Electronic Arts Inc.
Q4 2013 Earnings Call Transcript

Published: 8 May 2013

[Operator:]

Welcome, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. Now I'll turn the meeting over to Mr. Rob Sison, Vice President of Investor Relations. Thank you. You may begin.

[Rob Sison:]

Thank you, and welcome to EA's Fiscal 2013 Fourth Quarter Earnings Call. With me on the call today are Larry Probst, our Executive Chairman; Blake Jorgensen, our CFO; and Frank Gibeau, our President of Labels. Peter Moore, our COO, will be joining us for the Q&A portion of the call. Please note that our SEC filings and our earnings release are available at ir.ea.com. In addition, we have posted earnings slides to accompany our prepared remarks. Lastly, after the call, we will post our prepared remarks, an audio replay of this call and a transcript. This presentation and our comments include forward-looking statements regarding future events and the future financial performance of the company. Actual events may differ materially from our expectations. We refer you to our most recent Form 10-Q for a discussion of risks that could cause actual results to differ materially from those discussed today. Electronic Arts makes these statements as of May 7, 2013, and disclaims any duty to update them. Throughout this call, we will discuss both GAAP and non-GAAP financial measures. The comparable GAAP measures for certain non-GAAP measures to be discussed are

[Lawrence F. Probst:]

Thanks, Rob. As most of you know, I have agreed to serve as EA's Executive Chairman while the Board of Directors searches for a new CEO. In this role, I am focused on 3 key priorities

[Blake J. Jorgensen:]

Thanks, Larry. First, I'd like to begin with Q4 results. During the March quarter, the packaged goods market on the West continued to be soft, characteristic of what happens during a console transition. EA's total Q4 non-GAAP net revenue was $1.04 billion, which was within our guidance. In the quarter, we saw solid sales for SimCity, most notably from direct downloads. However, Crysis 3 and Dead Space 3 came in below our forecast. Compared to the same period last year, net revenue was up 6%, driven mainly by our digital revenue. EA's Q4 non-GAAP digital net revenue increased 45% year-over-year to $618 million. Trailing 12-month digital net revenue was $1.66 billion, representing growth of 36%. Our digital business continues to be a diversified mix of high-growth, profitable segments. Breaking the digital revenue down by type shows the following

[Frank D. Gibeau:]

Thanks. As Blake noted, it was a challenging year with both hits and misses on the product front. However, we're proud of our overall product quality, our progress in digital and our record for creating blockbusters across multiple genres and on multiple platforms. Additionally, the investments we made last year in next-gen technology will deliver great games this year. Now I want to offer some color on Q4 and a look ahead to the games we're developing in the new fiscal year for consoles, mobile and PC. I'll start with Q4 and SimCity, a great game that has recovered from a challenging launch. The short explanation for the launch is that the initial rush of consumers overwhelmed our gaming service, disrupting the consumer experience. As we stabilized the game and improved service in the first week, fans continued to pour in. So far, we are ahead of forecast, with more than 1.6 million units sold through to customers. The digital story is particularly strong, nearly 50% of those sales were high-margin digital downloads. The key takeaway here, SimCity is a highly resilient global franchise with a long service life in front of it, but we learned our lesson and are now building better processes to anticipate that service demand. This will not happen again. Also in Q4, we had some success that affirms our belief in the ongoing growth of the mobile and PC platforms. On mobile, The Simpsons

[Lawrence F. Probst:]

Thanks, Frank. To summarize, EA is in very good shape. At the core is a great team delivering innovative games and services. We have invested in product quality, digital delivery and sustainable leadership on console, PCs and mobile. In recent weeks, we underwent a reorganization to focus our product portfolio and reduce our operating costs, and we have constructed an ambitious but achievable business plan for our employees and shareholders. Best of all, we have an incredible lineup of games and services for our consumers. With that, Blake, Frank, Peter and I will take your questions.

[Operator:]

[Operator Instructions] Colin Sebastian from Robert Baird.

