Electronic Arts Inc.
Q4 2010 Earnings Call Transcript

Published: 12 May 2010

[Operator:]

Good day, ladies and gentlemen. Welcome to the Electronics Arts Fourth Quarter and Fiscal Year 2010 Earnings Conference Call. For opening remarks and introductions, I'd like to turn the conference over to Mr. Peter Ausnit, Vice President of Investor Relations. Please go ahead, sir.

[Peter Ausnit:]

Thank you, Sarah, and thank you, all for joining us this afternoon. Welcome to EA's Fiscal 2010 Fourth Quarter Earnings Call. Today on the call, we have John Riccitiello, our Chief Executive Officer; Eric Brown, our Chief Financial Officer; and John Schappert, our Chief Operating Officer. Before we begin, I'd like to remind you that you may find copies of our SEC filings, our earnings release and a replay of this webcast on our website at investor.ea.com. Shortly after the call, we will post a copy of our prepared remarks on our website. Throughout this call, we will present both GAAP and non-GAAP financial measures. Our earnings release provides a reconciliation of our GAAP to non-GAAP measures. These non-GAAP measures are not intended to be considered in isolation from, as a substitute for, or superior to our GAAP results. We encourage investors to consider all measures before making an investment decision. All comparisons made in the course of this call are against the same period in the prior year unless otherwise stated. Please see the supplemental information on our website for trailing 12-month segment shares, additional GAAP to non-GAAP reconciliations, a summary of our financial guidance and our title slate. During the course of this call, we may make forward-looking statements regarding future events and the future financial performance of the company. We caution you that actual events and results may differ materially. We refer you to our most recent Form 10-Q for a discussion of risk factors that could cause our actual results to differ materially from those discussed today. We make these statements as of May 11, 2010, and disclaim any duty to update them. Now I'd like to turn the call over to John.

[John Riccitiello:]

Thank you, Peter. Earlier today, EA announced results for both Q4 and fiscal 2010. We finished the fiscal year in the fourth quarter slightly ahead of the guidance we provided the Street on February 8. The quarter came in stronger than Street consensus. We are reaffirming our FY '11 financial guidance. Details on the quarter, our fiscal year financial performance and our guidance are in our press release and will be covered in more depth by Eric Brown. Key points I would highlight include these and note, these are non-GAAP numbers. FY '10 was EA's highest revenue year in history. We had a strong financial rebound and FY '10 versus FY '09 increasing EPS by $0.74. We made significant progress on each of our four strategic objectives

[Eric Brown:]

Thank you, John. EA reported solid Q4 financial results today with non-GAAP revenue coming in at the high end of the guidance range of $800 million to $815 million that we provided on February 8. Non-GAAP EPS exceeded the high end of our guidance range of $0.02 to $0.06 per share. Non-GAAP net revenue was $815 million, up 40% year-over-year. On a GAAP basis, net revenue was $979 million. At constant-currency rates, non-GAAP net revenue increased $210 million or 34% year-over-year. On a GAAP basis, net revenue increased $85 million or 10% year-over-year. Non-GAAP gross profit margin was 65.2% compared to 49.6% a year ago. This was up from the prior year primarily due to product mix featuring more owned IP and less distribution product versus Q4 last year. On a GAAP basis, gross profit margin was 69.6% versus 59.4% a year ago. Non-GAAP operating income was $34 million versus a non-GAAP operating loss of $165 million a year ago. On a GAAP basis, operating income was $83 million versus an operating loss of $62 million a year ago. Non-GAAP diluted earnings per share were $0.07 versus diluted loss per share of $0.37 a year ago. GAAP-diluted earnings per share was $0.09 versus a diluted loss per share of $0.13 a year ago. Headcount. We ended the quarter with 7,842 employees versus 9,106 a year ago. 22% of our employees are now on low-cost locations versus 18% a year ago. Cash flow from operations this quarter totaled $253 million versus $215 million a year ago. Fiscal year-to-date operating cash flow improved by $140 million from last year to $152 million. Q4 fiscal '10 highlights. In our packaged goods business. EA was the number one publisher in North America and Europe for the quarter reflecting a four-point share gain year-over-year. We were also number one for the fiscal year with four titles in the top 20 in both North America and Europe. Battlefield

