Electronic Arts F4Q09 (Qtr End 3/31/09) Earnings Call Transcript

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Electronic Arts Inc. (ERTS) F4Q09 Earnings Call May 5, 2009 5:00 PM ET


Tricia Gugler - Director, Investor Relations

John S. Riccitiello - Chief Executive Officer, Director

Eric F. Brown - Chief Financial Officer, Executive Vice President

Rod Humble -

John Pleasants - Chief Operating Officer and President - Global Publishing

Peter Moore - President, EA Sports Label


Heath Terry - Friedman Billings Ramsay

Justin Post - Merrill Lynch

Shawn Milne - Janney Montgomery Scott

Arvind Bhatia - Stern Agee Leach

Brent Thill - Citigroup

Edward Williams - BMO Capital Markets

John Taylor - Arcadia

Douglas Creutz - Cowen & Company

Anthony Gikas - Piper Jaffray

Colin Sebastian - Lazard Capital

Jeetil Patel - Deutsche Bank

Daniel Ernst - Hudson Square Research

Sean MacGowan - Needham & Company

Eric Handler - MTM Partners


Ladies and gentlemen, thank you for standing by. Welcome to the Electronic Arts fourth quarter and fiscal year 2009 earnings conference call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the call over to Ms. Tricia Gugler, Senior Director of Investor Relations. Please go ahead.

Tricia Gugler

Welcome to our fourth quarter fiscal 2009 earnings call. Today on the call we have John Riccitiello, our Chief Executive Officer; Eric Brown, our Chief Financial Officer; John Pleasants, our Chief Operating Officer; and Rod Humble, our Head of our EA Play Label.

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 web site 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, a substitute for or superior to our GAAP results and 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 for the prior year unless otherwise stated.

Please see the supplemental information on our website for our trailing twelve month segment shares, additional GAAP to non-GAAP reconciliations, a summary of our FY10 financial guidance and our Q110 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 5, 2009 and disclaim any duty to update them.

Now I would like to turn the call over to John.

John S. Riccitiello

Thanks Tricia. Earlier today we announced our Q4 FY09 results. We reported that our EPS in Q4 was better than expected and we successfully implemented our cost restructuring. We also confirmed our FY10 non-GAAP guidance.

On today’s call, I will touch briefly on the retail environment and the industry and provide an update on our strategy; Eric will review our Q409 results, provide an update on our cost cutting actions and our detailed guidance for FY10; Rod will discuss the upcoming launch of The Sims 3; and I’ll wrap up with a few closing thoughts, before we open it up for Q&A.

Let me start with the industry and retail environment. We continue to see a challenging environment. The retail channel is cleaner than it was one quarter ago, but retailers continue to be cautious with initial orders, waiting for confirmation of strong sell-through before committing to more inventory. In Europe, which has a more fragmented retail footprint, we saw a few retailers close their doors in the UK and Spain is suffering disproportionately due to piracy. Overall, retailers remain cautiously optimistic on the category and in some cases are increasing shelf space for the video game sector at the expense of other categories but remain conservative on inventory buying and management.

After a strong January and February software growth comp to 2008, we saw a negative comp in March turning industry growth negative in North America on a year-to-date basis. We expect negative monthly comps to continue from April thru June. We now expect software sales to grow in the low to mid-single digits in calendar year 09 across both North America and Europe. We anticipate comps to improve in the back half of the year fueled by a strong slate of games and easier compares. We remain cautiously optimistic on the industry.

For EA, I am confident in the quality of our games and the marketing and sales programs that we are building to create and sustain demand. In addition, I’m also pleased to see the investments we have made in online begin to payoff.

Ninety days ago we provided FY10 guidance, a quarter earlier than our usual pattern. Even though we are a bit more cautious on the industry today, we haven’t made any material changes to our assumptions and we are confirming our FY10 non-GAAP guidance. As we said on our last call, we took a more measured view of our top-line from the start, and we’ve cut our operating expenses significantly, down $500 million from our original projection and are focused on delivering the operating profit in our guidance.

Now on to our strategy -- as we discussed on our last call, we are focused on four main areas in FY10: Drive hits, particularly on EA’s core platforms, the PS3, Xbox 360 and PC; two, aggressively manage expenses; third, build on the progress we have made on the Nintendo Wii; and fourth, drive our digital services revenue.