[Colin A. Sebastian:]

I guess first off, curious now that you're talking a little bit more about the next gen, how should we expect EA's consumer online service in Origin fit together with some of the other platforms that have similar online services and platforms like Sony and Microsoft? And then secondly, sounds like you're seeing some better traction in The Old Republic since the switch to free-to-play and was hoping you could provide a little more color on some of the stats from the game, perhaps with a breakout as between free-to-play and the subscription side?

[Frank D. Gibeau:]

Sure. This is Frank. I'll start with the second question first. As you know, last year we took a new approach in Austin by introducing some new pricing models to Star Wars

[Peter Robert Moore:]

Yes, and Colin, let me address the Origin question. Just to update you on the installs, we're now at 47 million, of which 27 million are on the PC and then 20 million on mobile. And as you might imagine, with Battlefield 4 coming this year, we're expecting a very strong comp year-on-year on Origin. We love the fact that we can interact directly to our consumers through the Origin platform, and you can expect to see a ton of new consumer-friendly gamer-friendly upgrades in the feature set this year.

[Operator:]

Edward Williams from BMO Capital Markets.

[Edward S. Williams:]

Just a couple of quick questions. Larry, I was wondering if you and Blake can kind of follow up on your comments with regards to kind of your confidence level in the cost structure as we enter this console transition, given as you pointed out, Larry, that it's been 31 years, you haven't been able to keep costs flat on a year-to-year basis. And then secondly, Frank, if you can tell me a little bit more, just clarify for me a little bit more about Star Wars in terms of which platforms the games actually can be playable on?

[Blake J. Jorgensen:]

Let me start. This is Blake. I'll start with the operating margin question around the console transition. I think as everyone knows, we've given guidance over the last year that we were spending roughly $100 million a year on next-gen development. We've continued to include that in our expenses. What we've done is we've gone through a very detailed process to eliminate expenses associated with products that either aren't growing or aren't large enough or aren't on platforms that we feel are long-term viable in the industry. And then we've also focused on how to minimize costs around the support structures inside the organization to make sure that the studios are getting the core funding for developing games. And so we've tried to consolidate our marketing organizations. We've tried to consolidate our G&A support to make sure that we have a very lean structure. And we've taken those actions during the last 2 quarters to try to tee us up in a position where we'd be able to announce to you that we're going to hold our costs flat for the coming year. We're very confident of that. And for those who know Larry, he's a very tough manager. And so he's holding the executive team to that goal, and we're very focused on continuing to look for ways to bring our operating costs down to continue on the journey of expanding our margins.

[Frank D. Gibeau:]

On the -- this is Frank. On the second question about the agreement with Disney. We are not offering any additional details on which titles we're doing right now, but I do want to clarify and call out one thing that we do have rights to make the games on all platforms

[Operator:]

Justin Post from Merrill Lynch.

[A. Justin Post:]

Blake, maybe you could reconcile the $0.85 this year to the $1.15 next year x the tax change. What are the big, big drivers and how confident are you in that $1.15? Is there an upside case to that number that you guys are thinking about and maybe what are the potential risks?

[Blake J. Jorgensen:]

Justin, so I think -- let's start with the top, at the revenue line, the $4 billion in revenue we believe is a realistic revenue number within the guidance or within the confines of a console transition. As I said, we've tempered our views on the Gen3 titles, particularly our sports titles which will be out in the early fall. We also are very optimistic about Battlefield 4. The pre-orders look very strong, and we've had great reaction to the demos, as Frank has mentioned. So we're confident about the revenue line and that represents some serious growth across all of our different components, digital and packaged goods. On the OpEx side, we're also confident primarily because some of the cost actions we've taken and the fact that we fully baked in estimates for marketing expenses associated with both Gen3 and Gen4 titles, the costs associated with developing the new Disney Star Wars titles and the continued expansion of the mobile titles that Frank mentioned in his topic. So all in, I think we're in very good shape. The CapEx line is pretty consistent with what it has been in the past. And so we're fairly confident that we can deliver those subject to massive change in the market in the next couple of quarters. But based on what our expectations are for a smooth transition and primarily Gen3 revenues for us for the year, we're fairly confident of that.

