Electronic Arts' CEO Discusses Q4 2011 Results - Earnings Call Transcript

 |  About: Electronic Arts Inc. (EA)
by: SA Transcripts

Electronic Arts (ERTS) Q4 2011 Earnings Call May 4, 2011 5:00 PM ET


Good afternoon. My name is Kristin, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter Fiscal Year 2011 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Peter Ausnit, Vice President of Investor Relations. Sir, you may begin.

Peter Ausnit

Thank you. Welcome to EA's Fiscal 2011 Fourth Quarter earnings 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, and 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 and results 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 4, 2011, and disclaims any duty to update them.

Throughout this call, we will discuss both GAAP and non-GAAP financial measures. Our earnings release and the earnings slides provide 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. Now I'll turn the call over to John Riccitiello. John?

John Riccitiello

Thanks. I am happy to report another strong quarter to finish a strong fiscal year. In Q4, we beat the Street and hit the very high end of our expectations for total revenue, digital revenue and profit. For fiscal '11, EA delivered on all of its goals including revenue, market share and EPS. And perhaps most importantly, we substantially exceeded our own ambitious target for Digital revenue. We set out the year with a goal of hitting $750 million. In the end, our Digital non-GAAP revenue grew by 46% and exceeded $800 million.

I am particularly proud of EA's rapid growth and scale in Digital and that our growth rate almost doubled that of the Digital sector overall. We did it in a way no other competitor can, and in a way that best addresses the future opportunity in the market. We did it across multiple IP, across all the relevant platforms, from social to mobile to console, and across a variety of business models.

The consumer has changed. 200 million console players have become 1.5 billion consumers gaming on multiple devices. We are the only gaming company serving this wider opportunity. In a few moments, we will take you through our FY '12 guidance. Even though most will focus on the full year EPS guidance range, I would say that the underlying assumptions are more interesting.

I would draw your attention to our Digital non-GAAP revenue, which is expected to exceed $1 billion in fiscal '12. And just as importantly, it is worth noting that we expect to finish the fiscal year with a non-GAAP EPS run rate up roughly 50% from our fiscal '11 performance.

I'd now like to outline a shift in our strategies. On the established objectives around reducing title count, cutting costs and starting a Digital business, we did so recognizing that we needed to execute a turnaround, and the major part of what needed to change was to reduce titles and cost. Our strategies could be defined as fundamentally defensive. Today, we are announcing a big shift to OpEx. Over the coming years, we will transform EA from a packaged goods company, to a fully integrated Digital entertainment company. We're transforming EA to a games as a service model by focusing on 3 new strategies.

#1, intellectual property. We believe we are driving the strongest portfolio of IP in the industry with EA Sports, FIFA, Hasbro, Madden, Pogo, Battlefield, Need for Speed, The Sims, Tetris, Dragon Age, Mass Effect and more. We fully intend to make these properties into year-round businesses that lead their sectors across a range of platforms.

#2, platform. Increasingly, we see ourselves as a software platform every bit as much as we see ourselves as a content maker for other companies platforms. We had a great start with 112 million consumers in our nucleus registration system, up from 61 million a year ago. And while we will continue to be a great partner to our best retail customers and our first-party partners, you will see the beginnings of a consumer game platform emerge at EA that complements and extends the console ecosystem and addresses the wider opportunity on other devices.

#3, talent. To deliver on the 2 strategies above, IP and platform, we will expand on a model that is already working at EA, and only at EA. We are the only company with world-class teams working across platforms on social, mobile, and console development. We are integrating these teams and augmenting them with product monetization and marketing. It's a big change. As an investor, you can see this as a way to better manage our IP and drive up the ARPU for our core properties. As a developer, you can see this as the reason EA will be the most interesting and satisfying place to work in the game industry.

Now I'd like to outline our fiscal '12 guidance at a high-level. There are 3 factors that make fiscal '12 particularly challenging for EA. Following a record year for revenue and profitability, our EA Sports business is facing 2 potential league lockouts and will be comparing to a fiscal '11 that included a FIFA World Cup title. Year-over-year, these differences represent roughly a $250 million revenue challenge.

With Battlefield 3, we are mounting the biggest launch campaign for a game in EA's history. We think the franchise is worth it. We know the opportunity is worth it. Still this is a big commitment of resources.

We are preparing the launch of Star Wars: The Old Republic. The launch date, while in our fiscal year, is not yet certain. We see roughly $0.15 EPS variability between the potential launch windows.

Despite these investments and uncertainties, we are guiding a non-GAAP EPS range within the midpoint up 14%, and are confident we'll finish the fiscal year with EPS run rate up 50% versus fiscal '11.

In summary, we had a strong fiscal '11, delivering on all of our objectives, operational and financial. Starting now, we're shifting from defense to offense and we'll be transforming EA from being a packaged goods centric company to a fully integrated Digital model only EA can realize.

Fiscal '12 promises to be among the most exciting in EA's history, whether considered from a consumer perspective or from a purely financial investor perspective. Now I'll turn the call over to Eric.

Eric Brown

Thank you, John. EA had very good top and bottom line performance in Q4, hitting the upper end of our EPS guidance, and exceeding our overall and Digital revenue guidance, thanks to upside across our Digital portfolio and Packaged Goods performance both for frontline and Catalogue titles. We also met our initial full-year FY '11 guidance for non-GAAP revenue, non-GAAP EPS, and operating cash flow.

Q4 non-GAAP revenue of $995 million was the result of both good frontline title and Catalogue title performance. Catalogue revenue of 17% or $168 million in Q4 was the result of strong ongoing performance on FIFA 11, Need for Speed Hot Pursuit, Battlefield: Bad Company 2 and Dragon Age. For the fiscal year, the combination of Medal of Honor and Need for Speed Hot Pursuit have sold through approximately 8.5 million units.

Q4 Digital non-GAAP revenue was a record $268 million, growing 72% year-over-year. All revenue types and platforms of our Digital portfolio were up double digits year-over-year for the quarter. Please note that we had a total of approximately $27 million in Q4 Digital revenue that was either timing related or nonrecurring.

