12 July 2013), assuming it is not exercised before then and no event occurs to cause it to lapse earlier under the Rules. Dr David Reeves Chairman of the Remuneration Committee 54 Keywords Studios plc Governance Report of the Nomination Committee Roles and responsibilities The role of the Committee is to develop and maintain a formal, rigorous and transparent procedure for making recommendations on appointments and re-appointments to the Board. In addition, it is responsible for reviewing the succession plans for the Executive Directors and the Non-Executive Directors. This involves: • Reviewing the structure, size and composition of the Board and making recommendations to the Board with regard to any changes. • Assessing the effectiveness and performance of the Board and each of its Committees including consideration of the balance of skills, experience, independence and knowledge of the Company on the Board, its diversity, including gender, how the Board works together as a unit, and other factors relevant to its effectiveness. Identifying and nominating new members to the Board. • Considering succession planning for directors and members of the Executive Management Team. • • Reviewing the results of the Board performance evaluation process that relate to the composition of the Board. • Reviewing annually the time input required from Non-Executive Directors. Diversity The Committee reviews the Board Diversity Policy annually and did so most recently at its 28 June 2018 meeting. The policy acknowledges that an effective Board will include and make good use of differences in the skills, regional and industry experience, background, race, gender and other distinctions between Directors and emphasises that in identifying suitable candidates for appointment to the Board, the Committee will consider candidates on merit against objective criteria, with due regard for the benefits of diversity on the Board. Governance processes The Committee meets at least 1 time a year and at such other times as the Committee Chair or any member of the Committee may request. In 2018, the Committee met 4 times. The Committee has formal terms of reference which can be viewed on the Company’s website, www.keywordsstudios.com. Main activities Succession The Board is committed to effectively managing leadership succession and proactively engages with the senior management team to assess the executive talent pool. The Committee and the Board receives regular contributions from individuals in the wider executive group at meetings of the Board and Committees throughout the year. These contributions are valuable for our decision making and have helped the Non-Executive Directors to develop a clear understanding of the strength of the management team. Succession planning is designed to consider the planned process of transition to new leadership over time and also the potential for unforeseen change over a shorter timeframe. The Committee keeps in touch with the talent development process throughout the organisation, conscious of the strategic importance of promoting from within as far as possible to support the Company’s growth plans as set out in the Strategic Report. Senior management succession planning will continue to be a focus for 2019. Board and Committee Composition The Committee also reviewed the size, composition and skill set of the Board during the year and concluded that there was an appropriate mix of experience, skills and knowledge to provide strong and effective leadership. Board Performance Evaluation The Board, on the Committee’s recommendation conducted a board evaluation at the end of 2018. The findings from this evaluation, based on an in-depth questionnaire issued to each Director, were very positive and provided a number of valuable insights and recommendations which we will follow up on in 2019. Role of the Company Secretary In light of the growth of the business and the increasing complexity of the regulatory environment the Committee considered that the Company had reached the point where the Company Secretariat merited dedicated resource, independent of the finance function. On 28 June 2018, Liam O’Donoghue of ONE Advisory was appointed company Secretary, reporting to the Chairman and CEO. Annual evaluation of the Nomination Committee’s performance This year’s annual internal Board and Committee evaluation exercise was designed and led by the Company Secretary, working closely with the Chairman of the Board in order to provide objectivity. The areas covered were: structure & skills, operating effectiveness, operating efficiency, quality of information and ongoing development. The Board evaluation exercise identified a number of positive areas including the appointment of additional Non-Executive Directors during the year, the appointment of an independent Company Secretary and application of corporate governance practices. Although the Board and sub-committees are working well, areas highlighted for improvement include the need to spend more time discussing the effectiveness of the Company’s strategy from a day-to-day standpoint, and more site visits to the Company’s studio locations. These matters will be addressed during the 2019 financial year. In addition, individual reviews of Non-Executive Director’s performances were carried out by the Chairman, and the performance of the Chairman was reviewed by the rest of the Directors. This concluded that overall the Chairman devotes adequate time of the Company’s business, stays abreast of developments affecting the Company, and shows a strong understanding of the business. Ross Graham Chairman of the Nomination Committee 8 April 2019 Annual Report and Accounts 2018 55 Independent Auditor’s Report to the members of Keywords Studios plc Opinion We have audited the financial statements of Keywords Studios plc (the ‘parent company’) and its subsidiaries (the ‘group’) for the year ended 31 December 2018 which comprise the Group and Parent Company Statements of Financial Position, the Group Statement of Comprehensive Income, the Group and Parent Company Statements of Cash Flows, the Group and Parent Company Statements of Changes in Equity, and the notes to the financial statements, including a summary of significant accounting policies. The financial reporting framework that has been applied in the preparation of the financial statements is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006. In our opinion: • the financial statements give a true and fair view of the state of the group’s and of the parent company’s affairs as at 31 December 2018 and of the group’s profit for the year then ended; the group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; the parent company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006. • • • Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) and applicable law. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the financial statements section of our report. We are independent of the group in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, including the FRCs Ethical Standard as applied to listed entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Conclusions relating to going concern We have nothing to report in respect of the following matters in relation to which the ISAs (UK) require us to report to you where: the directors’ use of the going concern basis of accounting in the preparation of the financial statements is not appropriate; or • the directors have not disclosed in the financial statements any identified material uncertainties that may cast significant doubt about the • group’s or the parent company’s ability to continue to adopt the going concern basis of accounting for a period of at least twelve months from the date when the financial statements are authorised for issue. Key audit matters Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) we identified, including those which had the greatest effect on: the overall audit strategy, the allocation of resources in the audit; and directing the efforts of the engagement team. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. 1 Revenue Recognition – cut off Key Audit Matter Although the majority of the Groups revenue contracts are non complex in nature, there is a material accrued revenue balance as at 31 December 2018 of €6.3m (2017: €5.1m). We focused on this area due to the risk of management manipulation of the timing of revenue recognition and the cut off relating to accrued revenue at the year end. Related Disclosures Refer to note 2 of the accompanying consolidated financial statements for the accounting policies of the Group in relation to Revenue Recognition. Audit Response We have performed audit procedures to understand the application of the revenue recognition accounting policies and to assess whether for each material revenue stream, that revenue has been recognized correctly in accordance with the Group Revenue Recognition policy. We have completed a substantive based audit approach across all full scope locations and completed specific audit procedures on a sample basis on less significant components of the group. Our audit work included, but was not restricted to, validating a sample of transactions both throughout the year and around the year end, to assess that the stage of completion and therefore accrued revenue is reflective of the underlying project status. We have tested these transactions to supporting documentation such as sales orders and contracts from customers, project status evidence, and subsequent billing. When examining samples of transactions around the year end we have assessed whether the revenue has been recognised in the correct period. 56 Keywords Studios plc Financial Statements 2 Business Combinations Key Audit Matter The Group has entered into a significant number of acquisitions and business combinations throughout the year, which have had a material and extensive impact on the group’s financial performance and position. Following the purchase price allocations (in which identifiable assets and liabilities assumed were recognised at fair value), €154m (2017: €108m) of goodwill has been recognised cumulatively to date. The fair value of certain identifiable assets acquired and liabilities assumed in a business combination is different from their carrying amounts in the acquired statements of financial position which can give rise to fair value adjustments as part of the purchase price allocations of these business combinations. Accordingly, the cumulative acquisitions are material and significant judgement is required in relation to the purchase price allocations including the resulting goodwill. Management determined the fair value of the identifiable assets and liabilities and notably the value of the customer relationships. The valuation of these assets was primarily based upon the expected future cash flows related to these acquisitions. A number of these acquisitions have also included deferred consideration in the form of shares and cash payments at future dates, which add further complexity with regard to the acquisition-date fair value of such consideration as part of the consideration transferred in exchange for the acquisitions and business combinations. Related Disclosures Refer to note 2 of the accompanying consolidated financial statements for the accounting policy in relation to business combinations. In addition, detailed disclosures have been made in relation to each business combination in note 28 to the financial statements. Audit Response We have reviewed the underlying contracts and share purchase agreements relating to each acquisition to assess whether the basis for treatment of the acquisitions is in accordance with the accounting policy and International Financial Reporting Standard 3 – Business Combinations. We have assessed the carrying value of each material balance at the date of acquisition, and have reviewed management’s assessments of the fair value of the assets and liabilities acquired, and in particular, the methodology applied in the valuation of intangible assets and goodwill. Our procedures included; • We reviewed the methodology applied to identify the categories of intangible assets, • We evaluated whether the cash flow forecasts used in the valuation are consistent with information approved by the Board and have reviewed the historical accuracy of management’s forecasts in order to assess the reliance which can be placed upon managements forecasting, • We have challenged the key assumptions such as the growth factors and discount rates by comparing them to relevant market rates and historic acquisitions to verify that management had been consistent in its approach to valuations, and • We assessed the adequacy of the acquisition disclosures in the Group’s financial statements. In addition, we have examined the terms of all business combinations to assess whether the fair value of any deferred / contingent consideration is treated appropriately in accordance with the group accounting policy and IFRS 3. We also examined the key post combination employment contracts of former shareholders of the acquired entities, reviewing the substance of the transactions and considered whether they have been appropriately accounted for in line with the group accounting policy and the requirements of IFRS 3. 3 Valuation of goodwill and intangible assets Key Audit Matter As a result of both the current year and prior year acquisitions, the group has amassed significant intangible assets and goodwill balances. These balances are material to the financial statements, with goodwill carrying value of €154m (2017: €108m), and intangibles carrying value of €25.9m (2017: €23.5m). The valuation of goodwill and other intangible assets is significant to our audit due to the fact that the impairment test calculations are based on several key assumptions which are estimated by management, and are by nature judgemental. Key assumptions include the expected future cash flows for the forecasting period, the discount rates and perpetual growth rate. The Directors have concluded that there is one cash generating unit (“CGU”) in the group, for the purposes of impairment assessment. Related Disclosures Refer to note 2 of the accompanying consolidated financial statements for the accounting policy in relation to business combinations, intangible assets and goodwill. In addition, detailed disclosures have been made in relation to each business combination in notes 28 and 29 to the financial statements. Detailed disclosures are made in note 11 relating to goodwill, and note 12 in relation to intangible assets. Annual Report and Accounts 2018 57 Independent Auditor’s Report continued 3 Valuation of goodwill and intangible assets continued Audit Response We have reviewed the Directors assessment of the carrying value of goodwill and intangible assets. We have challenged the Directors assumptions in relation to CGU identification, cash flow forecasting, discount rates applied, and future growth rates. Our procedures included; • We have evaluated that the CGU identified is the lowest level at which management monitors goodwill and intangible assets, • We have reviewed the accuracy of the cash flow forecasts used, and ensured that these represent those which are reviewed by the Board, • We have reviewed and assessed the accuracy of the historical forecasts prepared by the Group, • We have assessed the key estimates and inputs into the discounted cash flow models, including the growth rates assumed, and tested these where possible to supporting evidence such as post year end activities, • We have completed sensitivity analyses in relation to the cash flow models and have stress tested all key assumptions used, and • We have considered the appropriateness of the disclosures relating to the valuation of goodwill and intangible assets in the financial statements. Our application of materiality We apply the concept of materiality both in planning and performing our audit, and in evaluating the effect of misstatements. We consider materiality to be the magnitude by which misstatements, including omissions in the financial statements, could influence the economic decisions of reasonable users that are taken on the basis of the financial statements. Importantly, misstatements below these levels will not necessarily be evaluated as immaterial as we also take into account the nature of identified misstatements, and in particular the circumstances of their occurrence, when evaluating their effect on the financial statements as a whole. We determined materiality for the financial statements as a whole to be €2.2m, which represents 10% of profit before taxation and represents less than 2% of equity. We consider profit before income tax to be the most significant determinant of the group’s financial performance used by shareholders and other users and therefore consider this as an appropriate basis for materiality. Our materiality is higher than the level we set for the year ended 31 December 2017 (€1.2m), due to the increased profits and equity position of the group. We agreed with the Audit Committee that we would report to the Committee all individual differences identified during the course of our audit in excess of €110,000, (2017: €60,000). We also agreed to report differences below this threshold that, in our view, warranted reporting on qualitative grounds. An overview of the scope of our audit Our audit was scoped by obtaining an understanding of the Group and its environment, including the group wide controls, and assessing the risks of material misstatement identified at group level. The Group has operations in 21 countries, and 66 wholly owned subsidiary entities. Based on our assessment, we have completed full scope audit procedures in relation to the following entities; Keywords Studios plc, Keywords International Limited, Sillabit S.R.L, Sperasoft Studios LLC, Cord Worldwide Limited, Studio Gobo Limited, Bitsy SG Limited, Electric Square Limited, Itsy SGD Limited, Alset Limited, and Keywords Studios Italia S.R.L (formerly Binari Sonori S.R.L). In addition, specific audit procedures have been completed in relation to certain material balances and transaction streams in Keywords Studios QC-Games Inc (formerly Babel Games Services Inc), VMC Consulting Corporation, Keywords Canada Holdings Inc (formerly Volt Canada Inc), Keywords Studios QC-Tech Inc (formerly Alchemic Dream Inc), Keywords (Shanghai) Information Technology Ltd, Synthesis Global Solutions SAS, Keywords Studios QC-Interactive Inc (formerly Enzyme Testing Lab Inc), Sperasoft Inc, and Lakshya Digital Private Limited. The above entities represent 73% of group revenues and over 90% of profit before tax. Whilst materiality for the financial statements as a whole was €2.2m, each component of the group was audited to a lower level of materiality. Audits of these components were performed at a materiality level calculated by reference to a proportion of group materiality appropriate to the relative scale of the business concerned. The Group auditor, BDO Dublin, has audited Keywords Studios plc, Keywords International Limited, Cord Worldwide Limited, Studio Gobo Limited Bitsy SG Limited, Electric Square Limited, Itsy SGD Limited, Alset Limited, and Keywords Studios QC-Interactive Inc (formerly Enzyme Testing Lab Inc). Their involvement in the work performed by other component auditors varies by location and involves, at a minimum, direction of the audit procedures to be completed, and review of the reports received in relation to the results of the audit work undertaken by component audit teams. In the current year, the Senior Statutory auditor or senior members of the Group audit team have visited the following reporting locations on planned visits: Canada (Babel Media, Volt), Russia (Sperasoft Studios LLC and Sperasoft Inc), and China (Keywords Shanghai). These visits are to direct and review the work performed by component auditors. At the parent company level we have also tested the consolidation process and carried out additional procedures to confirm our conclusion that there were no significant risks of material misstatement of the aggregated financial information of the remaining components not subject to full scope or specific procedures. 