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Executives

Andrew Wilson - Chief Executive Officer

Blake Jorgensen - Chief Financial Officer

Analysts

Stephen Ju - Credit Suisse

Electronic Arts Inc. (EA) Credit Suisse 2013 Annual Technology Conference December 3, 2013 4:30 PM ET

Stephen Ju - Credit Suisse

All right, I think we're going to go ahead and get started. I'm Stephen Ju, Research Analyst here at Credit Suisse; joined by Andrew Wilson, CEO; and Blake Jorgenson, CFO of Electronic Arts. Welcome gentlemen, and thanks for joining us.

So Andrew, you're 77 days in, into your new position as a CEO. Can you tell us, why you think the board chose you to lead the company?

Andrew Wilson

Yes, listen, we've spent some time kind of working through this and I actually asked them a lot of questions, as we went through the process, and I think it comes down to four things. And the first is I think they chose someone internal versus external. What I was saying was they like our strategy as a company, they believe we have great talent internally and they are looking for us to continue the strategy building hit titles with a foundation of cost management.

The second thing is I think they chose someone of my generation, I would say, because I have a long-term view on the company, it's not a short-term view, it's not a hack and slash cost cutting, but it's a long-term drive to profitable growth. And they wanted someone who had a requisite runway and the passion and commitment to the company long-term to drive that strategy forward.

The third thing is they I think other than maybe the earliest CEO, I'm the first CEO to come up through the organization from the studio system. I think what they're saying is that games are important, platform is important, analytics is important, marketing is important, but at the end of the day, the future of this company will live and die based on hit quality software. And they wanted someone with a passion, an understanding and an aptitude for that.

And then, lastly I think that I had the great fortune of leading our sports business for the last few years. And inside of our company, I think it was one of the more advanced thinking of the divisions of the company in terms of digital and our evolution to digital, our Games-as-a-Service mentality and our overall profitability. So I think you put those four things together and you get me.

Stephen Ju - Credit Suisse

And prior to you appointment, EA has provided the Street with a target of hitting 20%-plus percent operating margins in the next two to three years. Is the company still committed to the target?

Andrew Wilson

The short answer is, absolutely yes. And one of the things that Blake and I've been talking about since I took this role and certainly we've been part of the same management team for a while is really there an opportunity to kind of drive and accelerate that. And while it's too early to kind of make any commitments at this point, I think we feel bullish on our ability to effectively mange cost and drop those kind of margins.

Stephen Ju - Credit Suisse

Given your background in digital as well as exposure to the business model in Asia, how will you be looking to change EA's development and product planning?

Andrew Wilson

With Asia?

Stephen Ju - Credit Suisse

No. I mean, like in general, in terms of your development strategy. You have to be thinking about multiple territories, multiple platforms, multiple revenue models now. So how does that get reflected in your development strategy?

Andrew Wilson

Yes, listen, I think that if you take in the influx of new platforms, you take in the influx of new business models and you take in the influx of new territories, each one of those things brings about some great positives in terms of just broadening the gamer base. And again, when you think about growth in our industry, the single greatest driver of growth is the ability to get more people playing games.

However, the challenge of course is that you got to build for different geos, and different platforms and different business models, and it's very easy to get distracted in the environment where there were so many options. And one of things that we've been talking a lot about is the management team is really, how do we focus and how do we really drill down on what truly are the best opportunities.

And even in the short time that I've been in this role, we've really tried to re-architect the organizational structure and move away from silos and [ph] factums internally, and get to a view of EA as one company and one team, where we can truly manage and focus the investment against what are the biggest opportunities.

And in some cases that's Gen-4 console, in some cases that's mobile and in some cases that's PC free-to-play in emerging market. But what we are trying to do is make sure that we are eliminating duplication, inefficiency, hobby products that ultimately won't drive the long-term profitability of the company.

Stephen Ju - Credit Suisse

Now, the development cycles for leisure sports franchises went from rolling out at one shot, an entire seasons worth of content once a year to now rolling out incremental downloadable content in between annual cycles. So do you fee like from a development standpoint, you're running harder to capture the consumers' attention? And Blake, from your perspective, do you feel like the ROI on allocating the development staff to release the downloadable content superior to what you already see on the disc or is the payoff a little bit more difficult to discern?

Blake Jorgensen

On the ROI question, I think the payoff is exceptionally high and we also believe it's a great experience for the consumer. So it's a perfect win-win. The opportunity to allow consumers to play a game they love alongside of the sport, as it plays through the season and to add either extra content or ultimate team fantasy experiences that embrace and extend the game play are fabulous experiences from the consumer, and from our standpoint are very profitable ways to continue the franchise.