[John Schappert:]

Thanks, Eric. Q4 was a strong finish to the fiscal year, thanks to the launch of some great franchises in the quarter. EA has ranked number one in the western world with 19% segment share for fiscal '10. We had five titles that sold more than 4 million copies this fiscal year

[John Riccitiello:]

Thanks, John. Before we take your questions let me leave you with one last thought on a topic that means a great deal to us, the quality of our game. We banked on success as a company on a simple idea, fewer bigger hits in our core business which will translate into success in digital. What underpins this opportunity of extending the consumer experience with new content and new revenue opportunity is 100% dependent on ensuring that the consumers' first experience with each game delivers an extraordinary quality. Gamers are the most discerning consumers in the world of entertainment. They will not tolerate a shoddy product. Today, I believe that EA has turned a corner and that consumers now identify our games with high quality and innovation. I see it when I review games with our many talented teams and when I read the blogs where gamers communicate. We are rebuilding EA's reputation with consumers. Now we want to show investors how that translates into new revenue streams and increasing profitability. With that, John, Eric and I would be happy to take your questions.

[Operator:]

[Operator Instructions] And we'll go first to Edward Williams with BMO Capital Markets.

[Edward Williams:]

If we can just talk a little bit more about the Digital revenue. What are you seeing with regards to direct download of PC titles? What sort of a growth rate have you seen specifically in kind of that area or the use of Steam? And also, if you can comment a little bit, John. I think on your comments that you just made about the sales codes [ph] basically to people who are buying used games. How is that business looking at this point? And how significant do you see that business becoming over the course of, say, the next 12 to 18, 24 months?

[John Riccitiello:]

So I'll take the first part. Since John have the second, I'll have him follow up on that. In terms of Digital, I'm going to answer by sort of not answering. We are seeing significant uptick. It's particularly sharp with titles that have a history of being strong PC titles. We're still getting our arms around exactly the shape of that business. How much of it is coming off of our own site? How much of it is coming off from Steam? And I'm sure we'll let you in for more information on that at a later date, but consider it a small business growing rapidly for the moment.

[John Schappert:]

And for the Online Pass business, that business is about giving first-time users of one-time-use code, which enables online access plus gives them bonus content per game. And additionally, when they take that game home, they go online, they register, they download the free content. They also will see that there's additional downloadable content available for purchase. So our goal is to turn these customers from thinking that kind of it ends with a disc to really starts with a disc, that there's a lot of additional content for them to be able to purchase and to use in addition to the content that we give away. You mentioned -- we've done this before in a few of our past games, and the uptick of the, if you will, the registration, has been very, very high, exceeding 70% from the codes that we included with the likes of Battlefield

[Eric Brown:]

So Edward, this is Eric. I'd also add that if you look at our overall Digital business, it grew 33% year-over-year for the 12 months. The PC component of that, consisting of full games and extra content, grew at a rate above that average. So it's performing disproportionately better than the average of the overall portfolio. And it's important to note that EA is the number one publisher, overall, in terms of traditional PC market shares. So we have a very good slate of products for that particular platform.

[Operator:]

And we'll move on to Justin Post with BofA Merrill Lynch.

[Justin Post:]

John, when you think about the year, you had quite a few hits like FIFA, certainly, Battlefield, that exceeded your expectations. When you look at your margin profile, obviously, there were some games that lost money. If you were able to improve the hit ratio, how much of an impact do you think that would have on margins? And do you see that opportunity now that you've been with the company a couple of years to kind of improve that ratio.