58 Keywords Studios plc Financial Statements Other information The directors are responsible for the other information. The other information comprises the information included in the annual report, other than the financial statements and our auditor’s report thereon. Our opinion on the financial statements does not cover the other information and, except to the extent otherwise explicitly stated in our report, we do not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If we identify such material inconsistencies or apparent material misstatements, we are required to determine whether there is a material misstatement in the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Opinions on other matters prescribed by the Companies Act 2006 In our opinion, based on the work undertaken in the course of the audit: • the information given in the strategic report and the directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements; and the strategic report and the directors’ report have been prepared in accordance with applicable legal requirements. • Matters on which we are required to report by exception In the light of the knowledge and understanding of the group and the parent company and its environment obtained in the course of the audit, we have not identified material misstatements in the strategic report or the directors’ report. We have nothing to report in respect of the following matters in relation to which the Companies Act 2006 requires us to report to you if, in our opinion: • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or the parent company financial statements are not in agreement with the accounting records and returns; or • • certain disclosures of directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. Responsibilities of directors As explained more fully in the directors’ responsibilities statement set out on page 42 the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view, and for such internal control as the directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, the directors are responsible for assessing the group’s and the parent company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the group or the parent company or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibilities for the audit of the financial statements This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. A further description of our responsibilities for the audit of the financial statements is located on the Financial Reporting Council’s website at: www.frc.org.uk/auditorsresponsibilities. This description forms part of our auditor’s report. John O’Callaghan (Senior Statutory Auditor) For and on behalf of BDO, Statutory Auditor Dublin 2, Ireland 8 April 2019 Annual Report and Accounts 2018 59 Consolidated Statement of Comprehensive Income Revenue from contracts with customers Cost of sales Gross profit Share option expense Costs of acquisition and integration Amortisation of intangible assets Total of items excluded from adjusted profit measures Other administration expenses Administrative expenses Operating profit Financing income Financing cost Share of post-tax profit / (loss) of equity accounted associates Profit before taxation Tax expense Profit Other comprehensive income: Items that will not be reclassified subsequently to profit or loss Actuarial gain / (loss) on defined benefit plans Items that may be reclassified subsequently to profit or loss Exchange gain / (loss) in net investments foreign operations * Exchange gain / (loss) on translation of foreign operations Total comprehensive income Earnings per share Basic earnings per ordinary share Diluted earnings per ordinary share Note 4 5 17 5 12 6 6 27 7 Years ended 31 December 2018 €’000 2017 €’000 250,805 (154,997) 151,430 (96,345) 95,808 55,085 (4,129) (5,296) (6,872) (16,297) (56,826) (1,426) (3,016) (3,038) (7,480) (31,170) (73,123) (38,650) 22,685 16,435 791 (1,316) (66) 22,094 (7,191) 14,903 26 (4,467) – 11,994 (4,731) 7,263 19 27 (25) 1,270 771 16,971 € cent 23.16 22.24 8 8 (893) (3,598) 2,747 € cent 12.37 11.87 * Please note that “Exchange gain / (loss) on net investments in foreign operations” 2017, have been re-classified to correctly classify them as “Items that may be reclassified subsequently to profit or loss”, within Other Comprehensive Income. All Profit and Comprehensive Income is attributable to the shareholders. The notes from page 67 onwards form an integral part of these consolidated financial statements. On behalf of the Board Andrew Day Director 8 April 2019 David Broderick Director 60 Keywords Studios plc Financial Statements Consolidated Statement of Financial Position At 31 December Non-current assets Property, plant and equipment Goodwill Intangible assets Investment in associate Deferred tax assets Current assets Trade receivables Other receivables Cash and cash equivalents Total assets Equity Share capital Share capital – to be issued Share premium Merger reserve Foreign exchange reserve Shares held in EBT Share option reserve Retained earnings Total equity Current liabilities Trade payables Other payables Loans and borrowings Corporation tax liabilities Non-current liabilities Other payables Employee defined benefit plans Loans and borrowings Deferred tax liabilities Total equity and liabilities 13 11 12 27 26 14 15 16 16 16 16 18 20 18 19 20 26 Note 2018 €’000 15,002 154,202 25,884 160 2,967 198,215 37,019 23,459 39,871 100,349 2017 Restated (note 31) €’000 10,111 108,062 23,548 – 1,206 142,927 27,473 22,335 30,374 80,182 298,564 223,109 763 15,648 102,225 35,996 (1,463) (1,997) 6,674 34,529 737 11,620 102,054 28,878 (3,504) (1,997) 2,545 20,679 192,375 161,012 7,142 41,153 40,071 6,665 95,031 1,062 1,378 230 8,488 7,310 22,179 18,943 3,245 51,677 1,233 1,055 337 7,795 11,158 10,420 298,564 223,109 The notes from page 67 onwards form an integral part of these consolidated financial statements. The financial statements were approved and authorised for issue by the Board on 8 April 2019. On behalf of the Board Andrew Day Director 8 April 2019 David Broderick Director Annual Report and Accounts 2018 61 Consolidated Statement of Changes in Equity Share capital / shares to be issued €’000 Share capital €’000 Share premium €’000 Merger reserve €’000 Foreign exchange reserve €’000 Shares held in EBT €’000 Share option reserve €’000 Retained earnings €’000 Total equity €’000 Balance at 1 January 2017 654 8,792 19,983 22,109 987 (1,434) 1,305 14,308 66,704 Profit for the period Other comprehensive income Total comprehensive income for the period Contributions by and contributions to the owners: Shares issued for cash Share option expense Share options exercised Dividends paid (note 9) Acquisition related issuance of shares (note 16) Reclassification of share premium on acquisitions to merger reserve Contributions by and – – – 61 – 6 – 16 – – – – – – – – – – – 82,261 – 608 – – – – – – – – 2,947 – 5,971 – (798) 798 contributions to the owners 83 2,947 82,071 6,769 – (4,491) (4,491) – – – – – – – – – – – – (563) – – – – – – 7,263 (25) 7,263 (4,516) 7,238 2,747 – 1,240 – – – – – – – (867) – – 82,322 1,240 51 (867) 8,934 – (563) 1,240 (867) 91,680 Balance at 31 December 2017 Measurement period adjustment (note 31) Balance at 31 December 2017 737 11,739 102,054 28,878 (3,504) (1,997) 2,545 20,679 161,131 – (119) – – – – – – (119) restated 737 11,620 102,054 28,878 (3,504) (1,997) 2,545 20,679 161,012 Profit for the period Other comprehensive income Total comprehensive income for the period Contributions by and contributions to the owners: Shares issued for cash Share option expense Share options exercised Dividends paid (note 9) Acquisition related issuance of shares (note 16) Contributions by and contributions to the owners – – – – – 3 – 23 26 – – – – – – – – – – – – 171 – – – – – – – – 4,028 – 7,118 4,028 171 7,118 – 2,041 2,041 – – – – – – – – – – – – – – – – – – 14,903 27 14,903 2,068 14,930 16,971 – 4,129 – – – – – (1,080) – 4,129 174 (1,080) – – 11,169 4,129 (1,080) 14,392 Balance at 31 December 2018 763 15,648 102,225 35,996 (1,463) (1,997) 6,674 34,529 192,375 62 Keywords Studios plc Financial Statements Consolidated Statement of Cash Flows Cash flows from operating activities Profit after tax Income and expenses not affecting operating cash flows Depreciation Intangibles amortisation Income tax expense Share option expense Costs of acquisition & integration* Loss on disposal of fixed assets Unwinding of present value adjustment on deferred consideration* Share of post-tax loss of equity accounted associates Interest receivable Employee benefit costs Interest expense* Unrealised foreign exchange (gain) / loss Changes in operating assets and liabilities Decrease / (increase) in trade receivables Decrease / (increase) in MMTC and VGTC receivable Decrease / (increase) in other receivables (Decrease) / increase in trade and other payables Income taxes paid Net cash provided by operating activities Cash flows from investing activities Current year acquisition of subsidiaries net of cash acquired Prior year acquisition of subsidiaries net of cash acquired Settlement of deferred liabilities on acquisitions Investment in associate Acquisition of property, plant and equipment Investment in intangible assets Acquisition & integration cash outlay Interest received Net cash used in investing activities Cash flows from financing activities Repayment of loans Loan to finance acquisitions Dividends paid Financing EBT for share options exercised Shares issued for cash Interest paid Net cash provided by financing activities Increase / (decrease) in cash and cash equivalents Exchange (loss) / gain on cash and cash equivalents Cash and cash equivalents at beginning of the period Cash and cash equivalents at end of period Years ended 31 December Note 2018 €’000 2017 €’000 14,903 7,263 13 12 7 17 5 6 27 6 19 6 28 29 18 27 13 12 5 30 30 9 16 5,316 6,872 7,191 4,129 5,296 63 311 66 – 279 502 (992) 2,730 3,038 4,731 1,426 3,016 103 266 – (26) 209 312 2,033 29,033 17,838 (7,680) (370) 2,850 (252) (5,452) (6,304) 2,506 (873) (4,540) (82) (2,989) (5,454) 32,180 16,658 (24,163) (726) (1,603) (226) (9,440) (1,599) (4,530) – (86,776) – (298) – (3,803) – (3,016) 26 (42,287) (93,867) (10,835) 31,850 (1,080) – 174 (502) 19,607 9,500 (3) 30,374 39,871 (23) 10,250 (867) (563) 82,936 (279) 91,454 14,245 (891) 17,020 30,374 * Please note that comparatives have been re-classified to reflect current year presentation as the Directors consider this presentation to be more meaningful. Annual Report and Accounts 2018 63 Company Statement of Financial Position Non-current assets Property, plant and equipment Investment in subsidiaries Other receivables Current assets Other receivables Cash and cash equivalents Total assets Equity Share capital Share capital – to be issued Share premium Merger reserve Shares held in EBT Share option reserve Retained earnings Current liabilities Trade payables Other payables Loans and borrowings Corporation tax liabilities Non-current liabilities Other payables Total equity and liabilities Note At 31 December 2018 €’000 2017 €’000 13 21 15 15 16 16 16 18 20 389 30,670 175,509 206,568 1,737 438 2,175 208,743 763 15,648 102,225 41,677 (1,997) 6,674 (2,538) 1 30,659 3,300 33,960 129,153 6,261 135,414 169,374 737 11,739 102,054 34,561 (1,997) 2,545 (311) 162,452 149,328 285 5,435 40,000 3 45,723 215 1,578 18,250 3 20,046 18 568 – 208,743 169,374 In accordance with Companies Act 2006, the Company is availing of the exemption from presenting its individual Statement of Comprehensive Income to the Annual General Meeting and from filing it with Companies House. The amount of (loss) / profit after tax dealt with in the parent undertaking is (€1,147k), (2017: €9,161k). The notes on pages 67 onwards form an integral part of these financial statements. The financial statements were approved and authorised for issue by the Board on 8 April 2019. On behalf of the Board Andrew Day Director 8 April 2019 David Broderick Director 64 Keywords Studios plc Financial Statements Company Statement of Changes in Equity Share capital / shares to be issued €’000 Merger reserve re- structuring €’000 Share premium €’000 Share capital €’000 Merger reserve acquisitions €’000 Shares held by EBT €’000 Share option reserve €’000 Retained earnings €’000 Total equity €’000 Balance at 1 January 2017 654 8,792 19,983 5,313 22,479 (1,434) 1,305 (8,605) 48,487 Profit / (loss) for the period Total comprehensive income for the period Contributions by and contributions to the owners: Shares Issued for cash Share option expense Share options exercised Dividends paid (note 9) Acquisition related issuance of shares (note 16) Reclassification of share premium on acquisitions to merger reserves Contributions by and – – 61 – 6 – 16 – – – – – – – – – 82,261 – 608 – 2,947 – – (798) contributions to the owners 83 2,947 82,071 – – – – – – – – – – – – – – – 5,971 798 – – – – (563) – – – – – 9,161 9,161 9,161 9,161 – 1,240 – – – – – – – (867) – – 82,322 1,240 51 (867) 8,934 – 6,769 (563) 1,240 (867) 91,680 Balance at 31 December 2017 737 11,739 102,054 5,313 29,248 (1,997) 2,545 (311) 149,328 Profit / (loss) for the period Total comprehensive income for the period Contributions by and contributions to the owners: Share option expense Share options exercised Dividends paid (note 9) Acquisition related issuance of shares (note 16) Contributions by and contributions to the owners – – – 3 – 23 26 – – – – – 3,909 – – – 171 – – 3,909 171 – – – – – – – – – – – – 7,116 7,116 – – – – – – – – – (1,147) (1,147) (1,147) (1,147) 4,129 – – – – (1,080) 4,129 174 (1,080) – – 11,048 4,129 (1,080) 14,271 Balance at 31 December 2018 763 15,648 102,225 5,313 36,364 (1,997) 6,674 (2,538) 162,452 Annual Report and Accounts 2018 65 Company Statement of Cash Flows Years ended 31 December Note 2018 €’000 2017 €’000 (1,147) 9,161 13 30 9 16 255 (12) – 669 27 127 1,066 2,393 4,505 6,898 – 6,817 (415) 12 (403) (10,100) (32,401) 31,850 (1,080) 174 – (680) (12,237) (5,823) 6,261 438 100 (268) 203 366 – – 401 (10,400) 228 (10,172) – (610) – – – – (85,604) 10,250 (867) 82,936 (563) (229) 5,923 5,313 948 6,261 Cash flows from operating activities Profit / (loss) after tax Income and expenses not affecting operating cash flows Share option expense Interest income Share issuance costs Interest expense Depreciation Amounts written off financial assets Changes in operating assets and liabilities (Increase) / decrease in other receivables Increase / (decrease) in trade and other payables Income taxes paid / (refunded) Net cash generated / (used) by operating activities Cash flows from investing activities Acquisition of property, plant and equipment Interest received Net cash used in investing activities Cash flows from financing activities Repayment of loans Financing the acquisition of subsidiaries Loan to finance acquisitions Dividends paid Shares issued Financing EBT for share options exercised Interest paid Net cash generated / (used) in financing activities Increase / (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of the period Cash and cash equivalents at end of period 66 Keywords Studios plc Financial Statements Notes Forming Part of the Consolidated and Company Financial Statements 1 Basis of Preparation Keywords Studios PLC (the “Company”) is a company incorporated in the UK. The consolidated financial statements include the financial statements of the Company and its subsidiaries (the “Group”) made up to 31 December 2018. The Group was formed on 8 July 2013 when Keywords Studios PLC (formerly Keywords Studios Limited) acquired the entire share capital of Keywords International Limited through the issue of 31,901,332 ordinary shares. The parent company financial statements present information about the Company as a separate entity and not the Group. The consolidated and Company financial statements have been prepared in accordance with International Financial Reporting Standards, International Accounting Standards and interpretations (collectively IFRS) issued by the International Accounting Standards Board (IASB) as adopted by the European Union (“adopted IFRSs”). The financial statements have been prepared in thousands (€’000) and the financial statements are presented in Euro (€) which is the functional currency of the Group. New Standards, Interpretations and Amendments Effective 1 January 2018 Impact of IFRS 9 The Group implemented IFRS 9 Financial Instruments, as of 1 January 2018. The new standard includes revised guidance on the classification and measurement of financial instruments. With the exception of adopting the new expected credit loss model for calculating impairment on financial assets, the implementation of the new standard has not resulted in significant change in the relevant accounting policies for the Group. For the Group, the financial instruments that are impacted are trade receivables, and for the Company are inter-group receivables. At the end of each accounting period, the Group assesses the requirement for the impairment of trade receivables on the basis of the expected credit loss rate. Having assessed the requirements according to the standards, the Group has concluded that no significant additional impairment to the carrying values of the assets was required at 1 January 2018, or at 31 December 2018. The Company assesses the requirement for the impairment of inter-group receivables on the basis of the expected credit loss rate, and a small provision was recorded as at 31 December 2018 (note 23). The new standard has not resulted in a significant change in how the Group records financial liabilities. Impact of IFRS 15 The Group implemented IFRS 15, Revenue from Contracts with Customers, as of 1 January 2018. The new standard sets out revenue recognition requirements, and establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the Group’s contracts with customers. Following implementation of IFRS 15, there was no material impact of transition on retained earnings at 1 January 2018, on the Group’s statement of financial position as at 31 December 2018, on its statement of profit or loss and other comprehensive income, or on the cash flows for the period to 31 December 2018. The new standard also introduces expanded disclosure requirements; however, the implementation of the new standard did not result in a significant change in the revenue recognition accounting policies of the Group. New Standards, Interpretations and Amendments Not Yet Effective The Group has adopted the following standards from 1 January 2019. The Group does not expect any other standards issued by the IASB, but not yet effective, to have a material impact on the Group. Impact of IFRS 16 IFRS 16 Leases was issued in January 2016 and replaces IAS 17 Leases, IFRIC 4 Determining Whether an Arrangement Contains a Lease, SIC-15 – Operating Leases – Incentives and SIC-27 – Evaluating the Substance of Transactions Involving the Legal Form of a Lease. The new standard is applicable from 1 January 2019. The Group has entered into leases, across the business, principally relating to property. These property leases have varying terms and renewal rights. The Group has adopted IFRS 16 from 1 January 2019, by applying the modified retrospective approach. In 2019, the Group now recognise a liability to make lease payments (i.e. the lease liability) and an asset representing the right to use the underlying asset during the lease term (i.e. the right-of-use asset), for all material lease arrangements over 12 months in duration. The main impact on the financial statements will be to recognise on 1 January 2019, assets and liabilities, in the Statement of Financial Position in relation to right-of-use assets and liabilities (previously considered as operating leases), of €22.8m. In the 2019 Consolidated Statement of Comprehensive Income, as the right-of-use assets are capitalised and depreciated over the term of the lease, with an associated finance cost applied to the lease liability, we anticipate operating expenses will decrease, as lease payments of €7.1m (which is less than operating lease payments disclosed in note 5 as short term leases will continue to be recognised under IAS 17), previously recognised in administration expenses, are capitalised. In addition, depreciation expenses (also recognised in administration expenses) of €6.9m will be recognised, while financing costs will increase by €0.6m, under the new standard. This will lead to an improvement in EBITDA, Operating profit and Profit before taxation. The Group’s Cash Flow Statement in 2019 will separate the interest and capital repayment elements of leases payments. These financial statements made up to 31 December 2018 have been prepared under IAS 17 as outlined in note 2. Impact of IFRIC 23 IFRIC 23 Uncertainty over Income Tax Positions, which was issued in June 2017, clarifies how to recognise and measure current and deferred income tax assets and liabilities when there is uncertainty over income tax treatments. The new standard is applicable from 1 January 2019. The Group do not anticipate a material impact on the financial statements on transition to the new standard. Annual Report and Accounts 2018 67 Notes Forming Part of the Consolidated and Company Financial Statements continued 2 Significant Accounting Policies Basis of Consolidation Where the Company has control over an investee, it is classified as a subsidiary. The Company controls an investee if all three of the following elements are present: power over the investee, exposure to variable returns from the investee, and the ability of the investor to use its power to affect those variable returns. Control is reassessed whenever facts and circumstances indicate that there may be a change in any of these elements of control. De-facto control exists in situations where the Company has the practical ability to direct the relevant activities of the investee without holding the majority of the voting rights. In determining whether de-facto control exists, the Company considers all relevant facts and circumstances, including: • The size of the