I think the other important piece is when someone plays now in the case of FIFA, often times 12 months, the cost to reacquire that customer for the next FIFA is much, much lower. And we like that ability to keep the consumer in that cycle as well as to continue to improve the consumers experience through playing the games.

Stephen Ju - Credit Suisse

I think you bring up an interesting point, the cost of reacquiring a customer, and your marketing spend is one area, where you're realizing some of the cost savings. So how has the mix of marketing changed from the time you first took over as CFO to what it is now? Where are you getting these efficiencies?

Blake Jorgensen

So one of the biggest shifts for us was simply an organizational shift, trying to consolidate marketing inside the organization to stop the sprawl essentially and to get it under a single leader that allows for greater sharing of experiences, greater sharing of skill sets and more focused on where the dollars are being spend.

Longer term our real focus is to try to move away from traditional large scale marketing, heavy TV marketing to more ROI based marketing that's very customer-to-customer. Since we have a relationship directly with many of our customers, we're connected with many of them, we should be able to market to them at a much lower cost.

Andrew Wilson

And one of the things that we see, and again it's somewhat counterintuitive, you would think if you play the game for five weeks and then put it away, by the time the next version come around, you would have an appetite that would have build up over the last 10, 11 months to play that game again. And actually, the reverse is true. The closer we can get you in terms of engagement to the next launch, the greater propensity you have to purchase.

So that's why we're investing a lot in the live service post-launch, not just because of the monetization opportunity in and around the product that you just launch, but because it access as a key acquisition tool for the next product launch as well. And again, we're just extending that overall play from launch-to-launch.

Stephen Ju - Credit Suisse

At this point, I think we'll open up for questions on the floor, but while they are gathering questions I guess I'll lob in another one. So you undoubtedly spent a lot of time with your development teams to focus on what can be done with the new hardware. Setting the graphics, step up to one side, your engineer must be telling you there all kinds of other things that they can do with the hardware. So as you look out over the next five years, how will the game play for the likes of Madden and FIFA and Battlefield change?

Andrew Wilson

I think it's a really good question. The reality is our teams already starting to work on new innovation for our product. So one of the nuances here is that this transition, so this console cycle, both Sony and Microsoft platforms have simplified their architecture and simplified their tool sets.

So in the last transition we spend the first two to three years actually just trying to figure out how to get the most out of the boxes, and particularly because the two boxes were very different. So the good news now is I think that we have reached the level of quality at launch that we didn't get through last time. And our teams are already starting to think about investment in new innovation for the future.

In terms of actually talking about that I think it's a little early and certainly we don't want to give up a competitive advantage on that front. But what I would say is that engagement between you and your friends and engagement between you and the sport or you and a subject matter that you love through not just the graphical, but through the online capabilities and the connection capabilities are going to fundamentally change how you interact with entertainment software in the future.

Question-and-Answer Session

Unidentified Analyst

Two quick questions. One, in terms of category. If you go forward, let's say, two to three years out, how do you think about the mix between console PC's free-to-play? Is the mix should be roughly the same or do you think it will change? And just a second question, I think at a different conference you alluded to scope for gross margin to move in the high 70s, as you move more your business to digital. The move to gross margin is it on lower revenue numbers, because this is on digital revenue or do you think it just remains on the same revenue run rate?

Andrew Wilson

Let me take the first one. With respect to the kind of the balance shift, again I think there is three key components that are going to drive a change in the revenue mix over time. One is geographic based, one is platform based and one is business model based. And I don't think all of those things are mutually exclusive.

But as we fast-forward and you think about the competing kind of paradigms of console, which is potentially a smaller user base than mobile or PC free-to-play in large markets like Brazil and China, but has a significantly higher lifetime value per consumer at this stage versus the volume play that you get at PC free-to-play and mobile in these emerging markets. I believe that we could certainly get to a more balanced revenue mix between those two things versus the kind of heavily skewed console that we have today.

Blake Jorgensen

On the gross margin I think what you meant to say was the high 60s. We're running this year around 66%. And I think over the next couple of years we could see gross margins in the high 60s. Digital gross margins clearly are much higher than packaged goods gross margins.

You don't have physical movements, you don't have to keep the channel clean and that yields our gross margin for a digital product that can sometimes be in the high 70s, but the mix of our business will still have packaged goods in it for sometime to come. But we think over the next couple of years, because we've built the platform to service the business, we're doing all that in-house and because those digital margins are higher, the combination of those two will continue to allow some gross margins up closer to the 70s level.