[John Riccitiello:]

So a couple of thoughts on that. First off, the challenge, I think, we and many other publishers had in what was our fiscal '10 was an opening expectation for big to high, if not double-digit sector growth of the packaged good side. And we actually saw double-digit decline, so a big shift in expectations going into the year versus exiting the year. And I think you know that our strategy responded to a variety of different pressures, but we've been talking for a couple of years about shifting our profile. We made large number of titles, exploited a few of them in one way, packaged goods, with a much shorter number of titles that are much bigger, higher quality, exploited on multiple business models. And that's exactly what we're doing. So if you just go back to fiscal '09, when we had mid-70s in the number of titles. Fiscal '11, we've got mid-30s number of titles. We've cut our titles slate by a little bit more than half. Now in doing that, we're also getting more revenue per IP, and we're getting more revenue per IP by exploiting the best IP across multiple revenue models. Using FIFA as an example, it was once upon a time just a packaged-goods game. Now there is a fee for the packaged-goods game. There is FIFA Ultimate Team, which is disc-based DLC. We just announced our social network game. It's about to go out into a launch from its development stage. We are strong on Mobile. We have our FIFA franchise. We've done well on the iPhone. We've got FIFA Online in Korea. We've actually launched two titles this year

[Operator:]

And next, we'll hear from Jess Lubert with Wells Fargo.

[Jess Lubert:]

In terms of the guidance, I was hoping you could discuss some of the puts and takes to the outlook prior guidance excluding Rock Band. The current outlook includes two titles in the franchise, yet the top and bottom line forecast for fiscal 2011 are unchanged. In light of these additions, can you discuss the decision to leave the forecast as it was. And specifically, can you discuss how the recent decline in European currencies may have factored into the outlook.

[Eric Brown:]

Yes, this is Eric. I think that it's fair to say that there were a series of puts and takes that we incorporate into the current guidance versus 90 days ago. Currency is certainly something that we considered. We're seeing the market is fairly volatile right now, and we're seeing a weakening of the European currencies. And so that's going to have an adverse impact. We did have a pickup of some Distribution business as you noted. That's a net positive albeit a lower-margin business in terms of bottom line EPS impact. And so there are other puts and takes as well. And net, we ended up in the same guidance range with a mindful eye towards kind of currency impacts for the balance of the year.

[Operator:]

Moving on to Ben Schachter with Broadpoint AmTech.

[Benjamin Schachter:]

On Facebook first, I was wondering if you could talk about how do you think the business model is going to evolve there, particularly, as it relates to having a share or possibly sharing economics with the Facebook platform. And then, any other financial detail you could give us on Star Wars in terms of the quarterly run rate on expenses there? Or anything else that we should know? And then finally on SPORTS, just what does revenue look like for the overall category this year versus last?

[John Schappert:]

Ben, this is John Schappert. I'll take the Facebook question. So I think what you're referencing is the talk of credits and Facebook credits and different payment mechanisms with Facebook that are making the rounds. What we see is we see that as a net positive for the business because it reduces the friction for our users to go and pay for the services and products on Facebook. So we're supportive of that initiative. What we do see also happening in that space, because you asked how we see that business evolving, is we think that, that space is going to evolve similar to how we saw the Mobile segment evolved, where when you look at it right now, it's dominated by the brands and the IP that gamers know and trust. And so we're very excited about the launch of FIFA Superstars which is now in beta, which is the first IP we are bringing to that platform. So we're bullish on our IP on Facebook.

[John Riccitiello:]

Eric will do Star Wars and I'll do SPORTS.

[Eric Brown:]

With regards to the Star Wars, yes, there's little to add versus what we previously said on the title. It's clearly a more expensive project than any traditional packaged-goods product. We've noted that before. It's been in development for some time. We are expensing all R&D as we go along, and that's an important caveat. And the only other granularity we'd provide is that it is not included in our FY '11 release slate.