Let me provide a brief update on each one.

Drive hits -- we plan to match strong quality with strong marketing, particularly for our top ten PC, PS3 and Xbox 360 titles. We’ve got a strong lineup of titles this year coming from each of our labels. Our annual franchises are looking great and we have a number of quality titles that we didn’t have last year, including EA SPORTS Active, The Sims 3, Dragon Age, Mass Effect 2, Brutal Legends and Harry Potter.

Our marketing plans for these titles are well underway. Our goal is to ensure our marketing campaigns are crisp and that we optimize every dollar we spend. A few points here -- first, we are changing when we spend our marketing dollars versus the approach we took last year; and second, we are adjusting our allocation between traditional and new forms of media to ensure we are finding our consumers.

The first titles that will be getting EA’s revamped marketing are EA SPORTS Active, launching in May, and The Sims 3 launching in June.

Secondly, aggressively manage costs -- we have executed on our cost reduction plans slightly better than expected, ending FY09 with lower operating expenses than anticipated. I am pleased with the progress our teams have made during the quarter – never in EA’s history have we reduced costs this aggressively and at such a rapid pace. As we exit FY09, our cost reduction plans are substantially complete, and our focus is on executing our FY10 plans. Eric will provide a more detailed update shortly.

Third, capitalize on the progress we have made on the Wii. Versus a year ago, where I believe we only had a few Wii titles that charted well, this year we have at least ten that have the potential to chart well in both North America and Europe. For the first time, all of our games are either specifically designed for the Wii or the Wii game is the lead SKU.

One additional highlight -- we are bundling the Wii Motion Plus with Tiger Woods PGA TOUR 10 and EA SPORTS Grand Slam Tennis at launch.

We’re also moving ahead with a unique set of marketing plans for the Wii. We’re launching our own website dedicated to EA’s titles on the Wii later this month. We’re also building a brand campaign around EA on the Wii that will launch later this year and we’re taking a different approach to retail marketing.

Finally, drive our digital services revenue. I believe that as much as global publishing has long been a strategic advantage for EA, our direct-to-consumer initiatives will define our leadership in the years ahead. Our digital business is at scale at over $400 million and it is growing north of 20%. We’re the number one publisher in wireless in North America and Europe combined. This year we plan to extend that leadership, in part, by launching 30 games on the iPhone.

Digital content -- both full game downloads as well as micro-transactions -- were roughly $80 million in revenue, up 2x from FY08. We expect this to roughly double again in FY10. This is driving ARPU and margins.

On PC, our subscription revenue streams continue to grow with our Pogo and Warhammer businesses. We also plan to introduce two additional online subscription services later in the fiscal year.

And finally, Asia -- we recently began commercializing NBA Street Online in Korea and launched the open beta of FIFA Online 2 in China. This is an important milestone setting the stage for future growth in China. In FY10, we have a robust line-up of titles in Asia. After a multi-year period of investment in this area, we expect the business to be profitable in FY10.

That wraps up my update. Now, I would like to turn the call over to Eric.

Eric F. Brown

Good afternoon. For Q4, we delivered non-GAAP revenue of $609 million and non-GAAP diluted loss per share of $0.37. We came in better than expected on non-GAAP operating expenses and slightly lower than expected on revenue, netting to $0.05 above our guidance. This was done in a quarter where we were collectively focused on restructuring the business.

On a GAAP basis, revenue was $860 million and GAAP diluted loss per share was $0.13.

Key titles in the quarter were Skate 2 and Lord of the Rings Conquest -- each sold over 1 million copies; SimAnimals and MySims Party -- each sold over 0.5 million copies.

In our digital direct businesses, we generated $110 million in non-GAAP revenue, up 16% year-over-year, representing 18% of our total non-GAAP revenue in the quarter. We had strong performance across all units.

POGO ended the year with 1.8 million subscribers, up 9% from a year ago. Wireless revenue was $48 million. In February, we had four of the top 10 games in North America and five of the top 10 in Europe.

Digital download games and micro-transaction revenue was $25 million, up more than 2x from a year ago due to further expansion of our online distribution capabilities.