Stephen Ju - Credit Suisse

Couple of questions around digital. First curious, if you have any data on the next-gen consoles, how many game purchases were full game downloads. I think Sony provided data monthly on that, so I thought you might have some data now? And curious, how much of the mix will shift to full game digital downloads over a couple of years, and how we should think about the economic benefit?

Obviously, it's additive to gross margin, but with sales reserves, for example, they end up reversing anyway if you sell it through, so it seems like the big benefit is that you have ultimate flexibility in terms of pricing, merchandising, promotion, and so on, so forth. So how we should think about, what kind of benefit that will give your financial model that it wouldn't otherwise have?

Blake Jorgensen

So on the early data, it's still too early to tell. We haven't seen data yet, that's meaningful because of just the fact that we're really only a couple of weekends in, in the case of Sony, and really a full weekend and a bit with Microsoft, obviously positive. We think the trend will continue to be positive. The boxes have much greater storage capacity than the both consoles do. The consumers are finding the ability to download easier as they can download and play at the same time and there is more day and date downloads available for consumers now or our ability to stream in before the day starts to have the program playing as soon as available.

Longer-term that will continue to help our gross margins. I think it will also continue to help us build the connection with our consumer base and build the consumers' interest in further downloadable content overtime to extent that game play. We see all that as a positive. Sales reserves in the channel are substantial. We run at $0.15 on every dollar in many cases, and so you see that plus physical distribution cost and selling expenses cut down over time when you have more digital downloadable, full game downloads or digital downloadable content.

Stephen Ju - Credit Suisse

Just one clarification then one question. The question is when do you think we'll hit a third of units being full digital download? And then on the margin side, it would seem like the sales reserves should be a move point, gives you either end-up selling it through and you reverse the reserves or it doesn't sell through and you take it back in the digital world, you're either getting the revenue as it sell through or it doesn't sell through, so you don't take reserves because it didn't sell, so it seem like the reserves would be kind of neutral, so I'm just trying to understand what the bottomline margin benefit over the life is?

Blake Jorgensen

We use the reserves to keep the channel clean by providing future payments to retailers. We don't take any product back. The retailer is responsible for that product and for the pricing of the product. So the sales reserves acts as a marketing funding to keep the channel clean overtime. I don't know when the 30% target hits, that's probably still ways off, we're much lower than that today on full game downloads.

And I think a lot of the constraint there will continue to be bandwidth into people's homes, and as that changes that will help. At the same time, the size of the games have gotten bigger and more complex and so it's eaten up some of the benefits of bandwidth. But the trend is in the right direction and the trend helps our economics and so we're obviously excited about where the opportunity can go.

Stephen Ju - Credit Suisse

Do you think there is a, still come a day when you're selling the digital full download copy of the games at a discount to whatever is at retail? And there is currently a consumer disincentive to purchase at full price, given the trading value of the physical copy of the game.

Andrew Wilson

Listen, I think that we are going to evaluate the various business models, and I think that there is three business models that are going to emerge through the future, and they may or may not cross over between platforms and territories, but I think there is going to be free-to-play mechanism. I think there is going to be a premium mechanism, I think there is going to be a subscription based mechanism and different consumers are going to buy into that at different times for different reasons.

And at some level, the price is a driver, but we also look at an opportunity of acquisition and reach to a consumer is also important and is there a way we can incentivize digital through things other than price point, things like value, things like exclusive, things like benefits, nothing is off the table at all.

But again, we have a good partner in retail right now and that is an effective part of that business. And certainly as we kind of move forward, we want to make sure that we do things other than just pricing to incentivize and drive what we believe is going to be a very robust digital business.

Stephen Ju - Credit Suisse

The global is obviously a source of huge opportunity for you guys in the future. I think couple of quarters where you called out Apple as the biggest sort of retail partner in that regard, but as you look across sort of globally Apple does not have as a dominant footprint in some region, so what's your towards dealing with some of the I guess sources of traffic or reach out there?

Andrew Wilson

You mean like a [multiple speakers]? Listen, I think that it's an environment in an ecosystem that's developing in real time. And I think there have been some early movers in those territories to aggregate particularly around android devices, where there has been a lot of disparity between the service and different kind of storefronts.

Right now, there is a cost to participating in that and we are evaluating the benefits of that traffic and the benefits of that acquisition versus the cost of acquisition on our own with a different partner, who would otherwise provide a similar service at a lower rate. As it relates to Apple, again, they continue to grow in those markets and that we will continue to go direct in those markets.

As it relates to Google, in China, we will likely have to work with some partner, just given the regulatory conditions there. Japan, we are looking at going direct. We think there's an opportunity there and that there is a convergence on quality product in Japan that will serve us well.