[John Riccitiello:]

In terms of SPORTS, at the sector level, I would tell you that one way to think about it is it being sort of three sub-segments. One is sort of core SPORTS, league fashion SPORTS, if you will. Titles like FIFA, Madden, NBA Live fit into that category. Arcade titles like Wii Sports and analogous titles, others have put them out, including EA, Take-Two and others. And then lastly, the Fitness category, the core business is looking pretty healthy right now. We expect growth this year. We expect EA to do well this year. We've got a strong slate. And so that feels solid for us overall, an incremental title in like a World Cup year. What it under underpins, EA's core feels very solid. The Arcade business is really driven increasingly by First Party. And so the First Party business is still offering, packed down as it is with Wii Sports and Wii Sports Resort. It'll be interesting to see what the specific titles are that might or might not exist in around the other platform holders this year. Something that fit into that kind of Arcade category would include titles from EA this year like NBA Jam, which we previously announced. That's likely pretty volatile and driven more by the individual leases from First Parties and anything else. And lastly, Fitness, the Fitness business, we're a leader there with the EA SPORTS Active. We have a strong release slate this year. We can certainly expect more innovation from Nintendo. We expect a lot of competition. My general expectation this year is that we'll see unit growth, but we'll not see dollar growth as consumers buy fewer hardware peripherals associated with perhaps the Wii Fit platform because we're buying software expansions having the physical apparatus in place already. But overall, it feels like a solid business on the SPORTS side. Core is what we focused most on and that's looks real healthy.

[Operator:]

And moving on to Janney Capital Markets (sic) [Janney Montgomery Scott], Shawn Milne.

[Shawn Milne:]

I just wanted to quickly, a couple of housekeeping, follow up on the guidance there for fiscal '11. What was the rate that you now have implied in your guidance for the Euro?

[Eric Brown:]

For fiscal '11, we're assuming $1.36 USD to the Euro.

[Shawn Milne:]

I mean, it just feels like that back-of-the-envelope math, that's maybe $150 million impacts from where you were in prior guidance?

[Eric Brown:]

No, it's significantly less than that. The one thing I would note is that vis-à-vis the Euro, we are substantially hedged, not completely, but substantially hedged internally with good full year revenue offsets versus OpEx, and so less of a concern on the volatility of the Euro.

[Shawn Milne:]

I was talking more of top line, I guess, wrapping in the pound, but just back to the quarter, did you -- you said Battlefield's sell-through, 3 million units. What was the 5 million? Is that shipments live to date or is launched to date?

[Eric Brown:]

Yes, the 5 million units, which we noted on the press release, was as of yesterday or so. The total units sold into the channel.

[John Riccitiello:]

Including Digital.

[Eric Brown:]

Including Digital units, PC.

[Shawn Milne:]

So for the quarter, could you give us the exact shipments for the quarter.

[Eric Brown:]

3 million in sell-through in the quarter.

[Shawn Milne:]

It just feels like with Battlefield being so strong that you might have delivered a little bit more upside. Did you break out your catalog sales and what they were for the quarter?

[Eric Brown:]

We'll check the catalog sales for the quarter in terms of percent, we'll get back to you on that.

[Shawn Milne:]

Was catalog a little bit weaker than expected?

[John Riccitiello:]

Catalog was a little bit lighter than we expected because of strong Frontline releases.

[Eric Brown:]

Catalog was 23% of overall revenue for the fourth quarter.

[John Riccitiello:]

Yes, a couple of our titles had some surges right at the end of Q3, puts us encompass a little bit in Q4 in catalog. FIFA was among those. So nothing really uneven there other than it was a little bit different in shape of what we might have expected otherwise.

[Operator:]

Next, we'll hear from Arvind Bhatia with Sterne Agee.