Warhammer ended the year with over 300,000 subscribers.

We executed sharply on our cost reduction plans, ending the year at $2.18 billion in non-GAAP operating expenses versus our previous guidance of $2.25 billion, approximately $70 million better than expected. This savings came from lower costs from headcount related items, contracted services, and marketing.

Approximately 75% of the headcount reductions were completed by year-end and we have closed five facilities. We expect the remaining restructuring actions to be completed by the end of Q2 fiscal 10. We enter FY10 having effectively reset our operating expense run-rate.

I would now like to discuss Q4 in more detail. Please note that all of the following references to fourth quarter results are non-GAAP, unless otherwise stated.

Non-GAAP revenue was $609 million, down 34% from a year ago. At constant currency rates, revenue decreased 30%. This decline primarily relates to a decline in catalog revenue, which is revenue related to launches in prior quarters, which was 37% of total revenue versus 35% a year ago.

As expected, frontline revenue was down due to shipping smaller scale titles in the quarter versus a year ago. Skate 2 and Lord of the Rings did not comp last year’s launch of Army of Two and Burnout Paradise. Distribution revenue was also down, given the strong comp of Rock Band in the prior year.

By geography, North America non-GAAP revenue was $366 million, down $178 million or 33%; international non-GAAP revenue was $243 million, down $132 million or 35%.

Moving to the rest of the income statement, non-GAAP gross profit was $302 million, down 35%, consistent with the decline in non-GAAP revenue.

Non-GAAP gross profit margin was 49.6% versus 50.4% a year ago. The decrease is primarily attributable to a higher mix of revenue from licensed IP and higher sales reserves, slightly offset by a lower mix of distribution revenue.

During the quarter, we amended a licensor agreement related to the use of certain IP in our games. This resulted in a GAAP charge of $38 million to cost of goods sold due to the loss on this IP commitment. This has no impact on our FY09 non-GAAP gross profit or our cash flows.

Our non-GAAP operating expenses are down $21 million year-over-year to $467 million as a result of our cost reduction program. The bonus expense in Q409 was comparable to Q4 last year.

Non-GAAP marketing and sales expense was $111 million, down $12 million due to lower advertising and lower personnel-related costs. Non-GAAP G&A expense was $61 million, down $19 million due to lower bad debt expense and lower contracted services costs.

Non-GAAP R&D was $295 million, up $10 million as a result of increased developer advances in EA Partners, slightly offset by lower personnel-related costs.

During the quarter, we recorded $39 million of total restructuring expense.

Below the operating income line, non-GAAP other income and expense was a loss of $2 million due to a decline in interest income and increased foreign exchange losses.

Income taxes -- on a GAAP basis we recorded a tax benefit of $17 million. We haven’t recorded any net benefits for U.S. deferred tax benefits due to the valuation allowance. On a non-GAAP basis, we recorded taxes at 28%.

GAAP diluted loss per share was $0.13 versus a diluted loss per share of $0.30 a year ago. Non-GAAP diluted loss per share was $0.37 versus diluted earnings per share of $0.09 a year ago.

Our trailing twelve month operating cash flow was $12 million versus $338 million for the prior period.

Turning to the balance sheet, cash and short term investments were approximately $2.2 billion at quarter end, up approximately $200 million from last quarter due to cash generated from operations.

Marketable equity securities were $365 million, up $63 million from last quarter due to increases in the market value of our strategic investments. At quarter end, we had a net unrealized gain of $190 million.

Gross accounts receivable were $333 million, down from last year and consistent with the revenue decline.

Reserves against outstanding receivables totaled $217 million, down $21 million from a year ago. Reserve levels were 9% of trailing six month non-GAAP revenue, consistent with last year. As a percentage of trailing nine month non-GAAP revenue, reserves were 6%, down one point from last year.

Inventory was $217 million, up $49 million from a year ago. Excluding our EA Partner inventory, for which EA has limited exposure, inventory was roughly flat year-over-year.

Ending deferred net revenue from packaged goods and digital content was $261 million, down $126 million from a year ago.