And in Korea, we're in the process of looking at launching some mobile products there outside of the Kakao network because we believe that the quality of our products, together with the partner that we are planning to working with will serve us better than what we see as a second-tier tax of Kakao.

Stephen Ju - Credit Suisse

Now given soccer's popularity in Latin America, are you looking at that market as a possibility for FIFA Online for you right now, given the growth profile of Internet users in countries like Brazil and Mexico?

Andrew Wilson

Absolutely, I mean we have announced that we're going to take FIFA Online World, which is a similar. It's built on the same technology of FIFA Online 3, our free-to-play product in Korea, while with a slightly different kind of user layout on top to account for the different manifestation of the user base in Brazil versus Korea.

So we will launch that in Brazil and in Russia and then lead up to the World Cup and then start to move that through the rest of Latin America and Eastern Europe. And again, if you think about our strategy, we launched the first FIFA Online in Korea, right before the '06 World Cup and that was a great acquisition tool onboard ramp. There is no greater passion around global football than World Cup year.

With it being in Brazil, we expect that that is a very good and strong opportunity for us and we're going to work with our partners FIFA on acquisition for our free-to-play property there in Brazil, and look to them, kind of piggyback on the back of that. If you think about a UFC brand, which also had a huge following in Brazil, we're looking at how do we piggyback on the FIFA acquisition and then roll right into that market with UFC as well in a free-to-play context. So we're absolutely looking at the region in detail and we think we have at least two, but likely more products that will have very strong appeal there.

Stephen Ju - Credit Suisse

Now let's fast forward five years from now and think about what the world will look like then. So are there more PS4s and Xbox Ones sitting under TVs versus the installed base the current shelf, so now I get the last-gen hardware now?

Andrew Wilson

Five years in this business is hard to predict. You know if you go back five years, think about the things that have happen in the last five years. We've had a service-based mechanism evolve and manifest itself inside of the premium console business, which I don't think anyone would have predicted. We've had iPhone launch, which changed the world. We had android launch, which changed the world again. We had iPad's and other tablet devices come. So listen now, our market is a evolving at a very, very rapid right.

If I think about the next three years and certainly the conversations I have with various handset providers and setup box providers, I think the Microsoft and Sony had a real opportunity to build a strong following and a strong in-store base, where they continue to be the single best way to get high fidelity, high-definition interactive entertainment to your 80 inch television. If you think about Microsoft strategy, and I think that Sony shift some of this at least in the long-term view of bring a broader entertainment device in your living room. I think they have that time.

Again, I think that three years from now, four years from now, they're going to be under some fairly stiff competition for the living room from mobile providers, from Apple, from Google, from Roku, from Comcast to try and own that living room experience. But again, as of now, we think that they have the single best way to get high-definition interactive entertainment TV and we're going to work with them to make sure that we can deliver that to consumer.

Stephen Ju - Credit Suisse

Sticking with the five-year theme, is EA's revenue mix now predominately digital?

Andrew Wilson

I think listen, we're at 43% digital right now, and that's being kind of rapidly growing. So I don't think it's unreasonable to think that five years from now it could be a significant share of our topline revenue. I think the important thing is to understand is that that doesn't mean that we won't have partners to help us drive digital, and that might be Apple, that might be Google or that might be Samsung, or that might be GameStop or Microsoft or Sony. The important part is through that mechanism, we build a significantly stronger relationship with our end user and there is not mediation between often that user and that gives after greater ability to build products and deliver and maintain services that are more engaging for them.

Stephen Ju - Credit Suisse

As you adjust for the impact for FIFA and its sales internationally, is EA's regional revenue mix now predominately international?

Andrew Wilson

I think we indexed higher international now and if you think about that the opportunities that we're driving in Brazil, Eastern Europe and Asia, my expectations quite frankly is we continue to see international growth.

Stephen Ju - Credit Suisse

And which is your biggest revenue generating, quote unquote, devices? Is it PC, smartphone, tablet or the console?

Andrew Wilson

Today or five years from now. Listen, it might be a hologram that comes up through your living room floor. Again, I've talked to some folks that I see out in the audience today. For us we are less focused on the device and more focused on the modality of play.

We think there is a lean back experience on your living room sofa in from of 80 inch TV. We think there is a lean inexperience in some form of PC device. We think there is a lean over experience as it relates to mobile and tablet, and so for us we're less focused on the device and more focused on the modality of play because we think that will continue irrespective of what piece of technology you use to deliver the device.

Stephen Ju - Credit Suisse

I think with that we're out of time. Thanks very much Andy. Thank you very much.

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