Company’s voting rights relative to both the size and dispersion of other parties who hold voting rights; • Substantive potential voting rights held by the Company and by other parties; • Other contractual arrangements; and • Historic patterns in voting attendance. The consolidated financial statements present the results of the Company and its subsidiaries (“the Group”) as if they formed a single entity. Intercompany transactions and balances between Group companies are eliminated in full. Business Combinations The consolidated financial statements incorporate the results of business combinations using the purchase method. In the Consolidated Statement of Financial Position, the acquired identifiable assets, liabilities and contingent liabilities are initially recognised at their fair values at the acquisition date. The results of acquired operations are included in the consolidated income statement from the date on which control is obtained. They are consolidated until the date on which control ceases. Any contingent consideration payable is recognised at fair value at the acquisition date and is split between current liabilities and long-term liabilities depending on when it is due. The fair value of contingent consideration at acquisition date is arrived at through discounting the expected payment (based on scenario modelling) to present value. In general, in order for contingent consideration to become payable, pre-defined profit and / or revenue targets must be exceeded. At each balance sheet date, the fair value of the contingent consideration is revalued, with the expected pay-out determined separately in respect of each individual acquisition and any change recognised in the Statements of Comprehensive Income. For deferred consideration which is to be provided for by the issue of a fixed number of shares at a future defined date, where there is no obligation on Keywords to offer a variable number of shares, the deferred consideration is classified as an equity arrangement and the value of the shares is fixed at the date of the acquisition. Equity accounted investments The Group’s investments in its associates are accounted for using the equity method from the date significant influence is deemed to arise until the date on which significant influence / joint control ceases to exist or when the interest becomes classified as an asset held for sale. Goodwill Goodwill represents the excess of the cost of a business combination over, in the case of business combinations completed prior to 1 January 2010, the Group’s interest in the fair value of identifiable assets, liabilities and contingent liabilities acquired and, in the case of business combinations completed on or after 1 January 2010, the total acquisition date fair value of the identifiable assets, liabilities and contingent liabilities acquired. For business combinations completed prior to 1 January 2010, cost comprised the fair value of assets given, liabilities assumed and equity instruments issued, plus any direct costs of acquisition. Changes in the estimated value of contingent consideration arising on business combinations completed by this date were treated as an adjustment to cost and, in consequence, resulted in a change in the carrying value of goodwill. For business combinations completed on or after 1 January 2010, cost comprises the fair value of assets given, liabilities assumed and equity instruments issued, plus the amount of any non-controlling interests in the acquiree plus, if the business combination is achieved in stages, the fair value of the existing equity interest in the acquiree. Contingent consideration is included in acquisition date fair value and, in the case of contingent consideration classified as a financial liability, re-measured subsequently through profit or loss. For business combinations completed on or after 1 January 2010, direct costs of acquisition are recognised immediately as an expense. Goodwill is capitalised as an intangible asset with any impairment in carrying value being charged to the consolidated statement of comprehensive income. Intangible Assets The Group’s Intangible Assets comprise Customer Relationships and Other Intangible Assets. Customer Relationship Intangible assets, separately identified from goodwill acquired as part of a business combination (mainly Customer Relationships), are initially stated at fair value. The fair value attributed is determined by discounting the expected future cashflows generated from the net margin of the business from the main customers taken on at acquisition. The assets are amortised on a straight-line basis (to administration expenses) over their useful economic lives. A useful economic life of five years is deemed appropriate, however, this is re-examined for each acquisition. 68 Keywords Studios plc Financial Statements 2 Significant Accounting Policies continued Other Intangible Assets Other intangible assets include Intellectual Property and Music Licences, both acquired and internally developed. Other intangible assets are recognized as assets where it is probable that the use of the asset will generate future economic benefits and where the costs of the asset can be determined reliably. Other intangible assets that are acquired by the Group are stated at cost less accumulated amortization (see below) and impairment losses, if any. Subsequent expenditures on capitalised intangible assets are capitalised only when they increase the future economic benefits embodied in the specific assets to which they relate. All other expenditure is expensed as incurred. Other intangible assets with definite useful lives are amortized from the date they are available for use on a straight-line basis over their useful lives, being the estimated period over which the Group will use the assets. Residual amounts, useful lives and the amortization methods are reviewed at the end of every accounting period. Development costs are capitalised as an intangible asset if all of the following criteria are met: • • • • the technical feasibility of completing the intangible asset so that it will be available for use or sale; the intention to complete the intangible asset and use or sell it; the ability to use or sell the intangible asset; the asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the intangible asset if it is to be used internally; the availability of adequate technical, financial and other resources to complete the development and to use or sell it; the ability to measure reliably the expenditure attributable to the intangible asset during its development. • • Following initial recognition of the development expenditure as an intangible asset, the cost model is applied requiring the intangible asset to be carried at cost, less any accumulated amortization and accumulated impairment losses. The intangible asset is amortized on a straight-line basis over the period of its expected benefit, starting from the date of full commercial use of the product. During the period of development, the asset is tested for impairment annually. If specific events indicate that impairment of an item of intangible asset may have taken place, the item’s recoverability is assessed by comparing its carrying amount with its recoverable amount. The recoverable amount is the higher of the fair value net of disposal costs and the value in use. Impairment Impairment tests on goodwill and other intangible assets with indefinite useful economic lives are undertaken annually at the financial year end. Other non-financial assets are subject to impairment tests whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Where the carrying value of an asset exceeds its recoverable amount (i.e. the higher of value in use and fair value less costs to sell), the asset is written down accordingly. Where it is not possible to estimate the recoverable amount of an individual asset, the impairment test is carried out on the smallest group of assets to which it belongs for which there are separately identifiable cash flows; its cash generating units (“CGUs”). Goodwill is allocated on initial recognition to each of the Group’s CGUs that are expected to benefit from a business combination that gives rise to the goodwill. The Group has one CGU. This CGU represents the lowest level at which goodwill is monitored by the Group and the lowest level at which management captures information for internal management reporting purposes about the benefits of the goodwill. Impairment charges are included in profit or loss, except to the extent they reverse gains previously recognised in other comprehensive income. An impairment loss recognised for goodwill is not reversed. Cash and Cash Equivalents For the purpose of presentation in the Statement of Financial Position and on the Statement of Cash Flows, cash and cash equivalents include cash on hand and on call deposits with financial institutions. Foreign Currency Transactions entered into by Group entities in a currency other than the currency of the primary economic environment in which they operate (their “functional currency”) are recorded at the rates ruling when the transactions occur. The functional currency of the Company is Euro. Foreign currency monetary assets and liabilities are translated at the rates ruling at the reporting date. Exchange differences arising on the retranslation of unsettled monetary assets and liabilities are recognised immediately in profit or loss. On consolidation, the results of overseas operations are translated into Euro at rates approximating to this ruling when the transactions took place. All assets and liabilities of overseas operations, including goodwill arising on the acquisition of those operations, are translated at the rate ruling at the reporting date. Exchange differences arising on translating the opening net assets at opening rate and the results of overseas operations at actual rate are recognised in other comprehensive income and accumulated in the foreign exchange reserve. Exchange differences recognised in profit or loss in Group entities’ separate financial statements on the translation of long-term items forming part of the Group’s net investment in the overseas operation concerned are classified to other comprehensive income and accumulated in the foreign exchange reserve on consolidation. On disposal of a foreign operation, the cumulative exchange differences recognised in the foreign exchange reserve relating to that operation up to the date of disposal are transferred to the consolidated statement of comprehensive income as part of the profit or loss on disposal. Annual Report and Accounts 2018 69 Notes Forming Part of the Consolidated and Company Financial Statements continued 2 Significant Accounting Policies continued Revenue from Contracts with Customers Contracts are typically for services, performing agreed-upon tasks for a customer and can be time-and-materials or milestone based. Most contracts are short term in duration (generally less than one month), however milestone based contracts are typically long term and extend to many months (or over a year in many cases). Where there are multiple performance obligations outlined in a contract, each performance obligation is separately assessed, the transaction price is allocated to each obligation, and related revenues are recognised as services or assets are transferred to the customer. Revenue is derived from seven main service groupings: • Art Creation Services – Art creation services relate to the production of graphical art assets for inclusion in the video game including concept art creation along with 2D and 3D art asset production and animation. Contracts can be either time-and-materials based or milestone based, with performance obligations satisfied over time. Contracts are generally short term in duration, however for longer contracts the input method is used to measure progress. Time and materials based contract revenue is recognized as the related services are rendered. For milestone based contracts where progress can be measured reliably towards complete satisfaction of the performance obligation, revenue is recognised using the input method to measure progress. Where progress cannot be measured reliably, revenue is recognised on milestone acceptance. • Engineering – Engineering relates to software engineering services which are integrated with client processes to develop video games. Contracts can be either time-and-materials based or milestone based, with performance obligations satisfied over time. Contracts are generally long term in duration. Time and materials based contract revenue is recognised as the related services are rendered. For milestone based contracts where progress can be measured reliably towards complete satisfaction of the performance obligation, revenue is recognised using the input method to measure progress. Where progress cannot be measured reliably, revenue is recognised on milestone acceptance. • Audio / Voiceover Services – Audio Services relate to the audio production process for computer games and includes script translation, actor selection and talent management through pre-production, audio direction, recording, and post-production, including native language quality assurance of the recordings. Audio contracts may also involve music licencing or selling music soundtracks. Audio service contracts are typically milestone based, with performance obligations satisfied over time. Audio services contracts are generally short term in duration, however for longer contracts where progress towards complete satisfaction of the performance obligation can be measured reliably, revenue is recognised using the input method to measure progress. Where progress cannot be measured reliably, audio services revenue is recognised on milestone acceptance. Music licencing and music soundtracks performance obligations are assessed separately, and related revenue is recognised on licence inception and on delivery of the soundtracks, respectively. • Functional Testing – Functional Testing relates to quality assurance services provided to game producers to ensure games function as required. Contracts are typically time-and-materials based and performance obligations are satisfied over time. Contracts are generally short term in duration, however for longer contracts the input method is used to measure progress. Revenue is recognised as the related services are rendered. • Localization Services – Localization services relate to translation and cultural adaptation of in-game text and audio scripts across multiple game platforms and genres. Contracts are typically time-and-materials based and performance obligations are satisfied over time. Contracts are generally short term in duration, however for longer contracts the input method is used to measure progress. Localization contracts may also involve licencing translation software as a service. Such revenue is assessed separately. Revenue is recognised as the related services are rendered. • Localization Testing – Localization Testing involves testing the linguistic correctness and cultural acceptability of computer games. Contracts are typically time-and-materials based and performance obligations are satisfied over time. Contracts are generally short term in duration, however for longer contracts the input method is used to measure progress. Revenue is recognised as the related services are rendered. • Player Support – Player support relates to the live operations support services such as community management, player support and associated services provided to producers of games to ensure that consumers have a positive user experience. Contracts are typically time-and-materials based and performance obligations are satisfied over time. Contracts are generally long term with the input method used to measure progress. Revenue is recognised as the related services are rendered. Due to the nature of the services provided and the competitive nature of the market, contracts generally allocate specific transaction prices to separate performance obligations. Individual services or individual milestones generally involve extensive commercial negotiation to arrive the specific agreed-upon tasks, and the related pricing outlined in the contract. Such negotiations extend further for milestone based contracts to also include the criteria involved in the periodic and regular process of milestone acceptance by the customer. Such criteria may involve qualitative, as well as quantitative measures and judgements. In measuring progress towards complete satisfaction of performance obligations, the input method is considered to be the most appropriate method to depict the underlying nature of the contracts with customers, the interactive way the service is delivered and projects are managed with the customer. For time-and-materials contracts, other than tracking and valuing time expended, significant judgement is not normally involved. For milestone based contracts, progress is generally measured based on the proportion of contract costs incurred at the balance sheet date, (e.g. worked days) relative to the total estimated costs of the contract, involving estimates of the cost to completion etc. Added to this significant judgement can be involved in measuring progress towards customer acceptance of the milestone. Significant judgement may also be involved where circumstances arise that may change the original estimates of revenues, costs or extent of progress towards complete satisfaction of the performance obligations. In such circumstances estimates are revised. These revisions may result in increases or decreases in revenue or costs and are reflected in income in the period in which the circumstances that give rise to the revision became known. When the outcome of a contract cannot be measured reliably, contract revenue is recognised only to the extent that milestone have been accepted by the customer. Contract costs are recognised as incurred. When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised immediately. Revenue recognised represents the consideration received or receivable, net of sales taxes, rebates discounts and after eliminating intercompany sales. Revenue is recognised only where it is probable that consideration will be received. Where consideration is received and the related revenue has not been recognised, the consideration received is recognised as a contract liability (Deferred Revenue), until either revenue is recognised or the consideration is refunded. 