Before we get into our guidance, I would like to highlight several reporting changes: first, beginning in Q1, we will be deferring revenue on a GAAP only basis for every online-enabled game. Historically, we only deferred revenue for a subset of console and PC games, primarily those games where EA provided online hosting. Given our focus on driving our content digital/direct to consumer, all of our future online-enabled games will have the potential for post release downloadable content, including free content. As a result, we will now defer revenue on all online-enabled games, including our Xbox 360 SKUs. This change will result in an additional $500 million of revenue being deferred out of FY10 into FY11 on a GAAP only basis. This change will not impact our non-GAAP revenue, our non GAAP EPS, or our cash flows.

Second, this quarter we’ve adjusted and expanded our revenue reporting in our press release tables. For example, we now break out our digital service revenue. We believe this new presentation is more reflective of how we view the business. All prior periods have been adjusted to conform to this new presentation. Next quarter – we expect to report our co-publishing revenue with EA publisher revenue since the economics of these deals are more akin to EA publisher revenue versus distribution.

Third, effective this quarter, we are making several changes to our title and SKU definitions given our evolving business models. Under our new definition, we are making the following changes: we will no longer count expansion packs as titles or SKUs, given that the lines are blurring between the physical expansion packs and other post release content; we will be including our online only games as “titles”. The first country of launch will be counted as a “title”. For example, NBA Street launched in Korea in Q4 will be counted as a title; we will still call out important expansion packs and post release downloadable content. By this definition, our title count is over 50 and our SKU count is approximately 120; and finally, I would like to highlight that our Redwood City headquarters leases are scheduled to expire in July 2009. We are currently reviewing our options, including buying the building outright, financing the building purchase or extending the lease.

Now for our FY10 guidance -- we are confirming our non-GAAP guidance. On a GAAP basis, we expect revenue of $3.70 billion to $3.85 billion. This is $500 million lower than our previous GAAP revenue guidance for FY10 due to the additional revenue deferral beginning in Q1.

On a non-GAAP basis, we expect $4.3 billion of revenue, up 5% year-over-year or $200 million. The primary drivers of the revenue growth by business is as follows: roughly plus $300 million from the Play label driven by the launch of The Sims 3 and our two movie based titles; roughly plus $100 million from our EA Sports label, driven by EA SPORTS Active, EA SPORTS Grand Slam Tennis, and Fight Night Round 4. We expect our core simulation sports titles in total to be roughly flat year-over-year; roughly plus $200 million from our EA Games label, including our distribution business. This growth is driven by Mass Effect 2, Army of Two: 40th Day, Godfather 2, Dragon Age, Saboteur, Dante’s Inferno and Brutal Legend; and finally, we expect our distribution business, separate from the EA Games label statistic given above, to be down roughly $400 million year-over-year.

We’re planning our catalog revenue in FY10 to be down year-over-year and represent a smaller portion of our total revenue.

And finally, just a point on launch dates. In FY10, we expect to ship FIFA 10 and Need for Speed SHIFT at the end of Q2 versus Q3 in the prior year.

Gross margins -- we expect GAAP gross profit margins of approximately 51% to 53% and non-GAAP gross profit margins of approximately 58% to 59%. • We expect our non-GAAP gross profit margins to increase significantly year-over-year due to a lower mix of distribution revenue, lower SRA reserves, and a higher mix of owned IP.

Operating Expenses • We expect GAAP operating expenses to be under $2.4 billion and non-GAAP operating expenses of approximately $2.1 billion.

On a Non-GAAP basis, we expect all of our expense line items to be down in absolute dollars and down as a percentage of revenue. This is also true, assuming we pay a full bonus in FY10 versus a much lower bonus funding assumption in FY09. We expect R&D to be approximately 27% of revenue. We expect sales and marketing to be approximately 15% of revenue, and we expect G&A to be approximately 6% of revenue.

Below the line, we expect GAAP loss per share of $0.85 to $1.45 and non-GAAP EPS of $1.00. A dollar in non-GAAP EPS translates to a non-GAAP operating margin of approximately 10%.

We expect that non-GAAP other income and expense will be roughly $25 million, down from last year as a result of steep declines in interest rates.

On taxes, we expect our GAAP tax rate to continue to be volatile but on an absolute dollar basis, and subject to changes in the business or the tax laws, we expect tax expense ranging from $10 million to $45 million. Keep in mind, we continue to expect GAAP losses in FY10, creating additional valuation allowances on U.S. deferred tax assets. On a non-GAAP basis, we expect to record non-GAAP taxes at 28%.