Q4 non-GAAP gross profit margin was 67.3% compared to 65.2% a year ago. On a GAAP basis, gross profit margin was 69.9% compared to 69.6% last year. For the fiscal year, non-GAAP gross profit margins improved by 6 points, from 55.3% to 61.2% on higher Digital revenue, and an improved mix of EA titles compared to fiscal '10.

Q4 non-GAAP operating expenses of $559 million were slightly higher, driven by increased available compensation expenses since we exceeded plan for the year. GAAP operating expenses were $617 million in the quarter. Q4 non-GAAP operating margin was 11.2% versus 4.0% last year. On a GAAP basis, operating margin was 13.3% for Q4 compared to 8.5% last year. For the fiscal year, non-GAAP operating margins improved by 3.5 points from 4.7% in fiscal '10 to 8.2% in fiscal '11, a function of an increase in our Digital revenue mix, a more profitable Packaged Goods portfolio and a year-over-year reduction in R&D expense.

Q4 non-GAAP earnings per share was $0.25 versus $0.07 a year ago, bringing us to a total of non-GAAP EPS of $0.70. GAAP earnings per share was $0.45 in Q4 versus $0.09 a year ago. The principal adjustments between our non-GAAP and GAAP EPS is the revenue deferral, and we ended fiscal '11 with more than $1 billion in GAAP deferred revenue.

Headcount, we ended the quarter with 7,645 employees versus 7,842 a year ago, and 7,742 in Q3 fiscal '11. 22% of our employees are in low cost locations and the breakdown of headcount is 5,544 in R&D, 929 in market and sales, 990 in G&A and 182 in cost of goods.

Cash flow from operations this quarter totaled $253 million, the same as last year. Our full year fiscal '11 operating cash flow has increased to $320 million, which is up $168 million versus fiscal '10. Capital expenditures have declined year-over-year and fiscal '11 free cash flow of $261 million is up by $414 million versus last year and up $181 million excluding the fiscal '10 purchase of the Redwood Shores headquarters.

EA has approximately $6.70 per share in cash, short-term investments and marketable securities, and is debt free. At year-end, roughly 16% of our cash and short-term investments were onshore.

Inventory levels were well managed and at year-end have fallen to $77 million, the lowest level in almost 4 years, an indication of our success in reducing lower margin distribution inventory, and the benefits of an increasing mix of Digital business, which has no physical inventory requirements.

Reserves for sales returns and allowances as a percentage of trailing 6-month non-GAAP net revenue were 13%, up from 10% a year ago, and are up on a 9-month basis to 9% from 6% last year.

Sector performance. Overall, the Worldwide Interactive Entertainment segment was up mid-single digits in the March quarter. Packaged Goods were down 14% for the quarter, but Digital continues to perform well and is up over 20% for the quarter. For the March quarter, the Western Packaged Goods market was down 12%, comprised of a 6% decline in high-definition platforms, driven by a change in the Easter timing and the industry release slate, and an 18% decline in low definition platforms.

EA was the number one publisher in the Western World for the quarter, with 19% share in North America, 20% share in Europe and 19% share overall in the Western World versus 19% a year ago. Our share in fiscal '11 was 17% overall, with 16% in North America and 18% in Europe.

Industry software sales and high-definition consoles and PCs remained strong and played to EA's strength on these platforms. In fiscal '11, PC and high-definition console software sales in the Western World grew by 13%. In fiscal '11, approximately 80% of EA's total Packaged Goods revenue was on these growing, high definition platforms which offer attractive Digital extension opportunities for EA.

Digital highlights for Q4 and fiscal 2011. In Q4, non-GAAP Digital revenue increased by 72% from $156 million to $268 million, comprising 27% of total revenue this quarter. And this growth far outstrips sector performance. For fiscal '11, EA generated Digital revenue totaling $833 million, up 46% from the full year. DLC and free-to-play micro transaction content was $18 million in Q4, up almost 200% versus last year. Mobile and other handheld Digital revenue continues to grow at or above the market, and was up 25% versus last year thanks to growth in smartphone related revenue, which more than offset a reduction in feature phone related revenue.

Full game downloads were $34 million, up 21% year-over-year. Revenue from subscriptions, Digital advertising and other was $51 million, an increase of 50%.

Notable DLC contributors included the FIFA 11 and Battlefield: Bad Company 2 franchises, which as of the end of the year, posted non-GAAP Digital revenue of $46 million and $48 million, respectively, with more anticipated in fiscal '12. It is now possible for us to see more than $50 million in high margin Digital revenue derived from a single core Packaged Goods franchise.

As of the end of Q4, we had approximately 112 million users in our Nucleus consumer registration system, up from 61 million a year ago. The number of monthly active users in Nucleus is now well past 20 million as of March fiscal '11. Please note that in addition to our Nucleus registered users, we have tens of millions of additional consumers playing our social and browser-based games, which will eventually be registered in the Nucleus system for upsell and cross sell opportunities.

Guidance. Our fiscal '12 non-GAAP EPS guidance of $0.70 to $0.90 shows EPS growth of more than 14% at the midpoint versus our fiscal '11 results. This compares to the 10% plus growth we referenced on the last call. There are several key assumptions worth noting: We have planned our NFL business conservatively; there is no fee for World Cup title compared to last year; we will not have an NBA simulation title in fiscal '12; we continued to make investments in our Digital business; and we assumed that Star Wars: The Old Republic ships in the calendar year, but our guidance range accounts for a range of ship dates within the fiscal year.

Fiscal '12 non-GAAP revenue. On a non-GAAP basis, we expect a total of $3.75 billion to $3.95 billion in fiscal '12 revenue. We expect to grow Digital faster than the industry, reaching approximately $1.05 billion to $1.1 billion for the full year. Our non-GAAP expectations for publishing revenue range from $2.5 billion to $2.65 billion and our distribution to revenue expectations are approximately $200 million.