70 Keywords Studios plc Financial Statements 2 Significant Accounting Policies continued Multimedia Tax Credits / Video Game Tax Credits The multimedia tax credits (“MMTC”) received in Montreal and video games tax credits (“VGTC”) in the UK, are a credit related to staff costs. Accordingly, they are treated as a deduction against direct costs. The nature of the grants is such that they are not dependent on taxable profits. Tax credits have only been recognised where management believe that a tax credit will be recoverable based on their experience and the success of similar historical claims. Share-based Payments The Company issues equity settled share-based payments to certain employees and Directors under a share options plan and a Long-Term Incentive Plan (“LTIP”). The fair value determined at the grant date is expensed on a straight-line basis over the vesting period, based on the Company’s estimate of shares that will eventually vest and adjusted for the effect of non-market-based vesting conditions. At each reporting date, the Company revises its estimate of the number of equity instruments expected to vest as a result of the effect of non-market-based vesting conditions. The impact of the revision of the original estimates, if any, is recognised in profit or loss such that the cumulative expense reflects the revised estimate, with a corresponding adjustment to equity reserves. The Company has no legal or constructive obligation to repurchase or settle the options in cash. Where share-based payments are issued to employees of subsidiary companies, the annual cost of the option is expensed in the holding company and recharged to the subsidiary company through an inter-company charge. Share Option Plan These are measured at fair value, taking into account market vesting conditions but not non-market vesting conditions on the grant date using a Black-Scholes option pricing model which calculates the fair value of an option by using the vesting period, the expected volatility of the share price, the current share price, the exercise price and the risk-free interest rate. The fair value of the option is amortised over the vesting period, with one-third of the options vesting after two years, one-third after three years, and the balance vest after four years. The only vesting condition is continuous service. There is no requirement to revalue the option at any subsequent date. The charge that is recognised is adjusted to reflect failure to vest due to non-achievement of a non-market vesting condition, but not failure to vest due to the non-achievement of a market vesting condition. LTIP An alternative share plan was introduced to give awards to Directors and staff, subject to outperforming the Numis Small Cap Index (excluding Investment Trusts) in terms of shareholder return over a three-year period. For the awards up to 2015, there were three award levels: one-third of the share options vest if the Company shall exceed the Total Shareholder Returns of the Numis Small Cap Index by not less than 10%, two-thirds if the shareholder return exceeds by over 20% and 100% if the shareholder return exceeds by over 30%. This was amended for the 2016 and 2017 awards to 100% if the shareholder return exceeds by over 45%, and a pro-rated return between 10% and 100% if the shareholder return exceeds by between 0% and 45%. These are measured at fair value, taking into account market vesting conditions but not non-market vesting conditions, at the date of grant, measured by using the Monte Carlo binomial model. The charge that is recognised is adjusted to reflect failure to vest due to non-achievement of a non-market vesting condition, but not failure to vest due to the non-achievement of a market vesting condition. Dividend Distribution Final dividends are recorded in the Group’s financial statements in the period in which they are approved by the Group’s shareholders. Interim dividends are recognised when paid. Income Taxes and Deferred Taxation Provision for income taxes is calculated in accordance with the tax legislations and applicable tax rates in force at the reporting date in the countries in which the Group companies have been incorporated. Deferred tax assets and liabilities are recognised where the carrying amount of an asset or liability in the consolidated statement of financial position differs from its tax base, except for differences arising on: • The initial recognition of goodwill; • The initial recognition of an asset or liability in a transaction which is not a business combination and at the time of the transaction affects • neither accounting or taxable profit; and Investments in subsidiaries and jointly controlled entities where the Group is able to control the timing of the reversal of the difference and it is probable that the difference will not reverse in the foreseeable future. The amount of the asset or liability is determined using tax rates that have been enacted or substantively enacted by the reporting date and are expected to apply when the deferred tax liabilities / (assets) are settled / (recovered). Deferred tax assets and liabilities are offset when the Group has a legally enforceable right to offset current tax assets and liabilities and the deferred tax assets and liabilities relate to taxes levied by the same tax authority on either: • The same taxable Group company; or • Different Group entities which intend either to settle current tax assets and liabilities on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in which significant amounts of deferred tax assets or liabilities are expected to be settled or recovered. Annual Report and Accounts 2018 71 Notes Forming Part of the Consolidated and Company Financial Statements continued 2 Significant Accounting Policies continued Property, Plant and Equipment Property, plant and equipment comprise computers, leasehold improvements, and office furniture and equipment, and are stated at cost less accumulated depreciation. Carrying amounts are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Where the carrying amount of an asset is greater than its estimated recoverable amount, it is written down immediately to its recoverable amount. Property, plant and equipment acquired through business combinations are valued at fair value on the date of acquisition. Depreciation is calculated to write off the cost of fixed assets on a straight-line basis over the expected useful lives of the assets concerned. The principal annual rates used for this purpose are: Computers and software Office furniture and equipment Building and leasehold improvements % 33.33 10.00 over the length of the lease Gains and losses on disposals are determined by comparing proceeds with carrying amount and are included in the consolidated statement of comprehensive income. Financial Assets The Group’s most significant financial assets comprise trade and other receivables and cash and cash equivalents in the statement of financial position, whereas the Company’s most significant financial assets comprise inter-group receivables. Trade Receivables Trade receivables, which principally represent amounts due from customers, are recognised at amortised cost as they meet the IFRS 9 classification test of being held to collect, and the cash flow characteristics represent solely payments of principal and interest. The Group’s impairment methodology has been revised in line with the requirements of IFRS 9. The simplified approach to providing for expected credit losses has been applied to trade receivables, which requires the use of a lifetime expected loss provision. As part of the IFRS 9 transition project, the Group assessed its existing trade and other receivables for impairment, using reasonable and supportable forward looking information that is available without undue cost or effort, to determine the credit risk of the receivables at the date on which they were initially recognised and compared that to the credit risk as at 1 January 2018. This assessment has not resulted in a material adjustment to trade and other receivables. Trade receivables are written-off when there is no reasonable expectation of recovery, such as a debtor failing to engage in a repayment plan with the company. There has been no significant change to the carrying value of trade and other receivables as a result of the implementation of IFRS 9. Previous accounting policy for impairment of trade and other receivables In the prior year, the impairment of trade receivables was assessed based on the incurred loss model. Individual receivables which were known to be uncollectible were written off by reducing the carrying amount directly. An estimate for doubtful debts was made when there was objective evidence that the Group would not be able to collect amounts due according to the original terms of receivables. Bad debts were written off when identified. Intercompany Receivables Intercompany receivables are recognised at amortised cost as they meet the IFRS 9 classification test of being held to collect, and the cash flow characteristics represent solely payments of principal and interest. The Group applies the general approach to applying the expected credit losses to its related party loans. Under the General Approach, at each reporting date, the Group determines whether there has been a Significant Increase in Credit Risk (SICR) since initial recognition and whether the loan is credit impaired. This determines the amount of expected credit losses to be recognised. There has been no significant change to the carrying value of intercompany receivables upon the implementation of IFRS 9. Previous accounting policy for intercompany receivables In the prior year, the impairment of intercompany receivables was based upon the incurred losses model, whereby impairment losses were recognised when there was objective evidence that the Group would not be able to collect amounts due to the original terms. Cash and cash equivalents Cash and cash equivalents are necessary for the working capital requirements of the Group. They include cash in hand, deposits held at call with banks and other short-term highly liquid investments. Where cash is on deposit with maturity dates greater than three months, it is disclosed as short-term investments. 72 Keywords Studios plc Financial Statements 2 Significant Accounting Policies continued Contract Assets Contract assets arising from Revenue from Contracts with Customers are recognised in accordance with our Revenue Recognition policy, as discussed separately in this note. The Group applies the simplified approach to assessing expected credit losses in relation to contract assets, as the maturities of such assets are less than 12 months. Based upon the recoverability of contract assets subsequent to the year end, no significant expected credit loss provision has been applied. Share Capital Financial instruments issued by the Group are treated as equity only to the extent that they do not meet the definition of a financial liability. The Group’s ordinary shares are classified as equity instruments. Financial Liabilities Trade payables, bank borrowings and other short-term monetary liabilities are initially recognised at fair value and subsequently carried at amortised cost using the effective interest method. Leased Assets Where substantially all of the risks and rewards of ownership are not transferred to the Group (“operating lease”), the total rental payables are charged to the consolidated statement of comprehensive income on a straight-line basis over the term of the lease. Finance Leases Where substantially all of the risks and rewards incidental to ownership of a leased asset have been transferred to the Group (a “finance lease”), the asset is treated as if it had been purchased outright. The amount initially recognised as an asset is the lower of the fair value of the leased property and the present value of the minimum lease payments payable over the term of the lease. The corresponding lease commitment is shown as a liability. Lease payments are analysed between capital and interest. The interest element is charged to the consolidated statement of comprehensive income over the period of the lease and is calculated so that it represents a constant proportion of the lease liability. The capital element reduces the balance owed to the lessor. Employee Benefit Trust Ordinary shares purchased by the Employee Benefit Trust on behalf of the parent company under the Terms of the Share Option Plan are deducted from equity on the face of the Consolidated Statement of Financial Position. No gain or loss is recognised in relation to the purchase, sale, issue or cancellation of the parent company’s ordinary shares. 3 Critical Accounting Estimates and Judgements The Group makes certain estimates and assumptions regarding the future. Estimates and judgements are continually evaluated based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. In the future, actual experience may differ from these estimates and assumptions. Judgements The judgements, apart from those involving estimations, that management have made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognised in the financial statement, are outlined below. • Functional Currency: The directors have considered the requirements of IAS 21 in determining the currency that most faithfully represents the economic effects of the underlying transactions, events and conditions to determine the Group’s functional currency. Detailed consideration has been given to both the Primary and Secondary Indicators in forming this conclusion. The Primary Indicators relate to revenues, regulation, competitive forces and costs, while the Secondary Indicators are primarily concerned with financing the business and the currency in which receipts from operating activities are usually retained. With a mix of currencies dominating the indicators, there is no clear single currency that influences the Group, however the EUR remains marginally the most dominant when all factors are considered. Therefore the directors consider the EUR as the currency that most faithfully represents the economic effects of the underlying transactions, events and conditions. • Business Combinations: When acquiring a business, the Group is required to identify and recognise intangible assets, the determination of which requires a significant degree of judgement. Acquisitions may also result in intangible benefits being brought into the Group, some of which qualify for recognition as intangible assets while other such benefits do not meet the recognition requirements of IFRS and therefore form part of goodwill. Customer relationships are recognised as separate assets where revenues are recurring in nature and material revenues have been generated with the customer for a continuous period of 3 years. For the Engineering service line, the key asset acquired is typically “know-how”, an asset that is not readily measurable and thus intrinsically linked to goodwill. Relationships are typically short term contract based rather than relationship based. Therefore neither customer contracts or customer relationships are typically recognised on the acquisition of an Engineering business. • Expected Credit Loss Provision on Company Receivables From Subsidiaries: As outlined in note 22, the Company has significant receivables from subsidiaries primarily related to investments in acquisitions. The Directors have assessed that they view a significant increase in credit risk to exist if there is evidence that a loan is 30 days past due its recoverable date, or if there is external or internal indicators that the subsidiary will not be in a position to repay its loan balances as it falls due. Similarly, the Group will conclude that a loan is in default if the scheduled repayments of either principal or interest are not being met. The Directors have assessed that loans due from subsidiaries of €175.5m (within Stage 1 of the IFRS 9 impairment assessment model), are within their repayment terms, and no significant increase in credit risk is noted. Furthermore having assessed the ongoing expected recovery strategy of these loans, the Directors have concluded that no material provision for expected credit losses is required. Separately the Company has balances of €1.6m, which are technically repayable upon demand. These loans are within Stage 3 of the IFRS 9 impairment assessment model. The Directors have reviewed in detail the recovery strategy in relation to these loans and have concluded that the majority of these loans will be recoverable Annual Report and Accounts 2018 73 Notes Forming Part of the Consolidated and Company Financial Statements continued 3 Critical Accounting Estimates and Judgements continued Judgements continued and therefore there is no material expected credit loss provision required. A small number of such loans are technically in a credit-impaired status. An expected credit loss of €183k (2017: nil) has been recognised in relation to these balances. Following on the rapid expansion of the Group, the Directors have commenced a re-structuring program with a view to optimising the Group structure, facilitate tax efficient repatriation of cash and re-payment of loans throughout the Group. The Directors have taken into account both the re-structuring program and the cash generating capacity of the Group, in concluding that all such loans are recoverable and the expected credit loss provisions are adequate. Estimates and assumptions The estimates and assumptions that could have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are monitored by the Directors on an ongoing basis. A number of areas requiring the use of estimates and critical judgements impact the Group’s earnings and financial position. These include revenue recognition, the computation of income taxes, the value of goodwill and intangible assets arising on acquisitions, the valuation of multimedia tax credits / video game tax credits and the valuation of defined retirement benefits. The Directors consider that no reasonably possible changes to any of the assumptions used in the estimates would in the view of the Directors give rise to significant risk of a material adjustment to the carrying value of the associated balances in the subsequent financial year. While a number of these areas were highlighted in the 2017 Annual Report, because the Directors consider that no reasonably possible changes to any of the assumptions used in the estimates would give rise to significant risk of a material adjustment, these items have been removed from the Critical Accounting Estimates and Judgements. 4 Revenue From Contracts With Customers and Segmental Analysis Revenue From Contracts With Customers Revenue recognised in the reporting period arises from contracts with customers, and is predominantly recognised over time. There were no significant amounts of revenue recognised in the reporting period that were included in a contract liability balance at the beginning of the reporting period, or from performance obligations satisfied in the previous reporting period. Revenue by line of business Engineering Art creation Audio Functional testing Localization Localization testing Player support 2018 €’000 2017 €’000 26,161 41,688 34,190 49,128 43,983 19,751 35,904 3,572 26,193 20,657 30,033 41,959 19,848 9,168 250,805 151,430 Analysis by geographical regions is made according to the Group’s operational jurisdictions. For many contracts, operations are completed in multiple sites. Revenue is associated with the jurisdiction from which the final invoice to the client is raised. This does not reflect the region of the Group’s customers; whose locations are worldwide. Canada Ireland Switzerland Italy India United States Japan United Kingdom Spain China Singapore Germany Brazil Mexico France Russia Poland Philippines Taiwan No single customer accounted for more than 10% (2017: None) of the Group’s revenue during the year. 74 Keywords Studios plc 2018 €’000 69,536 47,203 20,067 8,673 2,407 52,321 7,724 21,205 1,968 3,126 5,046 741 1,016 936 8,489 – 347 – – 2017 €’000 45,648 34,277 19,565 10,029 5,177 12,199 6,352 2,467 2,194 3,685 4,451 928 520 180 3,758 – – – – 250,805 151,430 Financial Statements 4 Revenue From Contracts With Customers and Segmental Analysis continued For all service lines excluding Engineering, contracts do not extend to more than one year, therefore we do not disclose information concerning unsatisfied performance obligations, as allowed under the practical expedient exemption under IFRS 15. This practical expedient is also availed of for Engineering contracts of less than one year in duration. For Engineering contracts that extend beyond one year the aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) as of the end of the reporting period is as follows: Value of undelivered performance obligations for contracts greater than one year At 31 December 2018 At 31 December 2017 Total undelivered €’000 10,417 – Scheduled completion within 1 year €’000 9,112 – Scheduled completion 1-2 years €’000 1,305 – The balances arise primarily in new acquisitions during 2018. There were no significant undelivered performance obligations for contracts greater than one year in 2017. Segmental Analysis Management considers that the Group’s activity as a single source supplier of Services to the gaming industry constitutes one operating and reporting segment, as defined under IFRS 8. Management review the performance of the Group by reference to Group-wide profit measures and the revenues derived from seven main service groupings. There is no allocation of operating expenses, profit measures, assets and liabilities to individual product groupings. Accordingly, the disclosures above are provided on a Group-wide basis. Activities are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker. The chief operating decision-maker has been identified as the executive management team made up of the Chief Executive Officer and the Finance Director. Geographical Analysis of Non-Current Assets from Continuing Businesses Canada Ireland Switzerland Italy India United States Japan United Kingdom Spain China Singapore Germany Brazil Mexico France Russia Poland Philippines Taiwan Geographical Analysis of Non-current Assets from Continuing Businesses Investment in associate Deferred tax assets Non-current assets 2018 €’000 11,760 3,542 11,117 11,650 2,321 84,685 796 48,929 1,535 7,850 52 1,097 888 885 6,318 797 267 595 4 2017 Restated (note 31) €’000 8,889 119 11,158 11,723 2,588 77,177 565 10,011 1,520 7,707 42 1,168 231 892 6,531 866 58 472 4 195,088 141,721 195,088 160 2,967 198,215 141,721 – 1,206 142,927 Annual Report and Accounts 2018 75 Notes Forming Part of the Consolidated and Company Financial Statements continued 5 Cost of Sales and Operating Profit Cost of sales Operating expenses * Multimedia tax credits / video game tax credits Other direct costs 2018 €’000 163,112 (12,220) 4,105 154,997 2017 €’000 98,850 (4,408) 1,903 96,345 * Please note the comparative has been re-classified to be consistent with current year presentation, as the Directors have determined this presentation to be more meaningful. Operating profit is stated after charging: Depreciation Amortisation of intangible assets Costs of acquisitions & integration Operating lease payments Costs of acquisitions & integration Post-acquisition integrations costs re: 2018 acquisitions (note 28) Post-acquisition integrations costs re: 2017 acquisitions (note 29) Fair value adjustments to contingent consideration Deferred consideration related to continuing employment Acquisition related and other borrowing costs Acquisition team and related costs Auditors’ remuneration Audit services Parent company and Group audit Subsidiary companies audit Non-audit services Acquisition related due diligence services Audit related assurance services Taxation compliance 6 Financing Income and Cost Finance income Interest received Foreign exchange gain Finance cost Bank charges Interest expense Unwinding of discounted liabilities * Foreign exchange loss Net financing income / (cost) 2018 €’000 5,316 6,872 5,296 8,708 2018 €’000 758 1,875 766 590 693 614 5,296 2018 €’000 329 137 – 16 7 489 2018 €’000 – 791 791 (503) (502) (311) – (1,316) (525) 2017 €’000 2,730 3,038 3,016 2,369 2017 €’000 – 2,336 – – – 680 3,016 2017 €’000 164 99 242 – 73 578 2017 Restated €’000 26 – 26 (320) (312) (266) (3,569) (4,467) (4,441) * Please note the comparative has been restated to separate “Unwinding of discounted liabilities” from “Interest expense”, as the Directors have determined this presentation to be the more meaningful. 