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Executives

John Riccitiello - Chief Executive Officer and Executive Director

John Schappert - Chief Operating Officer

Eric Brown - Chief Financial Officer and Executive Vice President

Peter Ausnit -

Analysts

Shawn Milne - Janney Montgomery Scott LLC

Benjamin Schachter - Broadpoint AmTech, Inc.

Arvind Bhatia - Sterne Agee & Leach Inc.

Jess Lubert - Wells Fargo Securities, LLC

Colin Sebastian - Lazard Capital Markets LLC

Edward Williams - BMO Capital Markets U.S.

Justin Post - BofA Merrill Lynch

Heath Terry - FBR Capital Markets & Co.

Electronic Arts (ERTS) Q4 2010 Earnings Call May 11, 2010 5:00 PM ET

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: Cost management, fewer but bigger games, improving game quality and driving digital revenue streams.

On cost. We successfully implemented a restructuring program, significantly reducing our cost base, packaged goods fewer but bigger gains. We were the number one publisher overall in Europe and North America combined. We're the number one publisher on PC, Xbox 360, PlayStation 3 and PlayStation 2. We achieved share growth in FY '10 versus FY '09 on 20% fewer titles.

Quality. Our investment in quality was a key reason for our segment share success. EA leads the industry in quality with 20 titles in fiscal '10 that received the Metacritic rating of 80 and above.

Digital. FY '10 revenue from our digital initiatives was up 33% over fiscal year '09. We saw a substantial growth in post-released downloadable content sales with big titles like Dragon Age, Mass Effect 2 and Battlefield: Bad Company 2.

We continue to lead on mobile, iPhone and now, iPad. In a tough market, our advertising sales were up and the acquisition of Playfish makes us a strong leader in social network gaming.

We enter FY '11 with strong momentum. The quality of our titles, both packaged goods and digital is something we feel passionate about at EA. We couldn't be more pleased with the people that make these games. This investment in quality is what allows us to extend our properties, connecting them to millions of consumers online.

With that, I'll turn the call over to Eric.

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: Bad Company 2. We sold through 3 million packaged and digital units in the quarter for Europe and North America combined. Battlefield: Bad Company 2 launched with the Metacritic grading of 89. And to date, we have sold through to over 4 million units of Battlefield: Bad Company 2.

Mass Effect 2 sold through over 1.6 million package and digital units in the quarter for Europe and North America combined and launched with the Metacritic rating of 96 on the Xbox 360.

Dante's Inferno sold through almost 1 million units in the quarter for Europe and North America combined, more than any other new intellectual property during the quarter. And the sequel title, ARMY OF TWO: THE 40th DAY sold through over 1 million units worldwide in the quarter.

Highlights from our digital business include downloadable content including Madden Ultimate Team, FIFA 10 Ultimate Team, Battlefield 1943 and Dragon Age which performed well in the quarter.

Mobile sales continue to grow year-over-year, and we had a strong launch of games from the iPad in April. We had 1.8 million total paying subscribers in the quarter. This includes Pogo as well as Massively Multiplayer Online or MMO subscribers. We finished the quarter with over 58 million registered users, up 18% from the prior quarter. Battlefield: Bad Company 2, FIFA 10 and Madden 10 were the top three titles driving user registrations in Q4.

Highlights from our catalog. FIFA 10 continues to be a top-selling title, ranking number six in Europe for Q4. To date, FIFA 10 has sold in over 10 million units since launch. Madden 10 finished the fiscal year strong, growing 9% year-over-year on the PS3 and Xbox 360 combined, a market improvement from the relatively slow start we have with Madden in Q2. Digital business results include the following: For the fiscal year, we had total digital revenue of $570 million, up 33% year-over-year, meeting our expeditions.