Our fiscal '12 plan currently includes a total of 22 primary titles, down from 36 in fiscal '11. Please note that we have included a fiscal '12 title plan in the press release that details our principal titles to be launched by quarter. However, this list does not include Star Wars: The Old Republic, which we will launch as a digital service.

GAAP revenue and EPS. Our expected fiscal '12 GAAP net revenue guidance is $3.7 billion to $3.9 billion. Our fiscal '12 GAAP EPS guidance range is break even to $0.28 per share. And GAAP tax expense is expected to be approximately $50 million.

GAAP gross profit margins. We expect GAAP gross profit margins of approximately 62%, and we expect full year non-GAAP gross profit margins of approximately 62% to 63%.

Operating expenses. We expect fiscal '12 non-GAAP operating expenses to be slightly greater than fiscal '11 given current FX rates, but essentially flat versus fiscal '11 in constant currency. GAAP operating expenses are expected to be approximately $2.25 billion.

Our fiscal '12 non-GAAP EPS guidance range corresponds to a non-GAAP operating income margin of approximately 8% to 10%, with approximately $5 million in other income and expense, a full year non-GAAP tax rate of 28% and the reduction in share count due to repurchase activity resulting in an estimated 329 million diluted shares for the year.

Q1 and full year phasing. For Q1 fiscal '12, we expect the following for non-GAAP results: Revenue between $460 million and $500 million, and a non-GAAP loss per share of $0.44 to $0.49. Non-GAAP gross profit margin is expected to be approximately 54%. Operating expense is expected to be roughly $470 million, and share count is an estimated 330 million. For GAAP results, we expect the following for Q1 fiscal '12: Revenue between $910 million and $950 million; and GAAP earnings per share of $0.44 to $0.53. Gross profit margin is expected to be approximately 75% to 76%. Operating expense is expected to be approximately $530 million and share count is an estimated 334 million.

For our full year phasing, please consider the following. The first half of fiscal '12 represents the continuation of fiscal '11 phasing trends, with our P&L driven by the timing of individual package titles and Digital growth. In the second half of the year, we'd expect to begin seeing a more ratable and profitable P&L based on subscription revenue growth in Star Wars: The Old Republic, and leverage from higher unit sales of key owned IP.

We expect fiscal '12's quarterly revenue phasing to be similar to fiscal '11, with non-GAAP revenue distributed as follows: Q1, approximately 13%; Q2 approximately 24%; Q3, approximately 38%; and Q4, approximately 25%. We expect to incur approximately 49% of our non-GAAP operating expenses in the first half of fiscal '12 and the balance in the second half. In terms of the split between R&D, marketing and sales and G&A for the year, we expect to incur roughly similar amounts for each category as we incurred in fiscal '11.

In terms of non-GAAP earnings phasing for fiscal '12 versus fiscal '11. The first half of the fiscal year will be down versus last year, but we expect year-over-year earnings growth at the midpoint of our guidance to be approximately 44% in the second half of fiscal '12 compared to fiscal '11. While we fully anticipate launching Star Wars: The Old Republic in Q2 or Q3, the low end of our guidance range assumes the outside possibility of a January launch.

Cash flow. We expect fiscal '12 operating cash flow to be $250 million to $300 million, down primarily due to the timing of certain license payments in fiscal '12. We expect fiscal '12 capital spending of $125 million to $150 million. EA is making 3 significant infrastructure investments in fiscal '12, server infrastructure for Star Wars: The Old Republic, Direct-to-Consumer infrastructure, and related information technology systems.

Foreign Exchange. Our guidance assumes the following FX rates for the fiscal year. USD $1.38 to the euro, USD $1.01 to the Canadian dollars, and USD $1.62 to the British pound. For the sector, we expect the Worldwide Interactive Entertainment segment will grow 5% to 10% in calendar '11 versus calendar '10, with more than 20% growth in Digital and an approximate 5% decrease in Packaged Goods.

We expect the Packaged Goods segment to remain bifurcated, with stronger growth of approximately 4% in high-definition consoles and PC, offsetting 15% decline from standard definition consoles and dedicated handheld devices.

We also want to provide increased investor visibility into 3 important financial considerations: #1, capital allocation strategy; #2, return on investment measures; and #3, our fiscal '12 exit earnings model.

Let me start with our capital allocation. We will remain focused on efficient capital allocation, ensuring that we remain well capitalized with adequate cash on hand to fund operations in light of a highly seasonal cash flows. As of March 31, 2011, EA had $2.2 billion in cash short-term investments and marketable securities, or approximately $6.70 per share. Out of that, $1.4 billion in cash short-term investments in marketable securities was onshore. We felt that onshore cash was greater than our foreseeable needs, so in February this year, we announced a $600 million repurchase program.

In Q4 fiscal '11, EA repurchased 3.1 million shares at a cost of $58 million. $542 million remains authorized for the repurchase program over the next 15 months.

EA takes into account its weighted average cost of capital of approximately 10% when

reviewing investment proposals, including the greenlight process for major game titles. While we had several financial hurdles for investments, one good reference point is the number of the titles that achieved a greater than 20% IRR on a stand-alone basis.

On this basis, the percentage of EA titles exceeding the financial target increased from approximately 50% in fiscal '10 to 70% in fiscal '11. This improvement was driven by continued cost control in our title development, hitting target ship windows, and getting more units and revenue, including Digital revenues from each of our major titles.

And finally, we expect that EA will exit fiscal '12 with a non-GAAP EPS run rate and operating margin greater than what is indicated by our full-year guidance range. The principal drivers here is the ship date of Star Wars. We opened fiscal '12 with Star Wars in development and incurring expense. We closed the year with Star Wars in operation, generating high-margin ratable Digital revenue and profits.

Now I'll turn the call over to Frank Gibeau.

Frank Gibeau

Thanks, Eric. I'm going to review some highlights from our fiscal '11 performance, and then provide some detail on 3 of our most exciting launches in fiscal '12; Battlefield 3, Need for Speed The Run, and Star Wars: The Old Republic.