76 Keywords Studios plc Financial Statements 7 Taxation Current income tax Income tax on profits of parent company Income tax on profits of subsidiaries Deferred tax (note 26) The tax charge for the year can be reconciled to accounting profit as follows: Profit before tax Tax charge based on the Effective Tax Rate* Corporate tax prior year (over) / under provision Deferred tax prior year (over) / under provision and impact of change in tax rates Items disallowed for tax purposes Exempt and non taxable income Tax incentives Current year tax losses utilised Current year tax losses where deferred tax has not been provided State and other direct taxes Other differences – net Total tax charge 2018 €’000 – 9,592 (2,401) 7,191 2018 €’000 22,094 5,345 (352) (368) 2,205 (588) (1,035) (131) 730 1,529 (144) 7,191 2017 Restated €’000 – 5,762 (1,031) 4,731 2017 Restated €’000 11,994 3,175 62 (55) 717 (259) (222) (40) 631 758 (36) 4,731 * Effective tax rate – being the statutory tax rate relative to the profit before tax in each jurisdiction 24.2% 26.5% Please note the reconciliation of Profit before tax to the Total tax charge for 2017 has been restated to present the note with reference to the effective tax rate, whereas in the 2017 financial statements the note was presented with reference to the UK tax rate, as the Directors have determined this presentation to be more meaningful. The Group’s subsidiaries are located in different jurisdictions and are taxed on their residual profit in those jurisdictions. The effective tax rate will vary year-on-year due to the effect of changes in tax rates and changes in the proportion of profits in each jurisdiction. Tax effects relating to each component on other comprehensive income Exchange gain / (loss) in net investments foreign operations Tax (expense) / benefit Net of tax amount Actuarial gain / (loss) on defined benefit plans Tax (expense) / benefit Net of tax amount Exchange gain / (loss) on translation of foreign operations Tax (expense) / benefit Net of tax amount 2018 €’000 1,270 – 1,270 27 6 33 771 – 771 2017 €’000 (893) – (893) (25) 7 (18) (3,598) – (3,598) Annual Report and Accounts 2018 77 Notes Forming Part of the Consolidated and Company Financial Statements continued 8 Earnings per Share Basic Diluted Profit for the period from continuing operations Denominator (weighted average number of equity shares) Basic* Diluting impact of share options Diluted* * Includes (weighted average) shares to be issued (note 16) 2018 € cent 23.16 22.24 €’000 14,903 2017 € cent 12.37 11.87 €’000 7,263 Number Number 64,335,162 2,679,932 58,720,884 2,477,788 67,015,094 61,198,672 1,321,707 2,174,526 Contingently issuable Ordinary Shares are excluded from the computation of diluted earnings per Ordinary Share where the conditions governing exercisability have not been satisfied: LTIPs Share options 2018 Number 951,800 544,900 1,496,700 2017 Number – – – Details of the number of share options outstanding at the year-end are set out in note 17. 9 Dividends Dividends paid Final Interim Dividends paid to shareholders 2017 Final Interim Dividends paid to shareholders 2018 Recommended Final In respect of 2016 2017 Approval date Apr-17 Sep-17 2017 2018 Apr-18 Sep-18 € Cent per share Pence STG £ per share 1.01 0.54 1.55 1.11 0.60 1.71 0.89 0.48 1.37 0.98 0.53 1.51 Total dividend €’000 563 304 867 696 384 1,080 Payment date Jun-17 Oct-17 Jun-18 Oct-18 In respect of 2018 Approval date Expected € cent per share Pence STG £ per share Expected total dividend €’000 Expected payment date 1.21 1.08 774 Jun-19 There are no income tax consequences for the Company in respect of the dividends proposed prior to issuance of the Consolidated Financial Statements and for which a liability has not been recognised. The Group does not recognise deferred tax on unremitted retained earnings as in general retained earnings are continually re-invested by the Group and dividends are only remitted where there are minimal tax consequences. At 31 December 2018 Retained Earnings available for distribution (being retained earnings plus share option reserve) in the Company were €4.1m (2017: €2.2m). The Directors do not foresee any impediment in continuing to implement the dividend policy of the Group. Following on distributions made in 2016 and 2017 that were not fully in compliance with the Companies Act 2006, the Directors have implemented legal advice to ensure ongoing compliance and rectify the oversights in earlier periods. 78 Keywords Studios plc Financial Statements 10 Staff Costs Total staff costs (including Directors) comprise the following: Salaries & related costs Share based payment costs Key management compensation: Salaries & related costs Social welfare costs Pension costs Share based payment costs 2018 €’000 146,785 4,129 150,914 2018 €’000 907 99 27 501 1,534 2017 €’000 81,563 1,426 82,989 2017 €’000 690 79 4 141 914 The key management compensation includes compensation to seven Directors of Keywords Studios PLC during the year (2017: seven). Group Average number of employees Operations General & administration Company Average number of employees Operations General & administration 2018 2017 4,733 505 5,238 2,921 246 3,167 2018 2017 – 13 13 – 8 8 Annual Report and Accounts 2018 79 Notes Forming Part of the Consolidated and Company Financial Statements continued 11 Goodwill At 1 January 2017 Recognition on acquisition of subsidiaries (note 29) Exchange rate movement At 31 December 2017 as reported Measurement period adjustment on Sperasoft goodwill (note 31) At 31 December 2017 restated Recognition on acquisition of subsidiaries (note 28) Exchange rate movement At 31 December 2018 €’000 46,799 66,853 (4,645) 109,007 (945) 108,062 43,144 2,996 154,202 The Group assesses the carrying value of goodwill each year on the basis of budget projections for the coming year extrapolated using a one to five year growth rate and a terminal value calculated using a long term growth rate projection. The discount rates used of 12.5% (2017: 12.5%) is based on the Board’s assessment of the WACC of the Group. The WACC assessment is supported by an annual independently calculated report, using the Capital Asset Pricing Model. However, the Board have excluded the impact of short term market volatility on these calculations in determining the Group WACC. Key Assumptions 1-5 year growth rate assumption Long term growth rate assumption Value in use (€m) Carrying value – goodwill (€m) Actual Sensitivity Analysis 2018 10% 2% 445 154 2017 10% 2% 371 108 2018 15% 2% 532 2017 15% 2% 399 2018 5% 2% 378 2017 5% 2% 284 The value in use calculations were consistently calculated year over year, with no significant changes in the assumptions made. The result of the value in use calculations was that no impairment is required in this period. 12 Intangible Assets Cost At 1 January 2017 Recognition on acquisition of subsidiaries Exchange rate movement At 31 December 2017 Recognition on acquisition of subsidiaries Additions Exchange rate movement At 31 December 2018 Amortisation At 1 January 2017 Amortisation charge Exchange rate movement At 31 December 2017 Amortisation charge Exchange rate movement At 31 December 2018 Net book value At 31 December 2017 At 31 December 2018 Customer relationships €’000 Intellectual property €’000 Music licences €’000 11,630 18,962 (1,310) 29,282 6,564 – 867 36,713 2,934 3,038 (238) 5,734 6,758 179 12,671 23,548 24,042 – – – – – 1,521 – 1,521 – – – – – – – – 1,521 – – – – 362 78 (4) 436 – – – – 114 1 115 – 321 Total €’000 11,630 18,962 (1,310) 29,282 6,926 1,599 863 38,670 2,934 3,038 (238) 5,734 6,872 180 12,786 23,548 25,884 Customer relationships, intellectual property and music licences are amortised on a straight-line basis over five years. Customer-relationships and music licence amortisation commences on acquisition, whereas intellectual property amortisation commences when the product is launched. 80 Keywords Studios plc Financial Statements 13 Property, Plant and Equipment Group Cost At 1 January 2017 Currency revaluation Additions Acquisitions through business combinations at fair value Disposals At 31 December 2017 Currency revaluation Additions Acquisitions through business combinations at fair value Disposals At 31 December 2018 Accumulated depreciation At 1 January 2017 Currency revaluation Depreciation charge Disposals At 31 December 2017 Currency revaluation Depreciation charge Disposals At 31 December 2018 Net book value At 31 December 2017 At 31 December 2018 Company Cost At 1 January 2017 Additions At 31 December 2017 Currency revaluation Additions At 31 December 2018 Accumulated depreciation At 1 January 2017 Depreciation charge At 31 December 2017 Depreciation charge At 31 December 2018 Net book value At 31 December 2017 At 31 December 2018 Computers and software €’000 Office furniture and equipment €’000 Leasehold improvements €’000 8,485 (685) 2,514 2,214 (54) 12,474 (114) 6,248 362 (645) 18,325 5,756 (293) 1,795 (6) 7,252 (51) 3,805 (645) 10,361 5,222 7,964 3,158 (216) 772 603 (1) 4,316 (15) 1,082 272 (248) 5,407 1,790 (111) 543 – 2,222 11 643 (185) 2,691 2,094 2,716 Total €’000 13,367 (1,123) 3,887 4,167 (84) 20,214 (102) 9,440 966 (982) 29,536 7,869 (476) 2,730 (20) 10,103 34 5,316 (919) 1,724 (222) 601 1,350 (29) 3,424 27 2,110 332 (89) 5,804 323 (72) 392 (14) 629 74 868 (89) 1,482 14,534 2,795 4,322 10,111 15,002 Computers and software €’000 Office furniture and equipment €’000 Leasehold improvements €’000 2 – 2 – 2 4 – 1 1 1 2 1 2 – – – – 145 145 – – – 8 8 – 137 – – – – 268 268 – – – 18 18 – 250 Total €’000 2 – 2 – 415 417 – 1 1 27 28 1 389 Annual Report and Accounts 2018 81 Notes Forming Part of the Consolidated and Company Financial Statements continued 14 Trade Receivables Group Trade receivables Provision for bad debts Financial asset held at amortised cost Trade receivables arise from revenues derived from contracts with customers. 15 Other Receivables Group Short Term* Accrued income from contracts with customers Prepayments & rent deposits Other receivables Multimedia tax credits / video games tax credits Tax and social security Company Short Term Intercompany receivables (financial assets held at amortised cost) Prepayments Other receivables Company Long Term Intercompany receivables (financial assets held at amortised cost) 2018 €’000 38,736 (1,717) 37,019 2017 €’000 27,891 (418) 27,473 2018 €’000 6,317 2,490 2,459 10,820 1,373 23,459 2018 €’000 1,600 109 28 1,737 2018 €’000 175,509 175,509 2017 €’000 5,140 4,179 2,524 10,016 476 22,335 2017 €’000 129,056 45 52 129,153 2017 €’000 3,300 3,300 * Please note the comparative Group Short Term, “Other Receivables” has been re-classified to be consistent with the current year presentation. Accrued income from contracts with customers, represent mainly contract assets in process and related items. The movement in the year is comprised of transfers in and out as items are accrued and subsequently invoiced to customers, with no significant amounts written off or impaired in the period. 82 Keywords Studios plc Financial Statements 16 Shareholders’ Equity Share Capital At 1 January 2017 54,428,882 2,889,707 654 19,983 22,109 8,792 Per share € Number of ordinary £0.01 shares Date Number of ordinary £0.01 shares to be issued Share capital €’000 Share premium €’000 Merger reserve €’000 Shares to be issued €’000 Shares issued on the first anniversary of the acquisition of Synthesis Shares issued on acquisition of Xloc Shares issued on acquisition of Gamesim Shares to be issued on acquisition of Red Hot Shares issued on acquisition of Asrec Shares to be issued on acquisition of Around the Word Shares issued on acquisition of d3t Shares to be issued on acquisition of Sperasoft Shares issued on acquisition of Lola Acquisition related issuance of shares Reclassification of share premium on acquisitions 13-Apr 10-May 17-May 22-May 04-Aug 04-Aug 19-Oct 13-Dec 15-Dec Placing of shares on the market Issue of shares on exercise of share options 24-Oct At 31 December 2017 Measurement period adjustment (note 31) At 31 December 2017 Restated Shares to be issued on acquisition of Cord & Laced Shares issued on the second anniversary of the 9.40 9.47 9.20 9.12 13.12 12.07 14.46 14.26 16.56 15.62 1.23 14.26 1,188,253 19,134 151,725 – 9,534 (1,188,253) – – 160,842 – – 42,368 – 10,106 66,262 – 252,248 – 1,421,120 (708,901) – 5,357,143 501,060 – – – 61,708,205 – 2,180,806 (8,806) 14 – 2 – – – – – – 16 – 61 6 – – – – – – – – – – 3,440 184 1,392 – 101 – 686 – 168 (3,454) – – 1,468 – 800 – 4,133 – 5,971 2,947 (798) 82,261 608 798 – – – – – 737 102,054 28,878 11,739 (119) – – – 61,708,205 2,172,000 737 102,054 28,878 11,620 09-Apr 17.48 – 73,744 – acquisition of Synthesis 24-Apr 2.91 1,188,263 (1,188,263) 15 Shares issued on the second anniversary of the acquisition of Synthesis in lieu of deferred cash 24-Apr 19.39 51,562 – Shares to be issued on acquisition of Fire Without Smoke 01-May 20.12 – 77,006 Shares issued on the second anniversary of the acquisition of Mindwalk Shares to be issued on acquisition of Blindlight Shares to be issued on acquisition of Snowed In Shares to be issued on acquisition of Studio 14-Jun 11-Jun 20-Jul 3.67 20.57 19.55 513,189 – – (513,189) 64,521 37,983 Gobo & Electric Square 20-Aug 19.74 Shares to be issued on acquisition of The TrailerFarm 18-Sep 21.33 Shares issued on the first anniversary of – – 254,529 11,070 Around the Word 01-Oct 12.07 66,262 (66,262) Acquisition related Issuance of shares 1,819,276 (1,248,861) Issue of shares on exercise of share options 0.67 260,805 – 1 – 6 – – – – 1 23 3 – – – – – – – – – – – – 1,289 3,440 (3,455) 999 – – 1,550 1,880 – – (1,886) 1,327 743 – – 5,024 236 799 (800) 7,118 4,028 171 – – At December 2018 63,788,286 923,139 763 102,225 35,996 15,648 There is no limit to the number of shares which the Company can issue, nor are there are any restrictions on dividends or distributions on such shares. Shares to be issued are valued at the share price at the date of acquisition, and are recorded as shares to be issued, in accordance with IAS 32.16. Shares held in the Employee Benefit Trust (“EBT”) Ordinary shares held in the EBT 2018 2017 Shares 335,425 €’000 1,997 Shares 335,425 €’000 1,997 Annual Report and Accounts 2018 83 Notes Forming Part of the Consolidated and Company Financial Statements continued 16 Shareholders’ Equity continued Reserves The following describes the nature and purpose of each reserve within owners’ equity: Reserve Description and purpose Retained earnings Cumulative net gains and losses recognised in the Consolidated Statement of Comprehensive Income. Foreign exchange reserve Gains or losses arising on retranslation of the net assets of the overseas operations into Euro. Share premium Share option reserve Shares to be issued The share premium account is the amount received for shares issued in excess of their nominal value, net of share issuance costs. The share option reserve is the credit arising on share-based payment charges in relation to the Company’s share option schemes. For deferred consideration which is to be provided for by the issue of a fixed number of shares at a future defined date, where there is no obligation on Keywords to offer a variable number of shares, the deferred consideration is classified as an Equity Arrangement and the value of the shares is fixed at the date of the acquisition. Merger reserve The merger reserve was initially created following the Group reconstruction, when Keywords Studios PLC acquired the Keywords International Limited Group of companies. When the Group uses Keywords Studios PLC shares as consideration for the acquisition of an entity, the value of the shares in excess of the nominal value (net of share issuance costs) is also recorded within this reserve, in line with S612 of the Companies Act 2006. 17 Share Options In July 2013, at the time of the IPO, the Company put in place a Share Option Scheme and a Long-Term Incentive Plan (“LTIP”). The charge in relation to these arrangements is shown below, with further details of the schemes following: Share option scheme expense LTIP option scheme expense 2018 €’000 646 3,483 4,129 2017 €’000 178 1,248 1,426 Of the total share option expense, €501k relates to Directors of the Company (2017: €141k). Share Option Scheme Share options are granted to Executive Directors and to permanent employees. The exercise price of the granted options is equal to the market price of the shares at the time of the award of the options. The Company has no legal or constructive obligation to repurchase or settle the options in cash. Movements in the number of share options outstanding and their related weighted average exercise prices are as follows: Outstanding at the beginning of the period Granted Lapsed Exercised Outstanding at the end of the period Exercisable at the end of the period Weighted average share price at date of exercise 2018 2017 Average exercise price in £ per share 2.79 17.10 13.24 1.93 7.11 1.47 17.68 Number of options 1,375,201 591,000 (65,246) (68,254) 1,832,701 706,524 Average exercise price in £ per share 2.79 7.76 3.56 1.35 2.79 1.30 12.32 Number of options 1,672,056 282,000 (30,000) (548,855) 1,375,201 515,296 84 Keywords Studios plc Financial Statements 17 Share Options continued Summary by share option arrangement Date of Option Exercise Price Outstanding at the beginning of the period Granted Lapsed Exercised Outstanding at the end of the period Exercisable at 31 December 2018 Exercisable 2019 Exercisable 2020 Exercisable 2021 Exercisable 2022 12-Jul-13 01-Jun-15 10-May-16 15-May-17 18-May-18 Total £1.20 £1.58 £2.54 £7.76 £17.10 285,311 – – (9,827) 275,484 275,484 – – – – 636,816 – (2,371) (29,412) 180,074 – (11,875) (29,015) 273,000 – (4,500) – – 591,000 (46,500) – 1,375,201 591,000 (65,246) (68,254) 605,033 139,184 268,500 544,500 1,832,701 403,988 201,045 – – – 27,052 56,066 56,066 – – – 89,500 89,500 89,500 – – – 181,500 181,500 181,500 706,524 346,611 327,066 271,000 181,500 The inputs into the Black-Scholes model, used to value the options are as follows: Date of Option 12-Jul-13 01-Jun-15 10-May-16 15-May-17 18-May-18 Total Weighted average share price (£) Weighted average exercise price (£) Fair value at measurement date (€) Average expected life Expected volatility Risk free rates Average expected dividends yield £1.23 £1.20 €0.81 3 Years 36.12% 0.50% 1.00% Weighted average remaining life of options in months – £1.64 £1.58 €0.56 3 Years 28.03% 0.90% 0.75% 2 £2.54 £2.54 €0.40 3 Years 27.17% 0.58% 0.55% 9 £7.74 £7.76 €1.13 3 Years 24.79% 0.16% 0.21% 17 £17.21 £17.10 €3.79 3 Years 35.87% 0.89% 0.10% 29 12 Expected volatility was determined by reference to KWS volatility. The expected life used in the model has been adjusted based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations. Long-term Incentive Plan Scheme An alternative share plan was introduced to give awards to Directors and staff subject to outperforming the Numis Small Cap (excluding Investment Trusts) index in terms of shareholder return over a three-year period. Movements in the number of share options outstanding and their related weighted average exercise prices are as follows: Summary by LTIP Arrangement Outstanding at the beginning of the period Granted Lapsed Exercised Outstanding at the end of the period Exercisable at the end of the period Weighted average share price at date of exercise 2018 2017 Average exercise price in £ per share 0.01 0.01 0.01 0.01 0.01 0.01 17.50 Number of options 1,976,416 996,000 (102,398) (192,551) 2,677,467 436,667 Average exercise price in £ per share 0.01 0.01 0.01 0.01 0.01 0.01 13.09 Number of options 1,443,691 696,000 (47,621) (115,654) 1,976,416 222,238 Annual Report and Accounts 2018 85 Notes Forming Part of the Consolidated and Company Financial Statements continued 17 Share Options continued Date of Option Exercise Price Outstanding at the beginning of the period Granted Lapsed Exercised 08-Jul-13 06-Jan-15 01-Jun-15 10-May-16 03-Oct-16 15-May-17 18-May-18 23-Jul-18 Total £0.01 £0.01 £0.01 £0.01 £0.01 £0.01 £0.01 £0.01 £0.01 222,238 – – – 101,060 – (11,198) (89,862) 317,118 – – (102,689) 610,000 – (15,000) – 30,000 – – – 696,000 – (32,000) – – 990,000 (44,200) – – 1,976,416 996,000 (102,398) (192,551) 6,000 – – Outstanding at the end of the period Exercisable at 31 December 2018 Exercisable 2019 Exercisable 2020 Exercisable 2021 222,238 222,238 – – – – – – – – 214,429 595,000 30,000 664,000 945,800 6,000 2,677,467 214,429 – – – – 595,000 – – – 30,000 – – – – 664,000 – – – – 945,800 – – – 6,000 436,667 625,000 664,000 951,800 Date of Option 08-Jul-13 06-Jan-15 01-Jun-15 10-May-16 03-Oct-16 15-May-17 18-May-18 23-Jul-18 Weighted average share price (£) Weighted average exercise price (£) Fair value at measurement date (€) Average expected life Expected volatility Risk free rates £1.23 £0.01 €0.62 3 Years 36.12% 0.50% £1.43 £0.01 €1.10 3 Years 31.20% 0.58% £1.64 £0.01 €1.40 3 Years 28.03% 0.90% £2.54 £0.01 €1.73 3 Years 27.17% 0.55% £4.15 £0.01 €2.06 3 Years 23.31% 0.08% £7.74 £0.01 €4.96 3 Years 24.79% 0.16% £17.21 £0.01 €11.82 3 Years 35.87% 0.89% £18.56 £0.01 €12.90 3 Years 35.87% 0.80% Weighted average remaining life of options in months – – – 4 9 17 29 31 15 08-Jul-13 06-Jan-15 01-Jun-15 10-May-16 03-Oct-16 15-May-17 18-May-18 23-Jul-18 Total LTIP’s vest on the third anniversary of the grant, if the performance criteria are met. LTIPs must be exercised before the seventh anniversary of the grant. The options were valued using a Monte Carlo binomial model using the following inputs: Expected volatility was determined by reference to KWS volatility. The expected life used in the model has been adjusted based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations. As any dividends earned are to be re-invested into the business the impact of dividends has been ignored in the calculation of the LTIP share option charge. 