[Arvind Bhatia:]

Just a couple of title-specific questions. Specifically on Medal of Honor, given that it's coming back after a gap, could you provide some sort of quantitative or qualitative color on that so we can form the right expectations in it's come back here. And then FIFA, with the two titles this year, can you help us understand where your thinking is in terms of the overall FIFA franchise growth that you're expecting this year?

[John Riccitiello:]

First on Medal of Honor, I would give you this color. We generally do not break out by title forecast. In fact, I don't think we ever had. I would tell you that, and this is probably maybe one of the largest statements we'll make on the call, we're not going to be happy until we've taken the leadership back in the first-person shooter category. And the tip of the spear is a combination of Battlefield

[Arvind Bhatia:]

One last one for Eric. Eric, you gave gross margin guidance for the year. Given the mix that you're modeling for the next few quarters, can you talk about gross margins on a quarterly basis?

[Eric Brown:]

Yes, at a high level, I would say that in Q1, this is on a non-GAAP basis, we're expecting gross profit margins in the low 60s; Q2, mid-50s; Q3, low 60s; and Q4, mid-60s.

[Operator:]

[Operator Instructions] We'll move on to Heath Terry with FBR Capital Markets.

[Heath Terry:]

I was wondering given the push especially with going to Online Pass on the SPORTS products, with the push behind registration keys, can you give us a sense of what you're seeing? What kind of impact you're seeing that have on the used market whether or not, at least at this point and the experience that you've had so far, you're seeing either the rate of games being sold back or the usage of those games hitting your servers changing at all?

[John Schappert:]

Heath, this is John Schappert. We don't participate in the used market, and we have not launched Online Pass yet. We launched it on Tiger. What I can give you some color on, though, is looking at Mass Effect with our servers network, in Dragon Age and Battlefield with our VIP code, which had basically bonus content with purchase for the first-time purchaser and the ability for second purchasers to purchase that bonus content, we saw a very, very high redemption rate, north of 70% of first-time purchasers using the code and redeeming the content. And we saw a low percentage, single-digit percent of purchasers, non-first-time registers purchasing the code. What we also saw there more so was by giving people this access code, we got them into the online world. And so we've seen very, very strong uptick in downloadable content across all of those titles because we have

[Heath Terry:]

Sure, yes, I get that. I guess what I'm trying to get to is you mentioned the low single-digit purchase for the used titles that were hitting the servers. On a relative basis, we're you seeing fewer of those used titles hitting your servers relative to maybe some titles that you had released last year that, obviously, didn't have these kind of registration keys?

[John Riccitiello:]

This is John. Just for clarity's sake, we don't have a way to distinguish a used consumer versus a new consumer when they're hitting our servers. We can't distinguish between someone who's got the code and doesn't have the code. And then we sell the code. I think what you're getting at is the answer to a question that we'll probably be in a better position to answer towards the end of this fiscal year in terms of exactly how much business we build among users that don't have codes or that they purchased the codes. What we can tell you is, and virtually, every way imaginable, the scenario where the consumer puts in the disc and reaches for their business models is on an uptick. And we've established this strategy among others to build our Direct-to-Consumer business often starting with the disc. We think it's a great idea. We think it's going to build our business, and we think it's a positive consumer experience. Invariably, the consumer is getting a boatload, more content and experience than the otherwise would. We used to literally pull our teams off of a game within probably four to six weeks pre-shift, and then they go work on something else because the game was done. It was going into manufacturing. Their job was done. John Schappert referred to that on his script earlier as once you shipped it [ph], forget it. Our teams are being held in place up through and beyond shift. They continue to create content to entertainment the consumer with new content associated with the IP they like best. This is why when we go from 72 titles or 75 titles a few short years ago, we believe we can successfully go to 36 titles, having our title counts and retaining our revenue by generating more revenue per IP, by extending our business models into subscriptions, into micro-transactions and to downloadable content. And then in the new platforms like social networks, we're putting our IP through the Pogo. We're building directed services like Tiger Online, FIFA Online and Battlefield Online.