The EA Games label delivered a record year for quality, scheduled predictability, and best of all, profitability, significantly exceeding our internal plan. A key goal we set out for the year was to increase the strength of our wholly owned IP over multiple platforms. We delivered on this with Need for Speed Hot Pursuit, Medal of Honor, Mass Effect 2 and Dragon Age. The big driver in this success was a measurable improvement in quality. The quality average across our entire portfolio of 9 games was an average of 84 Metacritic.

High quality on core games is key to our strategy to extend our properties to new platforms. Scheduled predictability was another big win for us. 100% of our internally developed games hit their launch date. The Games Label also nailed our goal for delivering digital revenue. On a full year basis, our downloadable content from console and PC combined was triple our fiscal '10 results. These Digital extensions have played a major role in increasing our profitability.

One of our Digital offerings is Dragon Age Legends, a free-to-play game currently on Facebook. This one is attracting a good fan base and monetizing nicely. Dragon Age Legends offers a lens into the future where a game franchise with a large and loyal fan base can attract new players and new revenue streams without cannibalizing the core product.

In fact, our research on player telemetry shows that people who first experience this franchise on the Facebook platform show strong intent to purchase the core game on PC and console. This is a win, win, win, free-to-play Facebook game generates incremental revenue, introduces new players to the franchise, and drives purchase intent for the higher end priced risk-based game. Free to play is additive, not cannibalistic.

In addition to Dragon Age legends, we have 6 free-to-play services live and in beta based on big franchises like Battlefield and Need for Speed. These services are scaling fast, with nearly 15 million registered users to date and strong revenue and profit growth. This model is also working at EA SPORTS and EA Play, which have launched Madden superstars, FIFA Superstars, and monopoly millionaires on Facebook, with many more to come. EA is uniquely suited to this multi-platform strategy and no other game company has the deep IP portfolio and the cross platform capability to capture this.

Next, let me outline 3 world-class launches we have planned for fiscal '12. I'll start with Battlefield 3 from our DICE Studio in Stockholm. The game is built on our brand-new Frostbite 2 Engine. It takes the battle to an urban landscape with dynamic weapons, destructible environments, vehicular warfare and a team oriented multi player that provides a highly competitive social experience. Battlefield 3 absolutely blew away critics when unveiled at the Game Developers Conference in March.

Pre-orders tell a compelling story. Pre-orders for Battlefield 3 are up more than 700% versus the same period before the launch of Battlefield: Bad Company 2. A lot of people are telling us they want to play this game on day 1. We know we had a big competitor, but head-to-head with Call of Duty in Q3, we have the superior game engine, superior development studio and a flat out superior game. Our goal is to significantly gain share in the huge FPS category and to put the other team on defense.

Come and see for yourself. We’ll be showing brand new code and features at E3 in June. I encourage everyone to make time for Battlefield 3.

Our second blockbuster in Need for Speed The Run was announced last week with a trailer that revealed another spectacular game in this globally recognized franchise. Developed by the Black Box team in Vancouver and built on a proprietary game engine Frostbite 2, Need for Speed The Run offers an edgier experience that takes players on an action-packed high-stakes race from San Francisco to New York.

And finally, the biggest event of the year will be Star Wars: The Old Republic, a jaw-dropping subscription-based MMO that is captivating critics and fans in the beta test. We currently have over 1 million double-opt-in beta testers for the world's first story-driven, fully-voiced MMO.

Everyone is waiting for us to announce the ship date. Sorry, but that's not going to happen today. We're holding the date for 2 reasons. First, we don't want to tip off the competition. Second, we want more data from the beta test to guarantee a spectacular experience at launch.

At EA Games Label, we couldn't be more proud of fiscal '11, or more excited about fiscal '12. No other company connect gamers through so many great titles on so many platforms. Now I'll turn the call back over to John Riccitiello.

John Riccitiello

Thanks, Frank. Fiscal '11 was a very good year for EA overall. You have heard from Frank on the record year his team has delivered at the EA Games Label and EA Sports had a record year for revenue and profitability. We are particularly proud of delivering the very high end of our financial guidance and exceeding our $750 million Digital non-GAAP revenue goal.

Today, we are a very different company. We have strengthened our IP portfolio, our quality, and importantly, extended our franchises onto new and fast-growing Digital platforms. From here, it's about building a better, more predictable and more profitable business.

We will continue to build the game industry's most powerful collection of globally recognized intellectual properties. We will build and launch a direct to consumer software platform, most importantly, the great hardware from the key first parties and the retail operations of our largest customers.

We will extend our hugely talented teams to create and manage IP across the entire spectrum of console, social and mobile platforms. This is all about building shareholder value. We're expanding our earnings power while building a more predictable, less seasonal, less cyclical business; a business that is less dependent on individual hits and more deeply anchored in the ongoing modernization of game franchises. We're shifting our offense in running plays no other company can. This is how we create greater shareholder value. With that, we are happy to take your questions.

Question-and-Answer Session


[Operator Instructions] Your first question is from Brian Pitz with UBS Investment Bank.

Brian Pitz - UBS Investment Bank

About the impact on the business from the PlayStation Network outage. Obviously, this is a pretty significant situation. Any results impacted to date? And can you help us understand the decisions that support Battlefield with a $100 million in marketing campaign? Is that going to be enough or is that too much? How should we be thinking about that investment?

John Riccitiello

This is John, Brian. We'll probably pick that up in a couple of pieces. One thing, I was alerted to during the call, just for everybody listening, is that it was apparently muffled and a little rough to hear. We made a switch, so we'll be a little clearer during Q&A, at least we hope so. And we've already posted and sent out the full transcript to allow those that may have missed a word here and there that they wanted to hear. Apologies for that, I have no idea what happened there. To your question, I'll take the second part first. Battlefield 3 is actually a misquote of something I said. What I said was, over $100 million in competitive spending, meaning, EA and Activision would spend well north of that competing for first-person shooter leadership this fall. That misquote got repeated and then built on in a few other gamer publications. And we are not putting out a specific budget for our Battlefield 3 launch campaign. We never do. And that was the reason I kept it in the generic, what I expected to combined to be, which will be more than that. Eric may want to speak to the point about PS3 and impact on our financial.