[Lawrence F. Probst:]

To answer your question about risk, I think the primary issue relates to the next-generation consoles and the questions are when and what kind of quantities and what sort of price point. But we think we have planned conservatively around that issue and around those questions, and we have a high level of confidence in the guidance we provided.

[A. Justin Post:]

Okay, great. And one maybe follow-up. How are you thinking about the Sims 4? Is that a really important earnings driver in the year?

[Blake J. Jorgensen:]

Well, it's clearly 100%-owned IP. As SimCity, that was in Q4, it's an important earnings driver in the fourth quarter. But I would take our announcement now a full -- almost a year ahead of schedule that we're very focused on making sure it's delivered in the quarter and will be delivered in a way in which we think consumers will gravitate to the title. And we'll see both strong packaged goods, as well as digital business in that title.

[Operator:]

Arvind Bhatia from Sterne Agee.

[Arvind Bhatia:]

I had a couple of questions. First of all, I was wondering if you guys can talk about Battlefield Premium, what you're assuming for fiscal '14 relative to fiscal '13? And then a couple of product questions on the NBA Live product. It's coming back. It's in your lineup now. Maybe a quick update on where that is in development?

[Frank D. Gibeau:]

Sure, Arvind. This is Frank. I'll take both questions. On NBA, we're very focused on getting into the NBA business in a significant way this year. It's a very competitive category. We're the clear market leader there. So you'll learn more about our plans on NBA at E3, and we're very excited about that. As it relates to Battlefield Premium, we have no announcements at this time as it relates to a potential premium program for Battlefield 4. We can tell you that premium on Battlefield 3 was accounted for in fiscal '13. It was a very well-received platform and subscription that the customers really liked and enjoyed. It was great value. So that would be the texture and color I'd give you on premium.

[Blake J. Jorgensen:]

What I would add -- and this has nothing to do with Battlefield 4 premium announcement. This is just a pure accounting statement. The accounting team here has been very focused on how do we recognize subscription revenue over time or on a ratable basis associated with the life of the subscription to try to avoid the lumpiness of the Battlefield 3 Premium. We know that frustrated people that they didn't see it until the end quarter, and so we're working to try to smooth that if we have future products like that.

[Arvind Bhatia:]

One quick one for Larry. Larry, you've gone through several transitions in this business. The technology leap we are about to see that you mentioned, how does that compare to what we've seen in the past and just give us your comfort and confidence level in what we are about to see in the coming generation.

[Lawrence F. Probst:]

In many respects, I think this is similar to what we have seen before. I mean, obviously these next-generation consoles are going to be more powerful and deliver more exciting and more fulfilling entertainment experiences. And obviously, these are companies that we have worked with historically and have good relationships with. So I think a lot of similarities to previous transitions. We're excited about it. As I said in my earlier comments, we think it's really important to get out of the box quickly with a portfolio of products that will drive market share for us and hopefully delight our consumers. So we're looking forward to it, and we think we're going to have a great reveal at E3. Frank?

[Frank D. Gibeau:]

Yes, the only thing I would add is that in comparison to last transition, we're in a much better state as a company in terms of our development. As I mentioned in my remarks, our investments in Frostbite and EA SPORTS over the last year has really put us in a position where the technology side or the engine side of this transition has largely been derisked. And so we feel very good about how we're heading into this console. We're in much better shape this time than we were last time.

[Operator:]

Doug Creutz from Cowen.

[Douglas Creutz:]

Yes, maybe you could comment on -- you had a pretty big divergence between some significant revenue growth in Europe in the quarter versus decline in North America and what was driving that? Were there specific titles or industry conditions and so forth?