On share count, you should use 323 million shares to compute the GAAP loss per share and 325 million to compute non-GAAP EPS.

Foreign exchange -- our foreign exchange assumptions used for guidance are based on the rates we used on our last call, which were close to current spot rates at that time: $1.40 U.S. to the Euro, $1.48 U.S. to the GBP, and $0.82 U.S. dollar to the Canadian dollar.

We are comfortable with our guidance at current rates. To the extent the U.S. dollar continues to strengthen against the Euro and GBP, we will have downside revenue and EPS exposure. To the extent the Canadian dollar strengthens against the U.S. dollar, we will also have downside EPS exposure.

This concludes our guidance and outlook commentary and with that, I will turn the call over to Rod.

Rod Humble

Thanks, Eric. I’m happy to be here today to talk about our upcoming launch of The Sims 3 on June 2nd. Just to refresh everyone’s memory, The Sims franchise has sold over 100 million copies since its launch in 2000. Our last big launch, The Sims 2, shipped in 2004 with a very long tail, selling over 4 million copies of the base game each year for three years in a row. For those who don’t know, we also keep our Sims 2 game fresh by supplementing it with additional content via expansion packs about every 3 to 6 months. So we start with a very large and enthusiastic community.

Today, I would like to talk about The Sims 3 -- the game itself, what we focused on from a creative standpoint, our online & community services, the consumers we expect to appeal to, and our marketing campaign.

I’ll start with the game. The Sims 3 allows you to make any place you want and any person you want and live out their lives any way you want. Compared to The Sims 2, we give you a town instead of just a house, and you now create characters that are more varied and lifelike than the any characters in any other video game ever made. With The Sims 3, you get to create an entire world that feels real from the people you create and interact with, to the town in which they live. Our revolutionary artificial intelligence simulates what every character is doing -- falling in love, getting a job, robbing their neighbor, or just enjoying a sunset at the beach. It’s all happening at once.

We’ve evolved from a packaged goods standalone game to a robust online community based experience. Lots to say here, but let me make a couple of points.

The game seamlessly supports the ability to create and share content with millions of other Sims players around the world, right from inside the game. The game has an integrated online store. From the start, customers are given 10 dollars to begin shopping. The game will be available for digital purchase, both at the EA Online Store and the digital stores of our retail partners. In addition, we have announced that at no additional charge we are making an entire second city available as a download on day one. Real places, real people and real interaction and sharing with your friends. That is The Sims 3.

Now let me talk about our target demographic. The design of The Sims 3 aims not only to retain our current Sims 2 customer base, but we also expect to attract new users to the world of The Sims. More than anything, it is the game characters and what they do that will excite our existing and new players. Live out your fantasies, whether these dreams are about being a great student, a criminal mastermind or a rock star. It’s all in the game and the motivations and capabilities for each of these character types is richly provided for.

We are also making the game more accessible to a broader audience. The game will play on a wide spectrum of PCs, including lower-end models. And for the first time, The Sims 3 will be available at launch on Apple Macintosh computers and iPhones. We know Apple users are big players of The Sims and we’re happy to be able to offer them a great game day and date at launch.

And finally, our marketing campaign. We postponed the launch date to June 2 allowing us to give The Sims 3 the campaign it deserves. Our marketing for this game is in high gear. Our “Let There Be Sims” marketing started with an aggressive outdoor campaign in major cities in the United States. In addition, around the world you will be seeing such things as Sims themed smart cars, trains, buses and mall displays.

Our retail campaign is the largest Electronic Arts has ever launched, including specially designed end caps and in-store displays.

Online -- we have a large online investment including search, ads and several innovative interactive applications that run across social networks and the web. We are also planning a significant TV presence.

So far, consumer, media and retail reaction has been extremely positive and pre-orders are tracking ahead of The Sims 2. I’ve been having a wonderful time playing The Sims 3 and I can’t wait until June 2nd when our players get to enjoy it too.

John S. Riccitiello

Thanks, Rod. A few closing thoughts -- first, we are confident we have the right strategy for driving hits. You’ll see this strategy executed when we ship The Sims 3, a high-quality, truly innovative game, supported by great marketing and supplemented with deeply integrated direct-to-consumer features.