Eric Brown

In terms of the PSN outage, obviously, we're hopeful that, that comes back online as quickly as possible. We are aware that heading into the construction of our Q1 guidance, we think there's a modest impact that we've already factored in here in the upcoming quarter.


Our next question is from the line of Justin Post with Merrill Lynch.

Ryan Gee - BofA Merrill Lynch

This is Ryan Gee calling in for Justin Post. I guess a couple of years back at your Analyst Day, and I think it was '08, you guys gave like an estimate for some of the different labels. And I was wondering if you can just update us on the size of your sports business. Maybe what it was in fiscal '11, and then what it could be in fiscal '12, some of the titles that are going in and out? And then also, on a beta test for Star Wars, it sounds like you guys are already ongoing with that. But how long does a test like that last before full product launch can actually take place?

John Riccitiello

I'll break that into two. I'll pick up on the sports point. I'm not sure about the relevance to sort of 2008, and we don't put out label-level financials. I would make the following points about the EA Sports business. It recorded record revenues in profit in fiscal '11, part of that is driven by a non-annual title, and FIFA World Cup, and which added north of $100 million to our business, very profitable revenue. And the Sports business, while still projecting strong profitability in a very good business for fiscal '12, we did note, and would note that there's about a quarter of $1 billion challenge that needs to be overcome in that business through the combination of risks either on lockouts, our decision on the ship date for NBA League Packaged Goods and then non-lapping the World Cup title. What's great is we've got strong guidance despite that, but those are sort of some of the headwinds on that business that you've identified correctly.

Frank Gibeau

With regards to your question on Star Wars, this is Frank, typically MMOs have about a 6 months run in terms of beta testing. We've been continuously testing Star Wars already and have already embarked on that process. So we feel very good about the type of telemetry and feedback that we've got coming in from that. And we have a very sizable sign up list of beta testers that are actively engaged in making the game better.


Your next question is from Edward Williams with BMO Capital Markets.

Edward Williams - BMO Capital Markets U.S.

Just a quick question to follow-up a little bit on the beta, if I could, for a moment. Can you give us a little bit of color as to what the level of interest is at this point in the Star Wars beta? And then for a look at your guidance for the year and the range of your guidance, can you comment a little bit about what's at the high end in terms of the assumption behind Star Wars? Is that kind of what the timing maybe in the launch of the game, or if you can give brackets around what we might be thinking of in terms of a sublevel or an ARPU level even?

Eric Brown

So this is Eric. And I'll take the second part of the question first. So our guidance range at the high-end of $0.90, we've given a ship date range of fiscal Q2 to fiscal Q3 for Star Wars. And so Star Wars shipping earlier i.e. in Q2 versus Q3 is factored into the $0.90 upper range. We are not giving any specific subscription or subscriber targets or ARPU. The only thing we've said about business models expected to be monthly subscription based, but beyond that, we haven't given any specific metrics for that. The other thing though, in terms of operating within the guidance range, moving from the upper end down to say, the middle or the lower end is, if the ship date should slip by a couple of months from Q2 into the latter portion of Q3, it's north of $0.05, $0.05 to $0.10, in terms of variability based on the ship date of Star Wars within the windows that we've provided there. And that is, of course, factored into the $0.20 overall non-GAAP EPS guidance range.

John Riccitiello

In terms of your first question about interest in the beta, it's exceedingly high. The demand metrics for this franchise are amongst the highest we've ever seen at Electronic Arts. And in fact, the customer data coming in from the beta test intend to purchase quality ratings, desirability, are all at the very high end of what our partners in the testing groups have seen. We're very excited and confident that we've got the right game.


The next question is from Brian Karimzad with Goldman Sachs.

Brian Karimzad - Goldman Sachs Group Inc.

I guess first one, just parsing a bit the Digital guidance, so this year x that $27 million one-off benefit you did about 40% Digital revenue growth. And for fiscal '12, you're implying 34% growth even though you have some benefit from the MMO in there. So if you were to think about what's baked in there excluding the MMO, is it safe to say you're assuming somewhere in the, call it, high 20%, low 30% growth range? Or are you baking in a more material deceleration from the fiscal '11 growth rate for Digital x the MMO?

Eric Brown

This is Eric. I mean we're looking to grow all portions of the Digital portfolio year-over-year. We're coming off a year where every line item was up 20% or better whether it's mobile, free to play, micro transaction, BLC, subscription advertising other et cetera, full game Digital downloads. So we've experienced strong growth across the portfolio. We think Star Wars will obviously lead to Digital growth. There's some variability based on the ship dates so we're going to get a partial, years of question of how many months do we get. So that has to be taken into account in terms of the guidance overall. Star Wars will be added to the 2 line items in terms of the guidance subscription and we expect to sell some of the clients via direct Digital downloads. So that will also be included in that Digital full game download category. The one area where there's likely to be a deceleration is in the Council related DLC. At this point in time what we've done is we've effectively digitally enabled, 90%, 95% of the portfolio versus less than say 25% 2 years ago. So we had the benefit of going from, in some cases, 0 Digital revenue in the franchise to 10 plus million of Digital revenue. So if there's any deceleration, it has to do with that aspect. You can't re-digitally enable every portfolio. What I would call out though, is that one of the things you can see in our FY '11 Digital results is strength coming out of our number one, Packaged Goods title, FIFA, where we reported in fiscal '11 more than $100 million in Digital revenue across all the revenue types, free to play, DLC, mobile, et cetera. So what we're starting to see is significant Digital leverage per Packaged Goods franchise. What we're looking to do over time is to get more titles into 50 plus million Digital extension level like we've done with FIFA and Battlefield: Bad Company 2.

Brian Karimzad - Goldman Sachs Group Inc.