We reported record mobile non-GAAP revenue of $212 million, up 12% year-over-year. We reported $358 million non-GAAP digital revenue from nonmobile sources, up 49% year-over-year. In the quarter, mobile non-GAAP revenue was $55 million, up 15% year-over-year driven by Tetris, The Sims 3, Bejeweled and Need for Speed. Q4 non-GAAP revenue from nonmobile sources was $101 million, up 66% year-over-year.

We have three different businesses in our Digital portfolio. Let me give you detail on each category.

The first category is console full games and downloadable content or DLC, which consists of digitally delivered, fully playable games and associated content packs. In Q4, EA SPORTS launched Madden Ultimate Team and FIFA 10 Ultimate Team. Both Madden Ultimate Team and FIFA 10 Ultimate Team exceeded our expectations. Our front-line titles in Q4 had extensive console deal sale offerings.

The second category is PC and browser full games and associated DLC, which consists of digitally delivered, fully playable PC games, associated content packs and free-to-play PC games with paid micro-transaction content. During the quarter, we launched several PC and browser games including Battlefield: Bad Company 2, Mass Effect 2, Command & Conquer 4 and Lord of Ultima. Battlefield: Bad Company 2 exceeded our expeditions as a PC-download title in Q4. Playfish launched a browser game called Hotel City in March, which looks promising and has already reached 13 million monthly active users and is a top 15 Facebook application.

The third category is mobile game services, subscriptions and advertising. Mobile consists of games delivered on feature phones, smartphones and handhelds such as the iPhone and the iPad. We launched five games on the iPad at the tail end of Q4. Game services, subscriptions and advertising, include advertising in Playfish social games, Pogo subscriptions, MMOs and browser-based games with subscription models. Pogo's subscription revenue for fiscal 10 was up 3%.

A few comments on the industry. The total sector inclusive of packaged goods and digital was up 3% in calendar '09. The worldwide packaged goods subsector was down 9% which was more than offset by digital being up by approximately 28%.

In the quarter, for Western markets overall, the total sector, including digital was up. The packaged goods subsector was down 2% which was more than offset by digital. By region, North America was down 5% and Europe was up 1%. We saw a growth trends in Spain, Italy and Germany although U.K. and France were down. In fiscal '10 the packaged goods subsector in both North America and Europe was down 11% which contrasts sharply with EA's strong performance.

In the quarter and despite console hardware shortages, year-over-year PS3 software sales increased 41% in Western world markets, Xbox 360 software sales increased 1% and Wii software sales decreased 9%. In the quarter, top 20 titles in North America increased dollar share to 43% versus 41% in the prior year.

For fiscal '11, we are affirming our Q1 non-GAAP and GAAP guidance, our full-year non-GAAP guidance and we are updating our full-year GAAP guidance. We expect the market, inclusive of packaged goods and digital, to grow 8% year-to-year in calendar 2010 based on the assumption that total worldwide packaged goods, consistent with the recent industry reports, will be down 3% offset by digital growth of approximately 26%.

We expect to end fiscal '11 with total headcount of approximately 8,200, and our managing headcount consistent with the restructuring plan that called for a shift from high-cost to low-cost locations. Total low-cost location headcount is increasing from approximately 22% to 26% at the end of fiscal '11.

Regarding exchange rates, we are assuming the $1.36 U.S. to the euro, $0.95 U.S. to the Canadian dollar and $1.55 U.S. to the British pound. Currency markets are volatile, and our R&D costs will increase if the Canadian dollar strengthens.

Packaged goods. Our fiscal '11 plan currently includes a total of 36 titles for the fiscal year excluding expansion packs. Our top 20 titles for fiscal '11 are expected to generate approximately 80% of total non-distribution packaged goods revenue. This compares to 76% in fiscal '10.

There is an updated FY '11 title plan in our earnings press release detailing our principal titles.

Our total variable marketing and advertising in fiscal '11 is an estimated $475 million, comparable to the total amount spent in fiscal '10. On a non-GAAP basis, we expect fiscal '11 revenue from EA published packaged goods titles to be between $2.75 billion to $3 billion which reflects flat share at the middle of the range.