Second, although we are in uncertain times, we continue to believe we have an extended hardware cycle and we continue to see robust growth with our various direct service businesses. Both are positives for properly positioned publishers.

Lastly, our digital direct-to-consumer initiatives are beginning to pay out. We are through the net investment stage and expect strong returns. I believe that as much as global publishing has long been a strategic advantage for EA, our digital service initiatives will define our leadership in the years ahead.

We look forward to seeing everyone at E3 in June. With that, we would be happy to take your questions.

Question-and-Answer Session


(Operator Instructions) And we will take our first question from Heath Terry with FBR Capital Markets.

Heath Terry - Friedman Billings Ramsay

Great, thank you. I was wondering if you could talk to us about the strategy for embedding Wii motion plus with or packaging Wii motion plus with Tiger and the tennis game -- what kind of marketing goes around that, what kind of impact do you think it’s going to have on the profitability for those titles and what kind of impact do you think it ultimately has on sales for those titles?

John S. Riccitiello

Well first off, I think it’s emblematic of a really strong partnership between Electronic Arts and Nintendo that we are very pleased with. And really I think it’s a function of the fact that we’ve got two great titles supporting the new hardware peripheral from Nintendo precisely at the moment they’d be bringing them to market, and so they and we collectively thought it was a great idea to bundle them. I don’t think it’s got really any material impact on our profitability. You know, we expect this to be a, if you will, a normal percentage profit title for us within our Wii portfolio.

I do think it can help us on sales and my reasoning there is that I think the new sensor is going to be in high demand and one of the best ways to get it is with a piece of software that best, if you will, exemplifies or shows you or benefits you as a consumer and you are going to get that combination with both Tiger and our Grand Slam Tennis.


(Operator Instructions) We’ll go next to Justin Post with Merrill Lynch.

Justin Post - Merrill Lynch

Great. Thank you. When you look at the $295 million in R&D for the fourth quarter, and you talked about getting to your expense initiatives, are you at the level now where you think that’s kind of going to flat line for a while? Was there any abnormal bonus numbers in that number in the fourth quarter? And how do you see that trending as one of the most variable lines in your income statement? Thanks.

Eric F. Brown

I’ll take that question. So a couple of comments here -- so first we ended the fiscal year slightly ahead of our targeted cost reductions and we gave the statistics in terms of the end-of-year headcount, so we are pleased to have moved through the restructuring plan. We believe embedded in our guidance of operating expense of approximately $2.1 billion on a non-GAAP basis. That’s the overall expense rate that we would like to reset the business to.

For Q4, in terms of the bonus effect, the actual accrual amount is roughly the same year over year, although we would note that we accrued less bonus on a full year basis compared to last year, given the performance, and that affects all the line items, R&D, marketing and sales, and G&A.

So in summary, Q4 landed about where we expected, slightly ahead of schedule in terms of OpEx and R&D specifically, and that gives us the correct baseline for FY10 moving forward.


Your next question comes from the line of Shawn Milne with Janney Montgomery Scott.

Shawn Milne - Janney Montgomery Scott

Thank you and good afternoon. John, I wonder if you could spend a little bit talking about EA SPORTS Active -- just a fair amount of buzz in front of the title launch, but specifically marketing plans around that and potentially what you would do for the EA SPORTS Active or the EA Active brand, you know, other opportunities around that. Thank you.

John S. Riccitiello

I’m glad you noticed the buzz. It’s an early indicator of a potential breakout success. It’s a title we’ve been working on for the better part of two years. We feel very good about it. Frankly, I think it’s the first high quality fitness product from a third-party publisher where you bring together both quality addictive game play, if you will, together with the actual threat that you would break a sweat, so it actually performs a function that it’s designed for, and it’s married to a very strong brand with EA Sports.

You are going to see advertising, if you are talking about the marketing, you are going to see what I think is a very strong ad campaign break over the next couple of weeks. It’s television based but we’ve also got strong online marketing components, strong retail marketing component and frankly the overall box and positioning works very well.

In terms of figuring out if the general concept is applicable to more categories, we’d actually like to be at least a couple of weeks into the sale of this one to see what consumer reaction is before we plan sequels. We are generally bullish and we are looking forward to success with the title.