And on Battlefield 3, I know I'm not going to get an absolute pre-sell number out of you, but can you give us some color on what mix of folks have elected for digital download when they made that pre-order? And also a sense for I'm guessing a lot these folks were already on Nucleus, so what mix of them were existing Battlefield purchasers or owners, or players?

John Riccitiello

Yes. These are pre-orders coming in from retail so we don't really have a mix on the Digital piece at this time. It's all basically apples to apples on a retail level. When we looked at on the Nucleus level, there's a lot of new users coming in. The game is a generation ahead of what's out there because of the Frostbite 2 technology. People are very excited so we're seeing a lot of interest coming in from non-Battlefield fans.

Frank Gibeau

I would also add that the first person shooter, we saw strong digital client uptick on Medal of Honor. So PC Digital Direct so it seems as though that mode of delivery is resonating well with the FPS fans.


Your next question is from James Hardiman with Longbow Research.

James Hardiman - Longbow Research LLC

First, you had a couple of really highly rated games that you came out with in the fourth quarter, certainly, Crysis 2, Dead Space 2. It seems like these are games that the critics at least like quite a bit, and yet the sales were maybe not quite where I'd hope and maybe you had hoped, have you learned some lessons about maybe the launch window so closely on the heels of a pretty solid first-person shooter game that came out over the holidays. and does that have any ramifications about how you think about launch Windows as you move forward with high-quality first-person shooters?

John Riccitiello

So almost all of us would probably have a different point of view on that, but I would start by saying that Dead Space 2, and I guess the post holiday window has dramatically outsold Dead Space 1. And that's precisely what we want to see with these things which is, we create a franchise, we manage to get to a reasonable profitability sort of with the first edition and build that intellectual property. So it's got the breadth and shoulders so each successive release can sell more than the one prior. That's where the profitability comes in our business. We've been doing that well. And Dead Space is a perfect example of that working despite it moving from a holiday quarter introduction to a post holiday follow on. And it did well and we're pleased with the outcome. Do you want to pick up on Crysis...

Frank Gibeau

Yes, Crysis 2, that shipped at the very end of March, so the data that's coming up through MPD and the others doesn't really reflect the full measure of how the game is selling. It's selling extremely well, and it's continuing to sell very well into the new fiscal year. So the title's got legs. It's extremely high-quality. The guys at Crytek really nailed on the product. And it's got a deep multiplayer, which is keeping it in the disc tray, and people are continuing to play, the marketing's continued to really branch out and bring new users in. So we're very pleased with the Crysis 2 launch. I think maybe we're looking at too early a read because it shipped so late in March.

John Riccitiello

I'd add one thought to this as well. I've mentioned this, as did Frank on the call, that we're pursuing Digital in a way that no other company is. And Dead Space is a perfect example of this more early innings than FIFA or Battlefield. But the core thesis that we're able to do that literally no one else can do, and it generates strong profit opportunity for us, is taking a property like Dead Space and then driving it across iPads, across iPhones, across Androids ultimately in social, DLC, ongoing micro transactions associated with the franchise. And what we're finding from our telemetry, and we have details on this that we're quite convinced were right, we're not trading dollars for pennies. We're, in fact, adding new revenue streams and increasing the interest in our existing business model while adding new business model. As we concentrate our intellectual property portfolio, we're doing something, as I said, no one else can do in that there really isn't a competitor that's a leader in console, a leader in PC, a leader in DLC, a leader in micro transaction, a big leader in iOS, a leader on social networks like Facebook. So it's taking our best properties, and frankly, I think if you try to evaluate any of them just on Packaged Goods, you're missing the larger picture and the larger opportunities that we have for EA.

James Hardiman - Longbow Research LLC

Very helpful. And then I was hoping you could maybe give us a little bit more color, you talked about a $250 million revenue challenge this year versus last. I'm assuming that a good chunk of that, you sort of know in terms of the NBA ELITE, certainly, in the FIFA. And then I was hoping you could maybe qualitatively talk about the piece that you don't know. It sounds like, that's primarily Madden. What are your sort of thoughts about whether or not a season this year or a delayed season, how does that affect Madden? And if the NFLPA and the NFL came in agreement tomorrow, how would that change you assumptions, and ultimately your guidance?

John Riccitiello

Well, think of it this way, one, there's 112 million fans out there with an opinion, and I may have insider seat, but in terms of trying to give you an insider's view, I won't do that here. I think that's really for the NFL and NFLPA to do. Personally, I'm a fan and I'm hopeful there's a season. In terms of business planning, we plan the business down about a third, $85 million, $90 million, on the principle that there's a lockout for the season. That's a worst-case planning assumption. We expect it to do better, if there's a season. And as I said, we're hopeful that there's at least a partial season. The third thing to know, and we communicated this some time ago at an investor conference, we have -- we came to an accord with the NFL, and PA regarding our business relationship with them that largely facilitates digital profit protection in a downside scenario. So think of revenue upside relatively modest upside if there's a season, but the revenue loss is baked into our guidance.

James Hardiman - Longbow Research LLC

And that's baked into your guidance throughout the full $0.70 to $0.90 range or is it ...

John Riccitiello

It's baked in at every scenario and the assumption is there's no season, that's what's baked in into our guidance.


Your next question is from Arvind Bhatia with Sterne Agee & Leach.

Arvind Bhatia - Sterne Agee & Leach Inc.

My first question guys is on the Direct-to-Consumer business that you're building. I think, Eric, I heard you say, part of the reason some of the expenses on the OpEx side will be higher, will be spending on that. Can you provide us some more color there? How soon you want to ramp that up? How big do you see that business over the next 12 to 24 months? Just what the plans are?