[Peter Robert Moore:]

Doug, it's Peter. I think a lot of it was the strength of our catalog in the quarter, particularly of FIFA in Europe continued to do extremely well. You saw our numbers on FIFA digital, particularly FIFA Ultimate Team. And that has a stronger bias towards the European market than it does towards the North American market, although North America is growing rapidly with the FIFA franchise. And we have great hope and expectations that, that will continue in fiscal '14. But I think you can point to strong catalog, growing digital, particularly in the European market that we're seeing now as those individual markets start to really come up to speed with their broadband distribution, not only through our own platform, Origin, but our third-party e-tailers in Europe. And again, as I say, through FIFA, I think those were the core drivers that you saw the discrepancy between North America and Europe.

[Blake J. Jorgensen:]

I think you're seeing the continued growth of FIFA as a product, and as we mentioned, the continued playing of that product all during the sports calendar. The old days of people playing for a quarter or maybe even 2 have gone away and the combination of FIFA with FIFA Ultimate Team has created an amazing consumer experience that continues through the entire sports year. And in the case of soccer, that's almost 12 months. That's just a fantastic business for us, and we're very excited about the coming sports calendar.

[Operator:]

Brian Pitz from Jefferies.

[Timothy O'Shea:]

Yes, it's Tim O'Shea for Brian Pitz. Just wondering if the Star Wars deal reflects a strategy shift away from internally developed IP? Or was that decision to acquire the license more opportunistic given Disney's decision to shut LucasArts? And I have a quick follow-up.

[Frank D. Gibeau:]

This is Frank. As it relates to our overall portfolio, this is very complementary to our wholly-owned IP plan. Wholly-owned IP is the centerpiece of our portfolio. We're going to continue to invest and grow that. The Star Wars products and ideas that we have for that business line are very complementary to what we are currently planning over the next couple of years. And it gives us a real opportunity to reach new markets and new audiences that potentially will be very accretive over the long term.

[Timothy O'Shea:]

And then quickly, I know you mentioned the 11 announced titles for fiscal '14. Just wanted to clarify, are these the only titles that are included in guidance? Or maybe is there something like a new Star Wars title? Or you mentioned some new games that might be announced at E3. Are those baked into guidance at all?

[Blake J. Jorgensen:]

The 11 titles are what we're basing our guidance on, plus the 15 mobile titles that Frank mentioned. So obviously, mobile's a large portion, but that is what we're basing guidance around. And if you feel like there’s a title that's missing, that's because we probably don't have it in our title plan for the year, were trying to be fairly focused this year and make sure that we get the Gen4 titles off the ground when those boxes are available.

[Timothy O'Shea:]

Got it.

[Frank D. Gibeau:]

And in the case of Star Wars, it is part of the guidance as well.

[Blake J. Jorgensen:]

Yes, the Star Wars expenses are in there. But obviously, we're not planning on shipping any title in FY '14.

[Operator:]

Mike Olson from Piper Jaffray.

[Andrew D. Connor:]

This is Andrew Connor on for Mike. I would ask about the console cycle and just understanding how most estimates suggest the new consoles are going to ramp slowly, so would just be curious how important to you really the current gen installed base is going to be really this fall, this holiday and next year? And then you alluded to E3 in talking about being able to talk about more next-gen titles. I'm just curious what you're expectations are in terms of the total number of sort of console titles after the next-gen consoles are out. And then lastly, obviously FIFA is doing very well globally and we're approaching a World Cup year, so just wanted to hear your sort of preliminary plans on calendar 2014 as it relates to FIFA.

[Frank D. Gibeau:]

This is Frank, I'll step through. I think there's about 4 questions there. In terms of the ramp on next-gen consoles, it's way too early to tell or forecast whether it's slow or fast. We're big believers in next-gen consoles being a key growth driver for -- we're looking at in terms of the overall market. So I don't think you can characterize next-gen consoles would grow slowly or fast. We'll learn more as we get further into the year, at E3 and beyond. As it relates to current gen platforms, I think we launched a PlayStation 2 version of FIFA about 2 years ago. Very profitably and that was a good product for what customers were looking for. The current gen platform is going to stick around for a while. It will be a viable platform much like PS2 was a very viable platform for an extended period of time. So it will not dry up and go away immediately. It'll be there as an existing platform for us to continue to publish games against over the next couple of years. As it relates to FIFA and an upcoming World Cup year, as you know, in the past we have done World Cup editions of the FIFA franchise. We have nothing to announce at this time on this call, but it's clearly going to be a soccer mad year next year with the World Cup coming and with the continued expansion and popularity of the Premier League and the other leagues around the world. So we don't see any slowdown happening in the soccer business for a while.