Distribution. We expect approximately $150 million in non-GAAP distribution revenue for fiscal '11.

Digital. EA is incurring significant development costs for a major new Massively Multiplayer Online game. However, this game is not expected to ship in fiscal '11.

In fiscal '11, we will continue to introduce new service and product features that benefit unique registered purchasers on PC and console games. Our most recent examples are the Map Packs that we released for Battlefield: Bad Company 2.

We are planning a number of digital service launches in fiscal '11. In March, we announced Need for Speed World in Beta, the MMO action racing game. This April, we launched Tiger Woods Online, an authentic and futuristic golf videogame experience available to a web browser. In Q2, we will launch FIFA Online.

We expect to grow our total digital revenue by approximately 30% from $570 million at fiscal '10 to approximately $750 million at fiscal '11. The year-over-year dollar growth of approximately $180 million is divided roughly as follows: Approximately 1/4 from console full games and DLC; approximately 1/2 from PC and browser full games and DLC; approximately 1/4 from mobile game services, suspensions and advertising.

Now to our guidance. We are maintaining our Q1 fiscal '11 GAAP and non-GAAP guidance.

Revenue. On a GAAP basis, we expect Q1 FY '11 revenue of $710 million to $715 million. On a non-GAAP basis, we expect Q1 FY '11 revenue of $460 million to $500 million. Q1 revenue is down year-over-year as we are comparing to a Q1 last year that included The Sims 3 and EA SPORTS Active launches.

The Q1 F '11 titles slate includes FIFA World Cup South Africa, Skate 3 and Tiger Woods PGA TOUR 11. There are five front-line titles versus 10 in the prior year. Below the line, we expect GAAP EPS ranging from a loss per share of $0.05 to a profit of $0.05 per share. We expect non-GAAP loss per share of $0.35 to $0.40.

For the full fiscal year, we expect the following: Revenue; on a GAAP basis we expect revenue of $3.35 billion to $3.6 billion, down from prior expectations of $3.45 billion to $3.7 billion primarily due to release schedule changes, which affect revenue deferrals; on a non-GAAP basis, we are affirming our total revenue guidance of $3.65 billion to $3.90 billion. Breaking this down into three components, we expect digital revenue of approximately $750 million in F '11. We expect approximately $150 million in distribution revenue, roughly a $450 million decrease year-over-year and we expect packaged goods revenue ranging from approximately $2.75 billion to $3 billion.

Revenue phasing. We currently expect the total of 36 front-line titles shipping in fiscal '11. By quarter, we expect to release the following number of titles in fiscal '11: Q1, six titles; Q2, seven titles; Q3, 16 titles; and Q4, seven titles.

I would like to remind everyone that last year's first fiscal quarter had unusually high revenue due to the launch schedule and the additional week of reported business. We expect fiscal '11's quarterly revenue phasing to be more consistent with prior years with non-GAAP revenue distributed as follows: Q1, approximately 13%; Q2, approximately 21%; Q3, approximately 42%; and Q4, approximately 24%.

Please note that as announced on May 5 and representing a change from our last earnings call, we have moved Medal of Honor to October 12, 2010, to optimize the launch window. This move has a negligible impact on full-year fiscal '11 non-GAAP net revenue, non-GAAP EPS and cash flow.

Q2 non-GAAP EPS is impacted due to the high margin of the Medal of Honor title and other items. We estimate an approximate $0.25 EPS reduction versus current analyst Q2 expectations.

Gross margins. We expect full-year GAAP gross profit margins of approximately 56% and non-GAAP gross profit margins of approximately 60%. Below the line, we expect GAAP-diluted loss per share of $0.85 to $1.15. We expect to generate non-GAAP EPS of $0.50 to $0.70.

This concludes our outlook and guidance, and with that, I'll turn the call over to our Chief Operating Officer, John Schappert.