18 Other Payables Group Current Accrued expenses Payroll taxes Other payables (ii) Deferred and contingent consideration (i) Related party payable (note 22) Non-current Other payables Deferred and contingent consideration (i) 86 Keywords Studios plc 2018 €’000 16,671 2,338 3,890 18,249 5 41,153 5 1,057 1,062 2017 Restated (note 31) €’000 15,229 1,530 2,986 2,425 9 22,179 16 1,217 1,233 Financial Statements 18 Other Payables continued Company Current Intercompany payable Accrued expenses Payroll taxes Other payables Deferred and contingent consideration (i) Non-current Intercompany payable Deferred and contingent consideration (i) (i) The movement in deferred and contingent consideration during the financial year was as follows: Group Opening balance Consideration settled by cash Consideration settled by shares Unwinding of discount (note 6) Additional liabilities from current year acquisitions (notes 28, 29) Fair value adjustment (note 5) Translation adjustment Company Opening balance Consideration settled by shares Unwinding of discount 2018 €’000 4,572 784 66 13 – 5,435 568 – 568 2018 €’000 3,642 (1,603) (1,000) 311 17,068 766 122 19,306 2018 €’000 971 (1,000) 29 – 2017 €’000 174 382 – 51 971 1,578 – – – 2017 Restated (note 31) €’000 1,730 (298) – 266 1,885 – 59 3,642 2017 €’000 860 – 111 971 In general, in order for contingent consideration to become payable, pre-defined profit and / or revenue targets must be exceeded. The valuation of contingent consideration is derived using data from sources that are not widely available to the public and involves a degree of judgement (Level 3 input in the fair value hierarchy). On an undiscounted basis, the Group may be liable for deferred and contingent consideration ranging from €0.6m to a maximum of €20.3m. A 10% movement in expected performance results, has no impact on the fair value of the contingent consideration, and hence there are no reasonably probable changes to the assumptions and inputs (including the discount rate), that would lead to a material change to the fair value of the total amount payable. (ii) Other payables includes deferred income from contracts with customers of €312K (2017: €nil), which mainly comprise items invoiced prior to services being delivered. The movement in the year is comprised of transfers in and out as items are deferred and subsequently recognised as revenue. Annual Report and Accounts 2018 87 Notes Forming Part of the Consolidated and Company Financial Statements continued 19 Employee Defined Benefit Plans In line with statutory requirements in Italy and India we are required to maintain employee defined benefit termination payment schemes. In Italy, on leaving employment, each employee is entitled to 1/13.5 of their final salary for each year of service. In India, on retirement at age 60, each employee with over 5 years service is entitled to 15/26 of their last drawn monthly salary for each year of service. At year end, the Group commissioned an actuarial valuation of the related liability, based on salaries, length of service and variables including employee turnover, estimated salary increases and the cost of capital. The liabilities at year end are recorded as long term. The actuarial loss is recorded separately within other comprehensive income. The movements through the year are detailed: Group Opening liability Italy at 1 January Liability India recognised 1 January 2018 Service cost* Interest cost Benefits paid Actuarial (gain) / loss recorded Closing liability at 31 December 2018 €’000 1,055 188 247 32 (117) (27) 1,378 2017 €’000 826 – 199 11 (6) 25 1,055 * Please note the comparative has been restated to reflect the current year presentation as the Directors have determined this presentation to be more meaningful. The Directors have considered the key specific risk factors which the Group faces due to the employee defined benefit plans which are in place. Having fully considered all specific elements of these plans the Directors believe that the key issues faced are as follows: • The plan is currently 100% unfunded, there are no specific assets to meet the future liabilities as they fall due, as such there will be a cash flow impact as the liabilities must be met with current working capital as they fall due. The Group has taken no specific actions to mitigate against these factors as due to the long-term nature of the plans it is expected that there will be no sudden financial impact on the Group’s results caused by any of these factors. A maturity profile of the obligation is not presented as the liability is not significant in the context of the Group. In 2019, the Group expects the costs of the employee benefit plan to be in line with current year levels, as staff levels in the Italian operations stay stable. The actuarial valuation is based on the Projected Unit Credit Method, in line with IAS 19. Actuarial valuations Defined benefit obligations Future service liability Value of accrued benefits* 2018 €’000 1,378 3,214 4,592 2017 Restated €’000 1,055 2,977 4,032 * Please note the comparative has been restated to reflect the current year presentation as the Directors have determined this presentation to be more meaningful. Cost for year Service cost Interest cost Actuarial (gain) / loss Actuarial (gain) / loss Change due to experience Change due to demographical assumptions Change due to financial assumptions 88 Keywords Studios plc 247 32 (27) 252 2 (38) 9 (27) 199 11 25 235 17 30 (22) 25 Financial Statements 19 Employee Defined Benefit Plan continued Assumptions Underlying the Actuarial Valuations and Sensitivities of the Assumptions For the actuarial valuations the following demographic and economic and financial assumptions were applied. Demographic Assumptions in respect of Italy, representing 84% of the overall liability • The probabilities of death were derived from the population demographics by age and sex, as recorded by the relevant Government Statistics Offices and reduced by 25%, while other key inputs were taken from relevant life assurance statistics. • Certain inputs were estimated by management including - Employee attrition rates at 5.71% per annum. - Cash advances estimated on the basis of company history of 2.42% incidence of advance per annum and a drawdown rate equal to 57.25%. 2018 2017 Economic & Financial Assumptions Salary increase Inflation Discount rate Key Statistics Staff (number) Average age (years) Average service (years) Average defined benefit per staff (€) Average salary for defined benefit (€) Interest Rate Sensitivities -0.25% 0.25% Mortality Rate Sensitivities -0.025% 0.025% Staff Turn Over Rate Sensitivities -0.50% 0.50% Staff Salary Increases Rate Sensitivities -0.50% 0.50% 3.08% 2.18% 2.43% 558 31.5 3.4 2,301 8,647 1,456 1,308 1,379 1,378 1,389 1,369 1,370 1,390 2.76% 1.70% 1.54% 98 39.3 4.5 8,595 34,438 1,136 983 1,056 1,055 1,067 1,045 1,029 1,084 Annual Report and Accounts 2018 89 Notes Forming Part of the Consolidated and Company Financial Statements continued Capital Management, Loans and Borrowings 20 (i) Loans & Borrowings Group Expiry within 1 Year Expiry between 1 and 2 years Expiry over 2 years 2018 €’000 40,071 – 230 40,301 2017 €’000 18,943 31 306 19,280 In 2017, the Company had a facility in place with Barclays Bank which allowed financing of up to €25m of which €18.25m was drawn down at 31 December 2017. In 2018 the Company entered into a new Syndicated Bank revolving credit facility (‘RCF’), completely replacing the existing facility. This transaction has been accounted for as an extinguishment of a financial liability under IFRS 9, along with the recognition of a new liability with the new lenders. There was no significant difference between the carrying value of the financial liability at the time of extinguishment and the settlement value of the loan. The RCF allows financing of up to €75 million, with an option to increase this by €30m to a total of €105 million. The RCF extends to June 2021, with an option to extend this maturity date by a further 2 years. As part of the facilities agreement, there are charges over the assets of the major subsidiaries of the Group and lenders require the Group to monitor and report interest cover and leverage ratios. Throughout the period, both ratios were well within permitted levels. Non-compliance with terms of the facilities agreement could result in lenders refusing to advance more funds, or in the worst case, calling in outstanding loans. There were a number of drawdowns during the year to fund new acquisitions. Towards the end of 2018, excess funds of €10.1m were used to make a partial repayment of outstanding loans. As at 31 December 2018 the Group had €40 million outstanding, at a rate based on a margin over EURIBOR, plus a separate margin charged for the unutilised facility. Loans owed by Enzyme at the end of 2017 of €0.4m reduced to €0.3m during 2018. Amounts owed by Sperasoft Inc. at the end of 2017 amounting to €0.6m were repaid during 2018. Loans and borrowings (classified as financial liabilities under IFRS 9), are held at amortised cost. Interest expenses which are calculated using the effective interest method, are disclosed in note 6. The currencies of these loans are as follows: Group Euro Canadian Dollars US Dollars Company Euro (ii) Capital management Group Loans and borrowings Less: cash and cash equivalents Net debt / (net cash) position Total equity Net debt / (net cash) to capital ratio (%) 2018 €’000 40,000 301 – 40,301 2018 €’000 40,000 40,000 2017 €’000 18,301 347 632 19,280 2017 €’000 18,250 18,250 2018 €’000 40,301 (39,871) 430 192,375 0.2% 2017 €’000 19,280 (30,374) (11,094) 161,012 -6.9% The Group manages capital by monitoring debt to capital and net debt ratios. This debt to capital ratio is calculated as net debt to total equity. Net debt is calculated as total debt (as shown in the consolidated statement of financial position) less cash and cash equivalents. The liquidity risk and cash management for the Group is managed centrally by the Group treasury function. The Board receives projections on a monthly basis as well as information regarding cash balances. The Group’s strategy is to preserve a strong cash base and secure access to finance at reasonable cost by maintaining a good credit rating. 90 Keywords Studios plc Financial Statements Investment in Subsidiaries 21 Company 2018 €’000 2017 €’000 30,670 30,659 The results and financial position of all the subsidiaries are included in the consolidated statements. Details of the Company and Group’s subsidiaries as at 31 December 2018 are set out below: Name Country of incorporation Keywords International Ltd Keywords International Ireland Japan Co Ltd Keywords International Inc KW Studios Limited USA UK Liquid Violet Ltd Keywords Studios QC- Games Inc. (Formerly Babel Games Services Inc.) UK Canada (Quebec) Babel Media USA Inc Babel Media India Private USA India Limited Date of incorporation / acquisition 13-May-98 30-Nov-10 26-Sep-12 29-May-13 19-Jan-14 17-Feb-14 17-Feb-14 17-Feb-14 Babel Media Ltd Keywords International UK Singapore 18-Feb-14 24-Apr-14 Proportion of voting rights and ordinary share capital held Registered office 100% Whelan House, South County Business Park, Dublin 18, Ireland. 100% 5F, Aoba No.1 Bldg. 2-3-1 Kudanminami, Chiyoda, Tokyo, 102-0074 Japan 100% 18300 Redmond Way, Suite 120, Redmond, WA 98052 100% 201 Temple Chambers, 3-7 Temple Avenue, London, England, EC4Y 0DT 100% Bryant House Bryant Road, Strood, Rochester, Kent, ME2 3EW 100% 1751 Richardson, suite 8400, Montréal, Québec, Canada H3K1G6 100% 1751 Richardson Office 8400, Montreal, Canada, H3K 1G6 100% 3rd floor, Vardhman Orchard Plaza, Plot No 4, LSC, West Enclave, Pitampura, New Delhi, 110034, India 100% Fifth Floor, 6 St. Andrew Street, London, EC4A 3AE 100% 20 Kallang Avenue, #06-6A, Lobby B, Pico Creative Centre, Singapore 339411 Italy 08-May-14 100% Via Egadi 2, Milano, MI, 20144, Italy USA USA 08-May-14 08-May-14 100% 350 N. Glenoaks Blvd., Suite 305, Burbank, CA 91502, USA 100% 350 N. Glenoaks Blvd., Suite 305, Burbank, CA 91502, USA Pte. Limited Keywords Studios Italy S.R.L. (Formerly Binari Sonori S.R.L) Binari Sonori America, Inc Binari Sonori Audio Productions LLC Lakshya Digital Private India 10-Oct-14 100% 3rd floor, Vardhman Orchard Plaza, Plot No 4, LSC, Limited West Enclave, Pitampura, New Delhi, 110034, India Edugames Solutions Private India 10-Oct-14 100% D – 3/C, Munirka Flats, New Delhi – 110067 Limited Lakshya Digital Singapore Singapore 10-Oct-14 100% 20 Kallang Avenue, #06-6A, Lobby B, Pico Creative Centre, Pte. Ltd Keywords Studios QC-Tech Inc. (Formerly Alchemic Dream Inc.) Canada (Quebec) 06-Jan-15 100% 1751 Richardson Street Suite 8400 Montreal QC H3K 1G6 Singapore 339411 Canada Keywords International Spain 09-Jan-15 100% Passeig de Gràcia 49, 1er2a, 08007 Barcelona, Catalonia, Spain Barcelona SL Keywords do Brasil Brazil 18-Jan-15 100% Av. Churchill, 109 – Sala 204 – Centro, Rio de Janeiro-RJ, Localizacao e Traducao Ltda (Formerly Reverb Localizacao-Prearacao de Documentos Ltda) Keywords (Shanghai) Information Technology Ltd Keywords Studios Spain SLU (Formerly Kite Team SL) Kite Team Mex S.de R.L. de. CV (Currently in process of changing name to Keywords Studios Mexico, S. DE R.L.DE C.V.) Brazil CEP: 20020-050 China 02-Apr-15 100% 142 Room, Building 7, No.311 Jin Gao Road, Pudong New District, Shanghai Spain 16-Jul-15 100% Julián Camarillo 6A, 3B, 28037 Madrid, Spain Mexico 16-Jul-15 100% Av. Insurgentes Sur 1853, Guadalupe Inn, 01020 Ciudad de México, CDMX Mexico Liquid Development LLC USA 20-Aug-15 100% 411 SW 2nd Ave #300, Portland, OR 97204, USA Annual Report and Accounts 2018 91 Notes Forming Part of the Consolidated and Company Financial Statements continued 21 Investment in Subsidiaries continued Name Keywords Asia Private Ltd (Formerly Ankama Asia Pte Ltd) Country of incorporation Date of incorporation / acquisition Proportion of voting rights and ordinary share capital held Registered office Singapore 22-Mar-16 100% 20 Kallang Avenue #06-6A, Lobby B Pico Creative Centre Singapore 339411 Synthesis Deutschland Germany 12-Apr-16 100% Holstenkamp 46 A, Bahrenfeld, 22525 Hamburg, Germany GmbH Sillabit S.R.L Synthesis Global Solutions Italy Switzerland 12-Apr-16 12-Apr-16 100% Via Marco D’Oggiono, 12, Milano (MI) 20123, Italy 100% Corso Elvezia 16, 6900 Lugano, Ticino, Switzerland SAS Keywords Studios France France 08-Jun-16 100% 11 rue Torricelli, 75017 Paris, France SAS (Formerly Keywords International SAS) Player Research Ltd Keywords Studios QC- Interactive Inc. SPOV Ltd Xloc Inc. GameSim Inc. Strongbox Ltd Red Hot Software (Shanghai) Ltd Red Hot Software (Zhengzhou) Ltd Eastern New Media Limited UK 26-Oct-16 100% 2nd Floor, Claremont House, 95 Queens Road, Brighton, Canada (Quebec) UK USA USA Seychelles China China 16-Nov-16 100% 1751 Richardson Street Suite 8400 Montreal QC H3K 1G6 England, BN1 3XE Canada 17-Feb-17 10-May-17 17-May-17 22-May-17 100% 205-209 Hackney Road, London, England, E2 8JL 100% 712 Presnell Court, Raleigh, NC 27615-1240, USA 100% 12000 Research Parkway, Suite 436, Orlando, FL 32826, USA 100% Suites 103, 106 and 107 Premier Building, Victoria, Mahe, Seychelles 22-May-17 100% Dong Ti Yu Hui Road #860, Building 5, 4th Floor, Shanghai, China 22-May-17 100% Room 207, 11th Floor, Building No. 3, No. 57 Ke Xue Da Dao, Zheng Zhou, He Nan, China Hong Kong 22-May-17 100% Flat/Rm 4304, 43F, China Resources Building, 26 Harbour Road, Wanchai, Hong Kong PT Limitless Indonesia Around the Word GmbH d3t Ltd Indonesia Germany UK 22-May-17 28-Jul-17 19-Oct-17 100% JI. Timoho II, No. 32, Yogyakarta, 100% Rosenstrasse 2, D-10178 Berlin 100% 201 Temple Chambers, 3-7 Temple Avenue, London, England, EC4Y 0DT Keywords US Holdings Inc USA 23-Oct-17 100% 1209 Orange Street, Wilmington, New Castle County, Delaware Keywords Canada Holdings Canada 27-Oct-17 100% 1751 Richardson Street Suite 8400 Montreal QC H3K 1G6 Inc. (Formerly Volt Canada Inc.) (Quebec) Canada Keywords Studios BC Inc. Canada (BC) 27-Oct-17 100% 400-725 Granville Street, Vancouver, BC V7G 1G5, Canada 19801, USA. (Formerly VMC Volt Information Sciences BC Inc.) VMC Consulting Corporation USA 27-Oct-17 100% 11611 Willows Road NE, Redmond, WA 98052, United States of Sperasoft Poland Spólka z.o.o. Poland Russia Sperasoft Studios LLC USA Sperasoft Inc Ireland Keywords Studios Ltd UK Keywords UK Holdings Limited Keywords Ventures Limited UK Cord World Wide Spain, SL Laced Music Ltd Spain UK 13-Dec-17 13-Dec-17 13-Dec-17 27-Mar-18 28-Mar-18 06-Apr-18 09-Apr-18 09-Apr-18 America 100% Ul. Na Kozłówce 27, 30-664 Kraków, Poland 100% 196084, Russia, Saint-Petersburg, Kievskaya street, 5 – building 100% 1013 Centre Road, Suite 403-B, Wilmington, DE 19805, USA 100% Whelan House, South County Business Park, Dublin 18, Ireland. 