[Peter Robert Moore:]

Andrew, this is Peter as well. Let me just add in from a sales perspective on consoles, and I've been through a couple of hardware trans, not as many as Larry, but a couple of hardware transitions myself. And typically what we see here, you're seeing a little bit of a polarization of the marketplace right now. The top 10 titles taking more and more of the unit revenue. In calendar year '12, we saw 49% of our total revenue occupied by the top 10 titles. And from that perspective, that will probably continue on a polarization basis until, to Frank and Larry's point, we learn more about next-gen announcements in -- at E3. You typically see a little bit of a slowing down of the current gen and then once next gen is out, you actually see an increase again. And we saw an actual -- when we looked at the numbers from the last transition, we saw an increase of 10% in the post-year launch of the current generation. So from that perspective, we're pretty bullish the current gen continues in its 8th year, pricing seems to be holding up well. So from the perspective of continuing to drive against Xbox 360 and PS3, we're extremely bullish.

[Andrew D. Connor:]

And if I could just ask a question on the total console title count with the addition to maybe some Star Wars games moving forward and NBA Live, do you expect the total console title count to increase during the next gen or is it going to kind of continue to be at this reduced level?

[Frank D. Gibeau:]

My expectation -- this is Frank. My expectation is that as the console transition gets through this year and expands, you'll see our title count go up.

[Operator:]

James Hardiman from Longbow Research.

[James Hardiman:]

Two questions. First on the guidance. Maybe Blake could take this one. From a cash flow perspective, talk a little bit about the uses there. Share count was down I think 20 million shares fiscal '13 versus '12 and your guidance is actually turning out a little bit much better cash flow it sounds like you guys are guiding to. How should I think about that? What are the other potential uses for that cash if not free cash -- share buybacks, I should say, or is that just conservative guidance at this point?

[Blake J. Jorgensen:]

We're not building into the guidance any share buyback forecast. We tend to do our guidance without that. You can assume that since we’re only about halfway through our buyback program we'll continue to look for ways to return cash to shareholders. The CapEx, as I said, it's pretty consistent with what it was last year, around $100 million. And so assume that everything is free cash flow below that until you see future buyback. As we do those, we'll report in to you each quarter what those buybacks were and how much we spend on them.

[James Hardiman:]

Great. And then a question for Frank on Star Wars. Obviously, you're extremely limited in terms of what you can say with regards to licensing arrangements, but can you tell us just a little bit directionally how the royalties may compare with the new Star Wars agreement with regards to maybe some of your other license-based games? Is this going to be a margin enhancing relationship? Or could it dilute margins a little bit? Obviously, Lucas has historically been known to charge a little bit of a premium in terms of royalties, but how does this fit in with the rest of your portfolio?

[Frank D. Gibeau:]

Yes, I can get into too much detail on how it compares and contrasts other than to say that the business plan that we looked at over the long term in this agreement was very good for Electronic Arts. It will contribute both top and bottom line growth. And as it relates to margins, we are very comfortable with making this investment, in making this commitment.

[Operator:]

Ben Schachter from Macquarie.

[Benjamin A. Schachter:]

Just a couple of questions for Larry and one for Blake. Larry, within the context of the financial history of EA over the past few years versus when you were last CEO, just wondering, at a high level, if you could help us understand your philosophy around guidance and around sort of leading the company internally and externally. And then long-term margins, there was no discussion about that on the call. In the past, you've achieved 20%-plus. Is that something that you're targeting again? And what are the key factors that could make that happen? And then, Blake, just help me understand that the guiding to flat OpEx, even though you just had pretty significant headcount reductions, just how does the math work there? Why don't we see OpEx going down?