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: Madden NFL 10, The Sims 3, Battlefield: Bad Company 2 and Need for Speed SHIFT. Our top-selling title was FIFA 10 which sold in more than 10 million copies since launch.

In terms of the current trading environment, the overall industry has remained positive, thanks to digital offsetting a slight decline in packaged goods. On the packaged goods side, in North America was down 5% in the March quarter, while Europe was up 1%, both better than the December quarter and consistent with our guidance for the year. We expect the packaged goods in April were sharply down with the console mix shift change favoring EA. We expect the overall packaged goods sector to pick up in the summer when major titles launch. We remain confident in our overall expectations for growth of this sector with packaged goods declining 3% in the calendar year.

Turning to E3. This year, you're going to see a strong portfolio of blockbuster titles from EA. The EA SPORTS Label will showcase Madden NFL 11, FIFA 11, NHL 11, NBA Live 11, Tiger Woods PGA TOUR 11 and EA SPORTS Active. We will also unveil games that make use of the new motion controllers from Sony and Microsoft.

That EA Play Label will showcase a new Harry Potter game and some great titles from our partnership with Hasbro. The Sims 3, EA's mainstream gaming mega brand with over 125 million units sold, is coming to consoles and will be available this fall on the PS3, Xbox 360, Wii and Nintendo DS. We will also highlight The Sims 3 expansion packs, including the recently announced The Sims 3 Ambitions Expansion Pack.

The EA Games Label will unveil a new Need for Speed title, Dead Space 2, and the return of one of the most storied franchises in first-person shooter history, Medal of Honor. EA Partners will run Bulletstorm from Epic Games, Crysis 2 from Crytek and in partnership with Lucas Arts, we will highlight the much anticipated Star Wars: The Old Republic. We will also show a marquee title in breathtaking 3D.

Next, I'd like to provide some highlights on our EA Interactive business unit which includes EA Mobile, Pogo and Playfish.

First on EA Mobile. We continue to be the number one mobile games publisher in Western markets. In March, we had seven of the top 10 games on Verizon and achieved more than half of the top 10 games on AT&T, Sprint and T-Mobile. I want to highlight that EA is the number one App Store publisher, a formidable achievement that affirms our belief that mobile consumers gravitate towards high quality and brands they recognize from other platforms.

Proving the point again that consumers love IP that they know, we launched five games on the iPad at the end of Q4 and had two of the top three grossing titles. Scrabble was the number one grossing title and Need for Speed was number three.

Second, Pogo continues to be one of the most engaging online gaming destinations, generating 5.4 billion minutes of play in March. It is one of the most diversified models in casual gaming generating multiple revenue streams: Subscription, advertising and micro-transactions.

From February to March, Pogo grew U.S. monthly unique visitors by 9% versus flat for the market and grew total online gaming minutes by 8% versus 2% for the market. Pogo's play rate among daily and monthly active users is 30%, placing it on par with the best performing social network games. At the end of Q4, we launched Pogo Facebook Beta. This application includes a total of 12 games including Poppit! and Word Whomp.

And third, Playfish is the number two social gaming site in a rapidly lower growing market. In Q4, we had two of the top 10 Facebook games: Restaurant City and Pet Society. In March, Playfish launched Hotel City, which is off to a promising start with 13 million monthly active users and is also a top 15 Facebook game.

At the end of April, Playfish had a total of 59 million monthly active users, up 17% since January. Daily active users have increased 23% since January. We couldn't be happier with the integration process and look forward to Playfish launching the first EA-branded title, FIFA Superstars, which is now in beta testing and is coming soon. We continue to believe that social network gamers will mass behind quality and brands they recognize as they have done in the Mobile segment.

Finally, I'd like to offer some detail on our progress in extending the consumer experience with online services and content. Yesterday, EA SPORTS introduced Online Pass, a program to give game owners more features and content by using a one-time use, game-specific access code printed on the back of the game manual. When the first purchaser goes online to register the software, he or she can receive title-specific bonus content and access the services like Clubs and Leagues, as well as online game play. Benefits that registered users also get and include news feeds from EA Sports, ESPN and others. Other content may be available after launch, and online pass will be available to secondary purchases for a fee.