100% 201 Temple Chambers, 3-7 Temple Avenue, London, England, EC4Y 0DT 100% 8 Clifford Street, London, United Kingdom, W1S 2LQ 100% Avenida Concha Espina 39 B28016, Madrid, Spain 100% 201 Temple Chambers, 3-7 Temple Avenue, London, England, EC4Y 0DT Cord Worldwide Ltd UK 09-Apr-18 100% 201 Temple Chambers, 3-7 Temple Avenue, London, England, Cord Artists Management UK 09-Apr-18 100% 12-14 Denman Street, London, England, W1D 7HJ EC4Y 0DT Limited Paleblue Limited Fire Without Smoke Ltd Fire Without Smoke Inc. UK UK USA 92 Keywords Studios plc 09-Apr-18 30-May-18 29-May-18 100% 12-14 Denman Street, London, England, W1D 7HJ 100% 98 Chingford Mount Road, South Chingford, London, E4 9AA 100% 12701 Marblestone Drive, Suite 330, Woodbridge, Virgina, 22192 USA Financial Statements 21 Investment in Subsidiaries continued Name Blindlight LLC Snowed In Studios, Inc Studio Gobo Limited Bitsy SG Limited Electric Square Limited Alset Ltd Itsy SGD Limited d3t Development Ltd The TrailerFarm Limited Country of incorporation USA Canada (Ontario) Date of incorporation / acquisition 11-Jun-18 19-Jul-18 Proportion of voting rights and ordinary share capital held Registered office 100% 8335 Sunset Blvd. West Hollywood, CA 90069 USA 100% 400 – 981 Wellington Street West Ottawa, Ontario K1Y 2Y1 Canada UK UK UK UK UK UK UK 20-Aug-18 100% Unit 8 Hove Business Centre, Fonthill Road, Hove, East Sussex, BN3 6HA 20-Aug-18 100% Unit 8 Hove Business Centre, Fonthill Road, Hove, East Sussex, United Kingdom, BN3 6HA 20-Aug-18 100% Unit 8 Hove Business Centre, Fonthill Road, Hove, East Sussex, England, BN3 6HA 20-Aug-18 100% Unit 8, Hove Business Centre, Fonthill Road, Hove, United Kingdom, BN3 6HA 20-Aug-18 100% Unit 8, Hove Business Centre, Fonthill Road, Hove, United Kingdom, BN3 6HA 30-Aug-18 100% 201 Temple Chambers, 3-7 Temple Avenue, London, England, EC4Y 0DT 18-Sep-18 100% The Old Casino, 28 Fourth Avenue, Hove, East Sussex, BN3 2PJ Post acquisition the Group reviews entities acquired to streamline activities and close any dormant entities acquired. Re-structuring details are set out below: Name Country of Incorporation Date of incorporation / acquisition Proportion of voting rights and ordinary share capital held Re-structuring details Date of re-structuring Maximal Studio Audiovisuais Ltda Brazil 22-Mar-18 100% Merged into Keywords do Brasil Localizacao 20-Sep-18 Keywords International Corporation Inc. Volta Creation Inc. Global Video Games Services Inc. La Marque Rose SARL AsRec SAS Dune Sound SAS Around the Word SAS GVGS Europe SARL Canada Canada Canada France France France France France 22-Dec-10 28-Jul-16 16-Nov-16 04-Aug-17 28-Jul-17 28-Jul-17 28-Jul-17 16-Nov-16 e Traducao Ltda 100% Merged into Keywords Canada Holdings Inc. 100% Merged into Keywords Canada Holdings Inc. 100% Merged into Keywords Canada Holdings Inc. 100% Merged into Keywords Studios France SAS 100% Merged into Keywords Studios France SAS 100% Merged into Keywords Studios France SAS 100% Merged into Keywords Studios France SAS 100% Dissolved 01-Jan-19 01-Jan-19 01-Jan-19 04-Oct-18 31-Aug-18 30-Nov-18 30-Nov-18 26-Dec-18 22 Related Parties and Shareholders Italicatessen Limited, a company registered in Ireland is related by virtue of a common significant shareholder. P.E.Q. Holdings Limited is 100% owner of Italicatessen Limited. At 31 December 2018, P.E.Q. Holdings Limited owned 6.3% (2017: 6.5%) of the Company. In addition, Mr. Giorgio Guastalla is a Director of Italicatessen Limited, P.E.Q. Holdings Limited and the Company, and owns, or controls, 90% of the share capital of P.E.Q. Holdings Limited. The following transactions arose with Italicatessen Limited, which provides canteen services to Keywords International Limited, on an arms length basis: Operating Expenses Canteen charges The following are year-end balances owing by the Group: Italicatessen Limited 2018 €’000 44 44 2018 €’000 5 5 2017 €’000 57 57 2017 €’000 9 9 The Company paid the following amounts, on an arms length basis, to Mr. Giorgio Guastalla, Director of the Company, and shareholder of P.E.Q. Holdings Limited, in respect of rent on premises occupied by employees of the Group in Dublin. Annual Report and Accounts 2018 93 Notes Forming Part of the Consolidated and Company Financial Statements continued 22 Related Parties and Shareholders continued Operating Expenses Rental payment The details of key management compensation (being the remuneration of the Directors) are set out in note 10. As at 31 December 2018 and 2017, the Company had amounts receivable from its subsidiaries as follows: Company Receivables from subsidiaries related to investment in acquisitions Receivables from subsidiaries relating to trading activities Company Company Short Term Company Long Term 2018 €’000 22 22 2017 €’000 22 22 2018 €’000 175,509 1,600 2017 €’000 117,732 14,624 177,109 132,356 2018 €’000 1,600 175,509 177,109 2017 €’000 129,056 3,300 132,356 23 Financial Instruments and Risk Management Interest Rate Risk Interest rate risk is the risk that the value of financial instruments will fluctuate due to changes in market interest rates. The Group’s income and operating cash flows are substantially independent of changes in market interest changes. The management monitors interest rate fluctuations on a continuous basis and acts accordingly. Where the Group has a significant amount of surplus cash, it invests in higher earning interest deposit accounts. Due to interest rate conditions, the interest rates for short-term deposits are at similar levels to those achieved for longer-terms. The Group is not unduly exposed to market interest rate fluctuations, and no interest rate sensitivity analysis has been presented as a result. Credit Risk The Group’s main financial assets are cash and cash equivalents, as well as trade and other receivables, which represent the Group’s maximum exposure to credit risk in connection with its financial assets. Credit risk arises when a failure by counterparties to discharge their obligations could reduce the amount of future cash inflows from financial assets on hand at the reporting date. Credit risk arising in the context of the Group’s operations is not significant with the total bad debt provision at the balance sheet date amounting to 4.6% of gross trade receivables (2017: 1.5%), with the majority of the year over year increase attributable to one customer. Customer credit risk is managed at appropriate Group locations according to established policies, procedures and controls. Customer credit quality is assessed and credit limits are established where appropriate. Outstanding customer balances are regularly monitored and a review for indicators of impairment (evidence of financial difficulty of the customer, payment default, breach of contract etc.) is carried out at each reporting date. Significant balances are reviewed individually while smaller balances are grouped and assessed collectively. Receivables balances are unsecured and non-interest-bearing. The trade receivables balances disclosed comprise a large number of customers spread across the Group’s activities and geographies with balances classified as “Not past due” representing 74% of the total trade receivables balance at the balance sheet date (2017: 61%). Trade and other receivables are carried on the statement of financial position net of bad debt provisions. Group Treasury manage bank balances centrally, and monitors the credit rating and stability of the institutions the Group banks with. 94 Keywords Studios plc Financial Statements 23 Financial Instruments and Risk Management continued The ageing of trade receivables that are past due but not impaired can be analysed as follows: Group At 31 December 2018 At 31 December 2017 Total €’000 Not past due €’000 1-2 months overdue €’000 More than 2 months past due €’000 37,019 27,473 27,504 16,713 7,996 9,126 1,519 1,634 A provision for doubtful debtors is included within trade receivables and can be reconciled as follows: Provision at the beginning of the year Impairment of financial assets (trade receivables) charged to administration expenses Foreign exchange movement in the year Utilised Provision at end of the year 2018 €’000 418 2,055 (30) (726) 1,717 2017 €’000 468 3 – (53) 418 Trade receivables loss allowance is estimated using a practical expedient to arrive at lifetime expected credit losses. Overdue receivables are evaluated to calculate an expected credit loss using a historical credit loss experience of 0.5% (2017: nil). Taking into account internal and external information, the historical credit loss experience may be adjusted where it is determined that there has been a significant increase in credit risk. Where there is evidence that a receivable is credit impaired, the impairment is recognised immediately, and impaired balances are removed from the expected credit loss calculation. Trade receivables gross Credit impaired Expected credit losses At 31 December 2018 Trade receivables gross Credit impaired Expected credit losses At 31 December 2017 Total €’000 Not past due €’000 1-2 months overdue €’000 39,074 (1,872) (183) 37,019 27,891 (418) – 27,473 27,874 (234) (136) 27,504 16,713 – – 16,713 8,586 (551) (39) 7,996 9,126 – – 9,126 More than 2 months past due €’000 2,614 (1,087) (8) 1,519 2,052 (418) – 1,634 Related party receivables of €nil were past due at 31 December 2018 (2017: €nil). Company As presented in note 22, receivables from subsidiaries relating to investments in acquisitions, comprise term loans extended to subsidiaries, while receivables from subsidiaries relating to trading activities, comprise trading balances repayable on demand. Balances are analysed in terms of the risk profile of the subsidiary. A small number of balances were deemed to be technically credit impaired under IFRS 9, and an expected credit loss of €183K (2017: nil), was recognised in the period related to these receivables. Taking into account internal and external information, it was determined that a significant increase in credit risk had not occurred in the reporting period for the remaining receivables from subsidiaries. A 12 month expected credit loss of €nil (2017: €nil) was recognised in the period related to these receivables. Currency Risk Currency risk is the risk that the value of financial instruments will fluctuate due to changes in foreign exchange rates. The foreign exchange risk arises for the Group where assets and liabilities arise in a currency other than the functional currency of the entity. The Group’s policy, where possible, is for Group entities to manage foreign exchange risk at a local level by matching the currency in which revenue is generated with the expenses incurred and by settling liabilities denominated in their functional currency with cash generated from their own operations in that currency. Where Group entities have liabilities denominated in a currency other than their functional currency (and have insufficient reserves of that currency to settle them), cash already denominated in that currency will, where possible, be transferred from elsewhere within the Group. Annual Report and Accounts 2018 95 Notes Forming Part of the Consolidated and Company Financial Statements continued 23 Financial Instruments and Risk Management continued Currency Risk continued Over the course of the year the Group’s currency exposure has increased and diversified due to the addition of the newly-acquired subsidiaries. The Group is predominantly exposed to currency risk on the balances held within working capital across the Group and the exposure is concentrated in the movement of the Canadian Dollar, US Dollar and Sterling against the Euro. The effect of a strengthening and weakening of 10% in those currencies against the Euro at the reporting date on the working capital balances would, all other variables held constant, have resulted in the following pre-tax profit / (loss) impact for the year: US Dollar to Euro Canadian Dollar to Euro Sterling to Euro 10% Strengthening 2018 €’000 10% Weakening 2018 €’000 10% Strengthening* 2017 €’000 2,140 2,026 884 (1,946) (1,842) (803) 2,363 1,267 620 10% Weakening* 2017 €’000 (2,148) (1,152) (564) * Please note the comparatives have been amended to reflect current year presentation, as the Directors consider this presentation to be more meaningful. Total Financial Assets and Liabilities The carrying amount of the financial assets and liabilities shown in the Group and Company statements of financial position are stated at amortised costs, with the exception of contingent consideration held at fair value. Liquidity Risk Liquidity risk arises from the Group’s management of working capital and the financial charges on its debt instruments. The Group’s policy is to ensure that it will have sufficient cash to allow it to meet its liabilities when they become due. The following are the contractual maturities (representing undiscounted contractual cash flows) of the Group’s and Company’s financial liabilities: Group Year ended 31 December 2018 Trade payables Deferred and contingent consideration (i) Other payables Loans and borrowings Loan interest Year ended 31 December 2017 Trade payables Deferred and contingent consideration (i) Other payables Loans and borrowings Loan interest Company Year ended 31 December 2018 Trade payables Deferred and contingent consideration (i) Other payables Loans and borrowings Loan interest Year ended 31 December 2017 Trade payables Deferred and contingent consideration (i) Other payables Loans and borrowings Loan interest Total €’000 Within 1 year €’000 7,142 19,306 22,909 40,301 55 7,142 18,249 22,904 40,071 55 Total €’000 Within 1 year €’000 7,310 4,468 19,770 19,280 80 7,310 3,251 19,754 18,943 80 1-2 years €’000 – 1,057 5 – 1-2 years €’000 – 1,217 16 31 2-5 years €’000 – – 230 2-5 years €’000 – – 306 Total €’000 Within 1 year €’000 1-2 years €’000 2-5 years €’000 285 – 6,003 40,000 55 285 – 5,435 40,000 55 – – – – – – 568 – Total €’000 Within 1 year €’000 1-2 years €’000 2-5 years €’000 215 971 607 18,250 80 215 971 607 18,250 80 – – – – – – – – Deferred and contingent consideration at 31 December 2018 has arisen on business combinations, and is based on set amounts to be paid in the future to sellers under share purchase agreements. 96 Keywords Studios plc Financial Statements 24 Operating Lease Commitments The Group occupies a portfolio of leased properties. The terms of property leases vary from country to country, although they all tend to be tenant repairing with rent reviews every two to five years and typically have a five year break clause, with options to renew. The total future value of the minimum lease payments is as follows: Group Not later than one year Later than one year and not later than five years Later than five years 2018 €’000 6,557 8,882 1,451 16,890 2017 €’000 4,561 10,708 4,793 20,062 25 Finance Lease Commitments The Group leases computer equipment and office telephone systems. Such assets are generally classified as finance leases, as the lease term equates to the estimated useful economic life of the assets concerned, and often the Group has the right to purchase the assets outright at the end of the minimum lease term by paying a nominal amount. As the carrying value of assets under finance lease commitments are negligible, the net book value of the assets is not disclosed. The total future value of the minimum lease payments is as follows: Group 2018 Not later than one year Later than one year and not later than five years Later than five years 2017 Not later than one year Later than one year and not later than five years Later than five years Minimum lease payments €’000 Interest €’000 Present value €’000 5 – – 5 25 20 – 45 – – – – 1 4 – 5 5 – – 5 24 16 – 40 Annual Report and Accounts 2018 97 Notes Forming Part of the Consolidated and Company Financial Statements continued 26 Deferred Tax Details of the deferred tax assets and liabilities, and amounts recognised in the profit or loss are as follows: Accelerated capital allowances Defined benefit termination payments Available losses Rent free period provisions Fixed asset tax base versus accounting book value Deferred tax related to multimedia tax credits Deferred tax arising on items deductible on a paid basis Deferred tax arising on intangibles Net tax assets / (liabilities) Impact of change in tax rates Prior year (over) / under provision Total (credited) / charged to Income Statement Accelerated capital allowances Defined benefit termination payments Available losses Rent free period provisions Fixed asset tax base versus accounting book value Deferred tax related to multimedia tax credits Other temporary differences Deferred tax arising on intangibles Net tax assets / (liabilities)* Impact of change in tax rates Prior year (over) / under provision Total (credited) / charged to Income Statement Asset 2018 €’000 – 66 875 30 558 – 1,438 – 2,967 – – – Asset 2017 €’000 – 32 237 17 258 – 581 81 1,206 – – – Liability 2018 €’000 1 – – – 71 2,468 155 5,793 8,488 – – – Liability 2017 €’000 1 – – – 139 2,284 112 5,259 7,795 – – – (Credited) / charged to Income Statement 2018 €’000 1 (3) 40 4 (100) (112) (415) (1,448) (2,033) (4) (364) (2,401) (Credited) / charged to Income Statement 2017 €’000 1 (2) (162) 13 (33) 132 (225) (700) (976) (149) 94 (1,031) Net 2018 €’000 (1) 66 875 30 487 (2,468) 1,283 (5,793) (5,521) – – – Net 2017 €’000 (1) 32 237 17 119 (2,284) 469 (5,178) (6,589) – – – * Please note that the comparative has been re-classified to reflect the current year presentation as the Directors have determined this presentation to be more meaningful. The deferred tax not recognised on available losses at the period end is €3.9m (2017: €3.1m). 27 Investment in Associate Opening balance Investment in AppSecTest Limited Post-acquisition changes in the Group’s share of net assets 2018 €’000 – 226 (66) 160 2017 €’000 – – – – In May 2018, the Group, through the newly established Keywords Ventures Ltd, invested £100k (€113k) in 15% of the share capital of AppSecTest Limited. Incorporated in the UK, AppSecTest is creating a cloud based automatic testing solution for mobile apps, including games (principally for GDPR compliance). A further investment of £100K (€113K) was made in September 2018 bringing the total investment to 30% of the share capital of the company. Under a shareholder agreement the Group is entitled to appoint one director to the board. Based on these factors, the Group consider that it has the power to exercise significant influence. 98 Keywords Studios plc Financial Statements 28 Business Combinations / Acquisitions Completed in the Current Year Cord €’000 Laced €’000 Maximal €’000 Fire Without Smoke €’000 Blindlight €’000 Snowed In €’000 Studio Gobo & Electric Square €’000 The TrailerFarm €’000 Total €’000 Date of acquisition 09-Apr-18 09-Apr-18 22-Mar-18 30-May-18 11-Jun-18 19-Jul-18 20-Aug-18 18-Sep-18 Acquisition company jurisdiction UK UK Brazil UK US Canada UK UK Book value of identifiable assets and liabilities Property, plant & equipment Intangible assets Trade and other receivables – gross Bad debt provision Cash and cash equivalents Trade and other payables Net book value Fair value adjustments Identifiable intangible assets – customer relationships Deferred tax liabilities Total fair value adjustments Total identifiable assets Goodwill Total consideration % Share capital acquired Satisfied by: Cash Deferred cash Deferred cash contingent on performance Shares to be issued Total consideration transferred Number of shares 79 362 1,135 – 1,803 (1,455) 1,924 2,163 (411) 1,752 3,676 2,377 6,053 100% 4,907 – – 1,146 6,053 – – 126 – 40 (224) (58) – – – 14 – 22 – 112 (271) (123) 11 – 810 (268) 1,123 (419) 1,257 4 – 256 – 96 (128) 228 – – – 1,404 (267) 2,413 (511) 1,137 1,902 (58) (123) 2,394 2,130 38 – 48 – 282 (122) 246 584 (159) 425 671 803 – 3,558 – 5,409 (1,404) 8,366 17 – 98 – 129 (51) 966 362 6,053 (268) 8,994 (4,074) 193 12,033 – – – – – – 6,564 (1,348) 5,216 8,366 193 17,249 521 463 647 524 4,455 5,949 2,003 25,870 1,322 43,144 6,849 8,079 2,674 34,236 1,515 60,393 100% 100% 100% 100% 100% 100% 100% 320 – – 143 463 345 – 179 – 524 4,726 – 574 1,549 3,097 – 3,655 1,327 1,822 109 17,015 1,033 – 743 11,164 5,024 925 – 354 236 33,157 1,142 15,926 10,168 6,849 8,079 2,674 34,236 1,515 60,393 Issued at the date of acquisition Fixed amount agreed to be issued – 65,550 – 8,194 – – – 77,006 – 64,521 – 37,983 – 254,529 – – 11,070 518,853 Annual Report and Accounts 2018 99 Notes Forming Part of the Consolidated and Company Financial Statements continued 28 Business Combinations / Acquisitions Completed in the Current Year continued Net cash outflow arising on acquisition Cash Less: cash and cash equivalent balances transferred Net cash outflow – acquisitions Related acquisition costs charged through to the Consolidated Statement of Comprehensive Income Pre-acquisition revenue in H1 Pre-acquisition revenue in H2 Pre-acquisition revenue with Keywords Group Post-acquisition revenue Pro forma revenue Pre-acquisition profit / (loss) before tax Post-acquisition profit / (loss) before tax Pro forma profit / (loss) before tax Cord €’000 4,907 (1,803) 3,104 104 1,721 – – 2,864 4,585 Laced €’000 320 (40) 280 20 47 – – 510 557 93 (10) (196) (103) 36 26 Maximal €’000 Blindlight €’000 Snowed In €’000 Fire Without Smoke €’000 Studio Gobo & Electric Square €’000 The TrailerFarm €’000 Total 2018 €’000 345 4,726 3,097 1,822 17,015 925 33,157 (112) (1,123) (96) (282) (5,409) (129) (8,994) 233 3,603 3,001 1,540 11,606 796 24,163 8 243 – (243) 180 180 82 319 138 1,653 – – 2,641 4 1,139 – – 2,653 57 1,013 – – 1,210 388 7,286 2,064 – 8,195 39 534 331 – 662 758 13,636 2,395 (243) 18,915 4,294 3,792 2,223 17,545 1,527 34,703 238 820 (143) 325 4,065 246 4,896 785 420 2,878 243 5,305 401 1,058 642 745 6,943 489 10,201 The acquisitions made in the year are in line with the Group’s strategy to grow organically and by acquisition, as it selectively consolidates the highly fragmented market for video game services. The companies will bring additional talent, expertise and industry experience to Keywords’ client base. Being able to offer the additional services to our clients will further enhance our reputation as the leading provider of services to the global video games industry. The amounts recognised in respect of the identifiable assets acquired and liabilities assumed of acquisitions in the year are set out in the table above. The main factors leading to the recognition of goodwill on the acquisitions are the presence of certain intangible assets in the acquired entities, which are not valued for separate recognition, such as: • The expertise and music industry experience in Cord & Laced. • The expertise in high end video game trailers and reputation within the industry in Fire Without Smoke. • The expertise in voiceover production, celebrity acquisition and rights management, game writing, music, sound design and motion capture in Blindlight. • The expertise and additional scale to Keywords’ new and growing video game development business in Snowed In and Studio Gobo & Electric Square. • The experience and expertise in producing trailers for the marketing and support of video games in The TrailerFarm. The total amount of goodwill arising on business combinations completed in the current year, that is expected to be deductible for tax purposes was €nil. 100 Keywords Studios plc Financial Statements 29 Business Combinations / Acquisitions completed in 2017 Spov Ltd. €’000 XLOC €’000 Gamesim €’000 Red Hot €’000 Around the Word €’000 Asrec €’000 Le Marque Rose €’000 d3t €’000 VMC €’000 Sperasoft €’000 Lola €’000 Total €’000 Restated Restated Date of acquisition 17-Feb-17 10-May-17 17-May-17 22-May-17 28-Jul-17 04-Aug-17 04-Aug-17 19-Oct-17 27-Oct-17 13-Dec-17 15-Dec-17 Acquisition Company Jurisdiction Book value of identifiable assets and liabilities Property, plant & equipment Trade and other receivables – gross Bad debt provision Cash and cash equivalents Trade and other payables Corporation tax payable Deferred