[Lawrence F. Probst:]

With regard to philosophy about planning and guidance, I would say my philosophy is to be conservative and exceed expectations. As we mentioned, as we went through the script, we've taken a hard look at the organization. We have really focused the product portfolio. We've made some adjustments in terms of headcount and operating expenses. My job is to make sure that we're growing the top line and the bottom line and rationalizing headcount and cost in conjunction with revenue. I think we've done a really good job of that in nailing down our fiscal '14 plan. I said earlier, we have a high level of confidence in the guidance that we provided, and we're excited about the product portfolio this year and future years going forward.

[Blake J. Jorgensen:]

Both on the margin and the guidance question. On the margin question, clearly, we've been very public about our goal to continue to march towards a 20% operating margin, if not higher. And that's a combination of continued expansion on the gross profit line. Digital is a major driver there, as well as our investment in the back office abilities to deliver our digital platform. And all of those are on track. The gross margin for the forecast is dampened slightly by the fact that Battlefield is such a large product for us, a number of units that will skew towards more packaged goods just because of its size and that counters the gross margin growth in some way, but we'll continue to be on that path. I think the key to remember on the operating expense forecast is Gen4 investments that we're making, plus investments in a couple of key products during the year. So you should assume that we'll spend more money marketing Battlefield than we did Medal of Honor, for example, and continuing to build out the digital platform and the mobile platform. As I think Frank said, investing in 15 mobile titles. All of those are what I would call increases in operating expenses. We counterbalanced all those by decreases in expenses associated with the organization and with some products that we're stopping. That's allowed us to hold OpEx flat, but those would be the reasons you're not seeing an OpEx coming down during the year.

[Operator:]

Eric Handler from MKM Partners.

[Eric O. Handler:]

Just wondered how we should be thinking about the catalog business this year and how it sort of plays out as you get closer to the transition of a next gen cycle? And also when you look at your cash and when you ended the year nearly $1.7 billion in cash. Let's say you generate another $300 million or so in free cash flow, how much cash do you really think you need on hand? And as a follow-up to a prior question talking about allocating the cash. Is acquisitions -- are those really viable at this point going forward? Or some of the other uses you might have for your cash.

[Peter Robert Moore:]

Eric, this is Peter. I'll talk about catalog. It's always a strong pillar for us to lean on as we head to a transitional period, and this year will be no different. As I mentioned earlier to a previous question, catalog was very strong for us in Q4. We expect it to be strong again in Q1, primarily because we have but 1 major release in FUSE. And then as we head into the transition and hopefully into next-gen consoles by the holiday, depending on what's announced in the next few months, it will still continue to be a large part of our business, but then our focus obviously moves to the front line titles. Our back end of the fiscal year is heavy laden as it typically is with our new releases, so we'll transition our publishing teams on the ground to focus on front line.

[Blake J. Jorgensen:]

On the cash question, we're very comfortable with the current cash balance. As a reminder, about 60% of that's offshore. We do have a convert outstanding that we think about all the time as a bill coming due at some point in the future. But also I think most important, we're very focused on the internal opportunities that we see today. We have purchased businesses over the last few years, and we've been spending our time trying to figure out how best to integrate those and leverage those. PopCap, for example, huge opportunity with the Plants vs. Zombies and Bejeweled franchises. And we're really focused on how we get our best value out of those existing franchises versus worrying about going out and buying something new. Our goal is to return cash to shareholders, and we'll do that in whatever is the most efficient way to do it at the right time. But you should continue to see buyback programs and very much a focus on generating cash flow over time.

[Rob Sison:]

Thank you much for joining our call, and we'll catch up with you next quarter.

[Blake J. Jorgensen:]

Thank you, everyone.

[Operator:]

Thank you. That does conclude today's conference. Thank you for your participation. You may now disconnect from the audio portion.