Eric Brown

Sure. Just to be clear, overall, you expect OpEx to be up slightly year-over-year but only due to FX overall and a constant currency basis roughly flat. We do however expect to increase capital spending year-over-year. And we called out really 3 items there. One is the buildout of the Star Wars server infrastructure to bring that service live, and the other 2 were to support our D-to-C [ph] initiatives. So we anticipate ramping a bit on the capital side as we deploy platform technologies and support systems to further beef up for example our nucleus registration system it's at 112 million registered users as of the end of the quarter roughly double where it was a year ago. That system has to be ultra scalable. So we've taken that into account in terms of our capital spending assumptions there. Also, we're making further investments in customer acquisition and monetization. CRM messaging is an area that we really started to focus on and we sent more than 500,000,000 direct messages in fiscal '11. We intend to increase capacity in that area as well. So those are a couple of examples of D-to-C [ph] investments that we have looking at FY '12.

John Riccitiello

And some color on that, that I think you were getting at about our spending on Digital, we are actually increasing our spend in Digital. What's happening is there's a shift in mix. If you were to take EA's aggregate investments in SG&A or look exclusively at R&D, the internal data shows us a pretty sharp waterfall. What we've been doing is stepping down investment against our core Packaged Goods business, and stepping up investment against Digital opportunity. In fact, this year, we're getting reasonably close to 50-50. Obviously, 3 years ago, we were closer to 90-10 so sort of under the surface of this business is a dramatic transformation of our resource allocation, which is why we described ourselves looking forward to a fully integrated Digital business because virtually everything we're doing now is against the Digital opportunity. It's where we see our growth. It's where we see our margin expansion. It gets us that less cyclical, less seasonable, more ratable, and more profitable business.

Arvind Bhatia - Sterne Agee & Leach Inc.

And then one Of your key titles for fiscal fourth quarter is of course Mass Effect 3 and I didn't hear too much about that so I'm wondering if you could take the opportunity maybe to talk a little bit about what's happening there and what you see so far?

Frank Gibeau

This is Frank. Yes, the Mass Effect 3 title is well under development up at our Edmonton studio, and we're very excited about the innovation we have planned for the game. For the first time in the Mass Effect series we're actually going to be able to launch on all platforms simultaneously, which will allow us to expand the market fairly dramatically. We have some announcements at E3 that I think everybody will be excited about in terms of some feature innovation and some new ways to play Mass Effect. But it was a very successful franchise for this year, it won 150 different awards. I think it’s Metacritic was nearly 95%. So this is a great platform for us to continue to build from, and we're very excited about Mass Effect 3.

John Riccitiello

Just to add a little bit, and this franchise is a personal favorite of mine, and I won't get into any gameplay strategies, but I will point out that the franchise has done exceptionally well so far and it's one of the franchises we're building on. And one other thing, Frank, and [indiscernible] and the team up in Edmonton have done, is essentially step-by-step adjust them to gameplay mechanics, and some of the features, which we'll see at E3, that can put this into a genre equivalent of shooter meets RPG, and essentially address a far larger market opportunity than Mass Effect 1 and Mass Effect 2 began to approach. So we're huge believers in the intellectual property. And we are purposely shifting it to address a larger market opportunity.


Your next question is from Atul Bagga with ThinkEquity.

Atul Bagga - ThinkEquity LLC

I have a couple of questions for you. A, I wanted to understand a little bit about your philosophy around investment in new IPs versus building out extending the existing IPs, how many new IPs are you going to expect to see year-over-year from EA?

John Riccitiello

So John here. A couple of thoughts. So just a few years ago, we had north of 75 Packaged Goods titles and in fiscal '12, we have 22. If you listen carefully to Eric's commentary during the call, if you could hear it over some of the interference that was there, we have a very strong focus on making sure we achieve green light hurdles involving our own profit metrics, the one important one is strong IRR. [indiscernible] titles were driving up the profitability, their ROIC for the company overall. We are still investing in new intellectual properties. At any given time, we have 2 or 3 in development. We do now, and we will be making announcements when it's appropriate to do so. But we're still believers in new intellectual property. If you want to think about where EA is trying to go, it's around this concept of about a dozen great IP that we can program if you will, 12 months of the year with 12 months of revenue across multiple platforms and multiple business models on a global opportunity. The second thing is, to that, trying to add one meaningful new property a year, recognizing that some genre, some sectors don't perform forever. Take the music genre, for example, it was all the rage on ours and a competitors call, a couple of years ago, and it's essentially not the subject today. So we're a believer in, if you will, our great dozen IP. And we recognize the need to add to that in order to keep it at a dozen to grow and expand that portfolio.

Atul Bagga - ThinkEquity LLC

That's helpful. And the second question is around your Nucleus database. I'm not sure if you guys touched upon this. So right now the $120 million Nucleus registration, does it include people who are coming from Playfish side? And going forward how do we see this evolving? Do you see EA becoming more focused on distribution, co-publishing given your platform advantage with the Nucleus registration database?

Eric Brown

This is Eric. So as of the end of Q4, we had 112 people registered in Nucleus -- 112 million and that did not include Playfish or some other game services like Pogo, or Marble. So if we were to take all of those other sources and merge it as we are in the process of doing and add it to Nucleus, it will be well north of 150 million, probably closer to 175 million, and we fully expect to integrate that user data from those other systems and drive -- and all future product releases registration to Nucleus. And so this really going to be an important asset to the company. It allows us to do some of the things that you're referring to direct market, both our titles and potentially titles that we digitally distribute on behalf of other developers. And so I think of this as evolving the way analogous to the way that we evolved our packaged goods distribution business through -- successfully through EAP.

John Riccitiello

The equation in our industry moving forward, in so many ways today, we talk about Packaged Goods, we talk about units, we talk about price. The conversation that's driving EA at this point is really more about the lifetime value of a consumer or customer, less the acquisition cost for that customer. And what Nucleus gets us is the opportunity to build directly against that type of a business model which can yield that more profitable business. I will tell you that we're going to focus a lot of our communication at E3 in describing what we mean by a platform that extends and augments console, PC and mobile that we put into our prepared comments today. We think it's actually one of the most valuable parts of our company and will lead us into a much better future. So it's a heavy emphasis here. So far we've been giving you the equivalent of eyeballs, we haven't been telling you what we're going to use it for. You're starting to pick up on that if you go to ea.com and look at our download now, et cetera, you can see a lot of new features. If you interact with our mobile games, our iPad games, you'll see, not only are you playing the Dead Space game on iPad, you're seeing the rest of our content come along with it. If you're interacting with a Chillingo product, whether it's Angry Birds or Cut the Rope, and you're involved in the Crystal platform there, you're seeing a lot of things under the surface that I think yield the best insight into where we're going as a company.