[Heath Terry:]

Was there some reason that the decision to do Pass wasn't done in front of the World Cup launch?

[John Riccitiello:]

The honest truth is we've been preparing for this for the better part of 18 months. Our first step was with what we did with NBA Live about a year and a half ago when we had the Live season data. And the first time we put something behind a coupon code is we had first in the industry. We had to build our infrastructure. We had to get what we called our nucleus registration database into a bullet-proof position so we knew we could manage intelligence and entitlements without leaving the consumer sort of left holding the bag where we make mistakes. We've now got more than 60 million people that have registered on that database, and we're managing entitlements from it. But it took us a while to build. It may seem simple, but the underlying database structure and architecture to support it was not simple. But we're now in a position to be able to do it across the full range of titles from Electronic Arts.

[Operator:]

And we'll now move on to Lazard Capital Markets, Colin Sebastian.

[Colin Sebastian:]

I guess first of all, we're curious how deeply you're integrating the motion-sensing controls into the second-half product lineup and how well you think that technology is progressing? Secondly, on the Facebook games, John, I think we've seen a bit of a low in growth there in the past couple of months. I'm wondering if you could provide your perspective on that. And then third, curious also on your perspective on what seems to be a bigger push at retail for the used products, someone in opposition of where you're headed with the Online Pass and whether you expect any impact there on new product sales as Wal-Mart and Best Buy seem to dig in on used.

[John Schappert:]

Colin, this is John Schappert. I'll take your first two, the first one with respect to motion-sensing controls in our products. We've only announced Tiger Woods for the Sony move to date, and we have more announcements you can expect from us at E3, inclusive of demos of some of this technology. So you'll have to wait until then to see and hear more. That said, we're bullish on these new controllers and this new technology because we think it brings new consumers into the market. It's going to be a big push, obviously, for the hardware companies. This fall, it's going to bring a lot of attention to our industry, a lot of new users to our industry and breathe some new life into these consoles, which is kind of exciting. So we're bullish on their upside for our space. With respect to Facebook, we're happy to say that our Playfish team has booked the MAU and DAU decline in the fourth quarter that Facebook saw. So basically, while most of the top 25 games dropped, in fact, they dropped by 4% in DAUs, Playfish increased by 23%. And their MAUs ended at 59 million at the end of April, which is up 17% since January. Now that was because of some nice, good reengineering efforts on Pet Society and Restaurant City to keep those titles fresh and new, as well as the launch of Hotel City, which is certainly made up for any declines in growing their share as well. So we're pretty bullish there. And again, we're excited about the upcoming launch of FIFA Superstars with them, too.

[John Riccitiello:]

This is John, regarding retail. First off, I'd just want to clarify, I don't view what we're doing is in opposition any way, shape or form relative retailers seeking to be in the second-sale business. I think it's notable that GameStop joined us with our press release to announce EA SPORTS Online Pass. I think it's an opportunity for us to build the business direct to consumers. I think retailers will ultimately find the best way to participate, and I think we'll be able to grow our business very successfully behind this strategy. Now in terms of the other retailers getting into second sale, they're mostly using third parties to do so. There has been a number of announcements. I would probably suffice it to say that it's a challenging business to operate because you're taking in inventory, repackaging the inventory, reselling the inventory, but I'm certainly happy not to begin. But for us at least, we look at our Online Pass and analogous businesses and strategies we've put in place over the last couple of years as being very pro-consumer, with delivering more content to consumers just the way they like it, and we're very pleased that the key retailers are supportive of our strategy just that.

[Operator:]

And that does conclude our question-and-answer session. Gentlemen, I'll turn the conference back over to you for any additional or closing comments.

[John Riccitiello:]

No. Thank you very much for joining us on the call, and we will see you at quarter out.

[Operator:]

Thank you. Ladies and gentlemen, that does conclude today's conference. We thank you for your participation today.