EA Sports titles, including Tiger Woods PGA TOUR, NCAA Football, Madden NFL, NHL, Fight Night and MMA Mixed Martial Arts will feature online pass. This concept builds upon similar initiatives from recent releases. Last year, The Sims 3 launched with an entire second city available for players who registered their game online. And Mass Effect 2, consumers were provided access to the server's network which offers additional missions, equipment, even a new character when the game is registered online.

Similar offerings were included the Dragon Age and Battlefield: Bad Company 2. These offerings reward purchase, add value to the game and keep players engaged. We believe the ship-it-and-forget-it mentality is giving way to much deeper relationships between the consumer, the game and the publisher.

With that, I'll hand it back over to John.

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.

Question-and-Answer Session

Operator

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

Edward Williams - BMO Capital Markets U.S.

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: Bad Company and Dragon Age and our recent Q4 releases. So we feel pretty good that we'll have good uptick there, and we think it's also a good opportunity to turn these packaged-goods consumers into Digital consumers.

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 - BofA Merrill Lynch

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: World Cup in addition to the core packaged-goods game people love and coming later in the year. Another great example is Need for Speed. Need for Speed is now two packaged-goods games. It was just an action game in the fall. We now have an Action business and a Simulation business. We brought our Simulation business out last year. We're turning to Action this year. In addition to that, we've announced Need for Speed online. I think you know it's a leading title on the iPhone. It's a leading title on the iPad. It's done well on a number of business models, including post-release downloadable contents. So what we've been doing is bringing up slight down in terms of the number and broaden it. Broadening it is a mild joke. We've been saying that kind of short and fat is the new tall and thin, meaning, a shorter list, but more broad-based spread across properties. So to answer your question, I think what we saw was a depression largely across the board relative to our early expectations as a consequence of less packaged-goods sales, overall. We're pleased with a number of our titles kind of reaching hit status, including titles like FIFA, Madden, Battlefield: Bad Company and a few others, The Sims. And as we go forward, we think we can better navigate the current environment, the rapid increase in Digital revenue stream with a lesser slate, exploited more ways.

Operator

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

Jess Lubert - Wells Fargo Securities, LLC

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 - Broadpoint AmTech, Inc.

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 - Janney Montgomery Scott LLC

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 - Janney Montgomery Scott LLC

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 - Janney Montgomery Scott LLC

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 - Janney Montgomery Scott LLC

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 - Janney Montgomery Scott LLC

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 - Janney Montgomery Scott LLC

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 - Sterne Agee & Leach Inc.

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: Bad Company and Medal of Honor. So we fully expect this to be a successful title this year. We're using a lot of the same technology between the two, the multi-player game. That is part of Medal of Honor this year. It's in fact built by our DICE Studio, which builds the Battlefield: Bad Company and Battlefield franchises for us, and we think it's a particularly strong title. So we've made great strides with Battlefield: Bad Company, and we expect to make further strides with Medal of Honor, and we have strong plans for years to come. This is an important strategic priority inside of our company, taking market share precisely here. In terms of FIFA, generally speaking, a World Cup title will do less than half, quarter-over-quarter, of what we would get out of a full FIFA franchise. And the challenge in every given time that we have a World Cup year is to get the title out there and then roll it back in. So there's nothing on the shelf for when the FIFA '11 ships into the marketplace.

Arvind Bhatia - Sterne Agee & Leach Inc.

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 - FBR Capital Markets & Co.

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: a, content available on day one for purchase; and b, we've seeded it with a bonus token of free content. So that is really our drive with our Online Pass.

Heath Terry - FBR Capital Markets & Co.

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 - FBR Capital Markets & Co.

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 - Lazard Capital Markets LLC

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.

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Source: Electronic Arts Q4 2010 Earnings Call Transcript
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