Atul Bagga - ThinkEquity LLC

And just to follow-up, how do you reconcile your partnership with Bigpoint with the Nucleus registration database that you guys are building?

Frank Gibeau

Yes. We had a relationship to distribute and publish some free-to-play games with Bigpoint. And I won't go into details in how we've worked that out, but we're very comfortable with the agreement that we struck with them to continue to drive against our goals in Nucleus.

John Riccitiello

Think of it like those trying to think this way, we actually don't think of ourselves in conflict with other distributors, as we build out EA's platform capability. If you're arguably -- there's a reason Kindle wants to be an application on the iPad or Netflix wants to be an application inside PlayStation 3, they want to push their content in as many ways as possible. When we push individual intellectual properties through other platforms, they ultimately register with us and become our users. And then we can ultimately monetize them in more ways than that first initial purchase. One of the great things about being an IP holder as opposed to just a distributor of content like some of the companies I just mentioned. Obviously, Amazon doesn't write books, and Netflix, for the most part, doesn't produce movies. When you own that intellectual property and you bring it inside your ecosystem, and you modify them, you do so at very high margins.


Your next question is from John Taylor with Arcadia.

John Taylor - Arcadia

I've got a couple of questions. I wonder if you could -- just maybe anticipating what you're going to do with E3, but when you talked about shifting from defense to offense, I wonder if you could sketch out kind of what that means in terms of planning, measuring, composition plans that sort of thing to get everybody sort of focused on the same set of goals. Any way you can kind of address that?

John Riccitiello

Only if you could spend a couple of weeks with us, but I think the best answer to that question is essentially this. We have radically reduced complexity in our company as we've gone from mid-70s to low-20s on titles. And those same intellectual properties are being promoted across all the various platforms and business models. We've identified intellectual property owners inside of our company, and we're sort of organizing around that. We are essentially charging those individuals and teams with the architecture of a plan that kind of involves console, PC, mobile, social, micro transaction, subscription, et cetera. So you get the vast simplification when you organize around a single organizing principle as opposed to multiple, which is what we have to do this past 3 years as we manage transition. So ultimately, I would say offense, is frankly a good description of what happens when you know what play to run over and over and over again and score touchdowns or make field goals. And right now, that model is our best property when across all of those various business models and having the teams that are charged with that it feel responsible, accountable and rewarded for success.

John Taylor - Arcadia

Let me ask one more. So Eric, the star Wars game, can you talk maybe about the difference in run rates before and after the game ships in terms of prebuild and then ongoing service beyond that?

Eric Brown

Well, I think, here's the way to look at it, and we made some specific comments about what our year looks like when measured with the a portion of the year with Star Wars versus where we exit the year where Star Wars is fully in operation. And so again, we opened the year fiscal '12 with Star Wars still in development with us incurring expense through our P&L. A fairly significant R&D expenses. At the end of the year, Star Wars will be live. I will have some of the cost shift from R&D into cost of goods as we activate the live services, the game masters, the customer care, et cetera. But all in, the Star Wars P&L flips from being dilutive at the beginning of the year to highly accretive at the end of the year. So that's really the point that we wanted to make. Now exactly what that delta is before and after is subject to assumptions about subscriber counts, retention, et cetera, we're just not in a position to get into that level of detail right now. But suffice it to say on a fully operational basis, 12 months of Star Wars will look even better on our P&L in regards to the partially contribution in fiscal '12.

John Riccitiello

We did give a little bit on the prepared comments and I pointed out, if you could again hear it over the technology. Our EPS run rate is essentially 50% higher than it was throughout fiscal '11 as we shift through the pre-and post-Star Wars ship date. so it's a pretty dramatic increase in earnings leverage. And one of the reasons for -- as a perspective, we said plus 10% on earnings during the last call, expecting a 65%, 66% EPS outcome for fiscal '11, implying $0.72, $0.73, $0.75. We just reported guidance of 70, 90, midpoint 80, up 14% versus our F'11 actual. But the full range is really explainable in the range of ship outcomes for Star Wars. And so we think that's a very attractive situation because the actual hit the pin on the dot for when we ship it doesn't affect the underlying value of Electronic Arts. A little bit later or a little bit earlier in the scheme of things is meaningless to everything other than fiscal '11 EPS outcome.


Your final question is from Sean McGowan with Needham & Co.

Sean McGowan - Needham & Company, LLC

I was wondering if you could comment on the some of the recent acquisitions that you made. And are you expecting to see additional ones, small strategic ones or anything bigger coming up?

John Riccitiello

Thank you for asking that question because one of the things we rather enjoy here is acquiring companies and then having people speculate that we've spent 5x more on it than we actually did, which is what happened the last time around with Chillingo. Here, we just picked up a company we feel great about, Firemint, a very strong creative organization and we did so at a vastly lower price than has been reported publicly. Eric, do you want to pick up on specifics?

Eric Brown

Yes, I think it's consistent with the strategy that we've articulated in terms of M&A. Smaller scale acquisitions that are purely digital. Firemint is going to continue to drive the overall mobile portfolio particularly on smartphones. They are extremely talented developers. They've already proven to sell us with a couple of blockbusters and there's more in the works. And as we look at the acquisition, overall on price, it's less than $25 million. If we look at the actual EBIT multiple, it's in the 4x range. And so, by any metric, it's a great pick up and we're super excited to have that talented team join EA.

John Riccitiello

All right. Ladies and gentlemen, thanks for joining us on our fiscal '12 earnings call and FY '11 report. See you next time. Thanks, very much.


This concludes today's conference. Thank you for your participation. You may now disconnect.

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