tax liabilities Loan Net book value Fair value adjustments Identifiable intangible assets – customer relationships Deferred tax liabilities Total fair value adjustments Total identifiable assets Goodwill as reported Measurement period adjustment (note 31) Goodwill (restated) Total consideration UK US US China France France France UK US / Canada Russia / US Mexico 30 7 13 230 342 123 148 188 1,834 1,053 13 3,981 16 – – (139) – – – (93) – – – (93) 491 – 491 398 33 – 120 (73) – – – 87 147 (59) 88 175 652 – 652 827 768 – 26 (353) – – – 975 – 584 (356) (64) – (0) 2,142 – 497 (2,067) – – – 49 – 76 (115) – – – 598 – 494 (504) – – – 602 18,255 – – (3,192) (150) (1,408) – 802 (678) – – – – 3,890 (944) 587 (2,710) (86) (46) (1,022) 147 – 43 (118) – – – 27,475 (944) 3,229 (10,305) (300) (1,454) (1,022) 454 1,369 914 133 736 914 15,339 722 85 20,660 – – – 1,465 (366) 651 (217) 1,099 434 – – – – – – – 13,245 (2,781) – 3,454 (691) – 10,464 2,763 – – – 18,962 (4,114) 14,848 454 2,468 1,348 133 736 914 25,803 3,485 85 35,508 3,828 2,513 3,495 577 1,293 2,886 32,128 18,206 784 66,853 – – – – – – – (945) – (945) 3,828 2,513 3,495 577 1,293 2,886 32,128 17,261 784 65,908 4,282 4,981 4,843 710 2,029 3,800 57,931 20,746 869 101,416 % Share capital acquired 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Asset Purchase Satisfied by: Cash Equity instruments Deferred cash (restated) Shares to be issued (restated) Total consideration transferred Number of shares Issued at the date of acquisition Fixed amount agreed to be issued 351 – 47 – 643 184 – – 2,888 1,394 – – 3,514 – – 1,467 2,500 – 1,543 800 610 100 – – 2,029 – – – 3,127 57,931 – – – 673 – – 16,733 – – 4,013 405 – 295 169 90,731 2,351 1,885 6,449 398 827 4,282 4,981 4,843 710 2,029 3,800 57,931 20,746 869 101,416 – – 19,134 151,725 – – 9,534 – 42,368 – – 222,767 – – 160,842 66,262 – – – – 252,248 10,106 489,458 Annual Report and Accounts 2018 101 Notes Forming Part of the Consolidated and Company Financial Statements continued 29 Business Combinations / Acquisitions completed in 2017 continued Net cash outflow arising on acquisition Spov Ltd. €’000 351 XLOC €’000 643 Gamesim €’000 Red Hot €’000 Around the Word €’000 2,888 3,514 2,500 Asrec €’000 610 Le Marque Rose €’000 d3t €’000 VMC €’000 Sperasoft €’000 2,029 3,127 57,931 16,733 Lola €’000 405 Total 2017 €’000 90,731 – – (120) (26) (584) (497) (76) (494) (802) – – (321) – – – – – – (587) (43) (3,229) – (405) (726) 351 523 2,862 2,609 2,003 534 1,535 2,325 57,931 16,146 (43) 86,776 9 4 – 9 3 70 435 – – 36 1,690 82 2 2,336 243 1,532 2,266 3,518 265 1,154 1,547 24,754 8,902 449 43,462 – – – 588 44 193 903 17,822 8,378 548 27,633 – 208 212 – 236 479 – 2,266 – 3,980 (575) 2,048 (43) 571 (189) 1,154 – 560 – 7,769 – 798 (997) – (1,804) 19,590 3,798 6,246 5,579 837 2,312 3,010 50,345 18,078 – 88,881 (10) 82 64 (203) (114) 397 305 848 (313) (32) (151) 120 2,358 (1,007) 313 141 191 (7) 824 (34) (213) (32) 461 1,153 – 109 40 113 3,182 (1,041) 68 – 68 1,484 2,336 3,820 Cash Less: cash and cash equivalent balances transferred Settled in 2018 re 2017 acquisitions Net cash outflow – acquisitions Related acquisition costs charged through to the Consolidated Statement of Comprehensive Income Pre-acquisition revenue in 2017 H1 Pre-acquisition revenue in 2017 H2 Adjustment for pre- acquisition trading with Keywords Group Post-acquisition revenue 2017 Pro forma revenue Pre-acquisition profit / (loss) before tax* Post-acquisition profit / (loss) before tax* Pro forma profit / (loss) before tax * Restated to exclude revenue from one contract that did not novate to VMC post acquisition and information that was not available when preparing the FY17 Annual Report. The acquisitions made in the prior year are in line with the Group’s strategy to grow organically and by acquisition, as it selectively consolidates the highly fragmented market for video game services. The companies will bring additional talent, expertise and industry experience to Keywords’ client base. Being able to offer the additional services to our clients will further enhance our reputation as the leading provider of services to the global video games industry. The amounts recognised in respect of the identifiable assets acquired and liabilities assumed of our acquisitions in the year are set out in the table above. The main factors leading to the recognition of goodwill on the acquisitions are the presence of certain intangible assets in the acquired entities, which are not valued for separate recognition, such as: • Expertise in art services and reputation within the industry in Spov. • Expertise in localization processes and reputation within the industry in XLOC. • The expertise in simulation technology for the games industry in Gamesim. • Broader access to the Chinese pool of video game art talent, which is the largest in the world, and expertise in art service for the games industry in Red Hot. • Expertise in audio service for the games industry and reputation in the French entities. • A software development team with capabilities including HD re-mastering, porting, optimisation, rendering and game systems and reputation within the industry in d3t. • Expertise in art and engineering services for the games industry and reputation in Sperasoft. The total amount of goodwill arising on business combinations completed in 2017, that is expected to be deductible for tax purposes was €nil. 102 Keywords Studios plc Financial Statements 30 Supplementary Information to the Statement of Cash Flows Group Movement on Loans Balance at 1 January 2017 Cash flows: Cash received via additional loans in the year Repayment of loans Non-cash flows Amounts recognised on business combinations Non-current transferred to current Balance at 31 December 2017 Cash flows: Cash received via additional loans in the year Repayment of loans Non-cash flows Foreign exchange difference on Canadian loans Non-current transferred to current Balance at 31 December 2018 31 Measurement Period Adjustment Group As reported 31 December 2017 Measurement period adjustment Restated 31 December 2017 Current €’000 8,025 Non-current €’000 345 10,250 (23) 632 59 18,943 31,850 (10,835) 6 107 40,071 – – 51 (59) 337 (107) 230 Total €’000 8,370 10,250 (23) 683 – 19,280 31,850 (10,835) 6 – 40,301 Deferred consideration €’000 4,468 (826) 3,642 Shares to be issued €’000 11,739 (119) Goodwill €’000 109,007 (945) 11,620 108,062 Other payables (current) €’000 23,005 (826) 22,179 Goodwill recognised on the acquisition of Sperasoft has been reduced by deferred cash consideration withheld of €826K and a reduction in shares to be issued of €119K under an acquisition agreement warranty claim, which occurred within the measurement period. Details of the restated purchase consideration and the restated goodwill are as follows: Sperasoft Acquisition Accounting – extract As reported 31 December 2017 Measurement period adjustment Restated 31 December 2017 Deferred Consideration €’000 Shares to be issued €’000 826 (826) – 4,132 (119) 4,013 Goodwill €’000 18,206 (945) 17,261 Full details of the restated purchase consideration, the restated goodwill and the fair value of identifiable assets and liabilities acquired as measured at the acquisition date, together with the other disclosures relevant to the acquisition as reported, are presented in note 29. The 2017 Group comparatives have been restated in these financial statements to include the effect of the adjustments noted. Under paragraph 10(f) of IAS 1 Presentation of financial statements, this restatement would ordinarily require the presentation of a third consolidated statement of financial position as at 31 December 2017. However, as the restatement would have no significant effect on the statement of financial position as at that date, the Directors do not consider that this would provide useful additional information and, in consequence, have not presented a third consolidated statement of financial position due to the restatement of prior period business combinations. The Company statement of financial position as at 31 December 2017 has not been restated, as the restatement would have no significant effect on the statement of financial position as at that date. Annual Report and Accounts 2018 103 Notes Forming Part of the Consolidated and Company Financial Statements continued 32 Events after the Reporting Date Acquisition of Sunny Side Up Creative Inc. On 4 January 2019, Keywords Canada Holdings Inc. acquired the entire issued share capital of Sunny Side Up Creative Inc. (“Sunny Side Up”). Based in Quebec City, Canada, Sunny Side Up produces high quality marketing assets for game publishers and developers including game trailers, key art assets and motion graphic production. The total consideration for the acquisition is CAD$5.9m, of which CAD$4.75m was paid in cash on completion, CAD$0.35m will be paid 18 months after the acquisition (subject to certain conditions being met) and the balance of the consideration is to be met through the issue of 60,179 new ordinary shares in Keywords on the first anniversary of the acquisition and will then be subject to orderly market provisions for a further 12 months. Acquisition of the GetSocial business and assets On 18 February 2019, Keywords Studios Netherlands BV and Keywords International Limited acquired the assets and business of GetSocial B.V. (“GetSocial”) a company based in The Hague, Netherlands. GetSocial is a cloud-based software platform that provides a suite of functions that enable games developers to manage all social interactions between their games and their players plus their friends’ networks. GetSocial works with Android, iOS and Unity apps, and supports interactions on most social media and messaging platforms including Facebook, Instagram and WhatsApp. The total consideration for the acquisition is €170K paid in cash. 104 Keywords Studios plc Financial Statements Supplementary Information Alternative Performance Measures The group reports certain alternative performance measures that are not required under IFRS. The group believes that these measures, in conjunction with our IFRS financial information, provide investors with meaningful understanding of the underlying financial and operating performance of the group. These measures are key for the ongoing assessment of performance by the board and management of the group. The measures are used to: • Assess and monitor the underlying trends of our results of our operations • Explain the group performance to the investor analyst community • Set internal management targets These measures can have limitations as analytical tools and therefore should not be considered in isolation, or as a substitute for IFRS measures. Other companies may calculate similarly named measures using different bases of calculations, and therefore they may not be comparable. The principal measures used by the group, with reconciliations to reported IFRS measures as reported, are as follows: Adjusted Operating Costs This comprises administration expense as reported on the Consolidated Statement of Comprehensive Income, before non-operating costs including; share option costs, costs of acquisitions and integration, amortisation, depreciation, and including bank charges. Calculation Reference in Financial Statements 2018 €’000 2017 €’000 2016 €’000 Consolidated Statement of Comprehensive Income 73,123 38,650 25,219 Administrative expenses Less non-operating costs Share option expense Costs of acquisition and integration Amortisation of intangible assets Non-controlling Interest Depreciation Bank charges Adjusted operating costs Consolidated Statement of Comprehensive Income Consolidated Statement of Comprehensive Income Consolidated Statement of Comprehensive Income Note 5 Note 6 (4,129) (5,296) (6,872) – (5,316) 503 (1,426) (3,016) (3,038) – (2,730) 320 52,013 28,760 (686) (1,316) (1,629) (61) (1,803) 229 19,953 96,585 Revenue from contracts with customers Consolidated Statement of Comprehensive Income 250,805 151,430 Adjusted operating costs as a % of revenue 20.7% 19.0% 20.7% EBITDA EBITDA comprises profit before taxation, adjusted for depreciation, amortisation, both interest income and expense, and exchange gains and losses. Calculation Reference in Financial Statements Profit before taxation Financing cost Financing income Depreciation Amortisation Bank charges EBITDA Consolidated Statement of Comprehensive Income Note 6 Note 6 Note 5 Consolidated Statement of Comprehensive Income Note 6 2018 €’000 22,094 1,316 (791) 5,316 6,872 (503) 2017 €’000 11,994 4,467 (26) 2,730 3,038 (320) 2016 €’000 9,435 2,118 (94) 1,803 1,629 (229) 34,304 21,883 14,662 Adjusted EBITDA Adjusted EBITDA comprises gross profit, less the adjusted operating costs, less the share of post-tax losses on the equity accounted associate. Calculation Reference in Financial Statements Gross profit Adjusted operating costs Share of post-tax profits of equity accounted associates Adjusted EBITDA Revenue from contracts with customers Adjusted EBITDA as a % of revenue Consolidated Statement of Comprehensive Income As above Consolidated Statement of Comprehensive Income 2018 €’000 95,808 (52,013) 2017 €’000 55,085 (28,760) 2016 €’000 36,678 (19,953) (66) – – 43,729 26,325 250,805 17.4% 151,430 17.4% 16,725 96,585 17.3% Annual Report and Accounts 2018 105 Supplementary Information Alternative Performance Measures continued Adjusted Profit before Tax Adjusted Profit before tax comprises adjusted EBITDA less interest and depreciation. Adjusted profit before tax comprises profit before tax as reported on the Consolidated Statement of Comprehensive Income, before non- operating costs including share option costs, costs of acquisitions and integration, amortisation, and foreign exchange gains and losses. Calculation Reference in Financial Statements Adjusted EBITDA Less non-operating costs; Interest expense* Interest received Depreciation Adjusted profit before tax As above Note 6 Note 6 Note 5 2018 €’000 2017 €’000 2016 €’000 43,729 26,325 16,725 (502) – (5,316) (578) 26 (2,730) (152) 94 (1,803) 37,911 23,043 14,864 Revenue from contracts with customers Consolidated Statement of Comprehensive Income 250,805 151,430 96,585 Adjusted profit before tax as a % of revenue 15.1% 15.2% 15.4% * The prior year comparative has not been re-classified to reflect current year presentation as the differences are not significant. Adjusted Effective Tax Rate The Adjusted effective tax rate is the tax expense as reported on the Consolidated Statement of Comprehensive Income, as a percentage of the adjusted profit before tax. Calculation Reference in Financial Statements Adjusted profit before tax Tax expense Adjusted effective tax rate As Above Consolidated Statement of Comprehensive Income Calculation; Tax expense / Adjusted profit before Tax 2018 €’000 37,911 7,191 19.0% 2017 €’000 23,043 4,731 20.5% 2016 €’000 14,864 3,223 21.7% Adjusted earnings per share The adjusted profit after tax comprises the adjusted profit before tax, less the tax expense as reported on the Consolidated Statement of Comprehensive Income. The adjusted earnings per share comprises the adjusted profit after tax over the non-diluted weighted average number of shares as reported on note 8. Calculation Reference in Financial Statements Adjusted profit before tax Tax expense Adjusted profit after tax As Above Consolidated Statement of Comprehensive Income Denominator (weighted average number of equity shares) Note 8 Adjusted earnings per share Adjusted earnings per share % growth Calculation; Adjusted profit after tax / weighted average number of shares 2018 €’000 37,911 (7,191) 30,720 2017 €’000 23,043 (4,731) 18,312 2016 €’000 14,864 (3,223) 11,641 64,335,162 58,720,884 55,918,481 € c per share € c per share € c per share 47.75 53% 31.18 51% 20.59 62% Return on Capital Employed (ROCE) ROCE represents adjusted profit before tax, including pre acquisition profit and excluding interest expense, expressed as a percentage of the average total capital employed. As the group continue to make multiple acquisitions each year, the calculation adjusts the profit before tax and the capital employed as if all the acquisitions made during each year were made at the start of that year. Total adjusted profit before tax (continuing) therefore comprises adjusted profit before tax, plus the add backs of net interest costs and bank charges, plus pre-acquisition profits of current year acquisitions. Capital employed represents equity as reported on the statement of financial position adding back cumulative amortisation of intangible assets and retirement benefits, acquisition related liabilities and adding the net borrowings. 106 Keywords Studios plc Return on Capital Employed (ROCE) continued Calculation Reference in Financial Statements Adjusted profit before tax Net interest cost* Bank charges Pre-acquisition profits of current year acquisitions As Above Note 6 Note 6 Notes 28 and 29 Adjusted profit before tax including pre-acquisition profit excluding interest expense Total equity Retirement benefits Cumulative amortization on acquired Intangibles Acquisition related liabilities Borrowings Cash and cash equivalents Capital employed Statement of Financial Position Note 19 Note 12 Note 18 Note 20 Statement of Financial Position 2018 €’000 2017 €’000 37,911 502 503 4,896 23,043 552 320 1,484 2016 €’000 14,864 152 229 2,040 43,812 25,399 17,285 192,375 1,378 12,786 19,306 40,301 (39,871) 161,012 1,055 5,734 3,642 19,280 (30,374) 66,704 826 2,934 1,730 8,370 (17,020) 226,275 160,349 63,544 Return on capital employed Adjusted profit before tax including pre acquisition profit excluding interest expense / capital employed 19.4% 15.8% 27.2% * The prior year comparative has not been re-classified to reflect current year presentation as the differences are not significant. Like-for-Like revenue comparison at constant exchange rates Like for like revenue at constant exchange rates is calculated by adjusting the prior year revenues comparison, by adding pre acquisition revenues for the corresponding period of ownership, as presented in the current year results, and applying consistent foreign exchange rates in both years. Free Cash Flow Free cash flow represents net cash flow provided by operating activities, plus income taxes paid, less capital expenditure. Calculation Reference in Financial Statements Net cash provided by operating activities Income taxes paid Acquisition of property, plant and equipment Consolidated Statement of Cash Flows Consolidated Statement of Cash Flows Consolidated Statement of Cash Flows Free cash flow before tax 2018 €’000 32,180 6,304 (9,440) 2017 €’000 16,658 5,454 (3,803) 2016 €’000 14,822 2,129 (2,306) 29,044 18,309 14,645 Adjusted free cash flow Adjusted free cash flow is a measure of cashflow adjusting for capital expenditure that is supporting growth in future periods as measured by capital expenditure in excess of maintenance capital expenditure and is represented by free cashflow before tax, plus capital expenditure in excess of depreciation. Calculation Free cash flow before tax Capital expenditure in excess of depreciation – Acquisition of property, plant & equipment Depreciation Reference in Financial Statements As Above 2018 €’000 2017 €’000 2016 €’000 29,044 18,309 14,645 Consolidated Statement of Cash Flows Consolidated Statement of Cash Flows 9,440 (5,316) 3,803 (2,730) 2,306 (1,803) Capital expenditure in excess of depreciation Calculation: Depreciation less Capital Expenditure 4,124 1,073 503 Adjusted free cash flow 33,168 19,382 15,148 Adjusted cash conversion rate Adjusted cash conversion percentage is the adjusted free cash flow as a percentage of the adjusted profit before tax: Calculation Adjusted free cash flow Adjusted profit before tax Reference in Financial Statements As Above As Above 2018 €’000 2017 €’000 2016 €’000 33,168 37,911 19,382 23,043 15,148 14,864 Adjusted cash conversion ratio Free cash flow before tax & capex adjusted as a % of adjusted profit before tax 87% 84% 102% Annual Report and Accounts 2018 107 Directors Secretary Registered Number Registered Office Auditors Remuneration Consultants Principal Bankers Supplementary Information Company Information David Broderick Andrew Day Georges Fornay Charlotta Ginman Ross Graham Giorgio Guastalla David Reeves Liam O’Donoghue 8548351 201 Temple Chambers 3-7 Temple Avenue London EC4Y 0DT BDO Registered Auditors Beaux Lane House Mercer Street Lower Dublin 2 Mercer Kepler Tower Place West London EC3R 5BU Barclays Bank 27 Soho Square London W1D 3QR HSBC Bank PLC 1 Grand Canal Square, Grand Canal Harbour, Dublin 2 Lloyds Bank PLC 25 Gresham Street, London EC2V 7HN Citibank Europe Plc 1 North Wall Quay Dublin 1 Nominated Adviser and Broker Financial PR Adviser Solicitors Numis Securities Limited The London Stock Exchange Building 10 Paternoster Square London EC4M 7LT MHP Communications 6 Agar Street London WC2N 4HN DWF LLP 20 Fenchurch Street London EC3M 3AG 108 Keywords Studios plc K e y w o r d s S t u d i o s P L C A n n u a l R e p o r t a n d A c c o u n t s 2 0 1 8 Keywords Studios PLC Whelan House South Country Business Park Dublin 18 Ireland T: +353 190 22 730 www.keywordsstudios.com