Your next question comes from the line of Arvind Bhatia with Stern Agee.

Arvind Bhatia - Stern Agee Leach

Good afternoon. My question pertains to the Harry Potter games coming out this year. I remember last year when the game was pushed out, you guys took out about $0.15 in EPS and pushed it into fiscal ’10. Is that still a good way to think about the overall franchise in terms of the contribution?

And my second question is on pre-orders for Tiger and EA Tennis, if you can provide us some indication there. Thank you.

Eric F. Brown

I’ll take the first half of that question -- with regard to the Harry Potter, it is again slated for launch at the end of our fiscal Q1 and overall expectations for the franchise are roughly comparable with what we thought a year ago and we think that the Wii SKU in particular is going to show very well on the title.

John S. Riccitiello

In terms of pre-orders on Tiger and Tennis, we spent an awful lot of time last year with pre-orders on sports. It was an area that sort of -- we didn’t open strong or we managed to recover from, and frankly we are learning that there’s not a -- not the same tight correlation we’ve historically seen with sports and pre-orders.

Having said that, for both of these titles, it’s a little early to track. We are not specifically putting any information out, it wasn’t part of our guidance and part of our communications this period, but we are confident that both titles look solid and do well in the market.


Your next question comes from the line of Brent Thill with Citigroup.

Brent Thill - Citigroup

Thanks. When you guys gave original guidance for fiscal ’10, the demand environment felt pretty poor. Is there any change that you are seeing in consumer behavior through the quarter, how you look at the rest of the year versus what you saw a few months back?

John Pleasants

I’ll just take a first crack at that and John may add on top of it -- the only difference that we’ve seen that’s material is obviously in March software sales year over year were down 17%. As we look forward, in terms of what’s happened in April, we haven’t noticed anything material to kind of offset that softness, so to speak, so it does give us a little bit of pause, which is why we are slightly softer on our overall guidance for the industry growth this year.

The one big particular note obviously is music. You know, the music category was down 36% for the first quarter and as much as 42% in March, and so we went to great lengths in our original guidance to take down our EAP business by $400 million in revenue, anticipating softness there but music is such an important part of the category and will continue to be an important part of the category. But when you have that kind of softness happening in something that’s now a high teens percentage of the category, that does affect the industry.

John S. Riccitiello

And I might add that I think some people were surprised by some of the hardware sell-through numbers in March. We didn’t find them particularly surprising. One of the things that we recognize is that at this point, if you will, the middle of the cycle, it’s a fairly mature cycle, what we generally see is individual hardware platforms respond very strongly to one of three stimulus -- either a particular piece of software or title that drives a platform, and we’ve seen that historically on -- with everything from a Halo to a Madden, FIFA, to a Final Fantasy can definitely drive hardware.

The second factor is when there is hardware news, a new peripheral -- Wii Fit Board, for example, last year -- the news around a particular platform can drive things, and then price. And of course, we didn’t see any price activity in the month of March and frankly, relative to the traditional stimulus that would push hardware, we just haven’t see a lot so far this calendar year, so we haven’t been particularly surprised by consumer reaction on the hardware side.


Your next question comes from the line of Edward Williams with BMO Capital Markets.

Edward Williams - BMO Capital Markets

Good afternoon -- a quick question on digital direct services. Can you give us an idea as to what you think the size of it will be in your FY2010? And can you characterize the relative gross margins, the significance of it? And then lastly, can you talk a little bit about how you see consumer devices, such as on live or the rumors around PSP that would be solely direct, digital direct and what you see the adoption for things like that being?

John S. Riccitiello

Why don’t you take the numbers and we’ll pick up from there?

Eric F. Brown

Okay, so at a high level, we finished a bit north of $400 million in digital direct revenue for fiscal ’09, and we’re expecting to get well past $0.5 billion in fiscal ’10, so it’s a very high growth rate, high profitability portion of our business and we are clearly pushing on a multitude of fronts in terms of digital, digital direct -- subscription, micro transactions, direct downloads, advertising, mobile, et cetera.

John Pleasants

As John pointed out in the beginning part of the discussion, this is a big year for us because this is where a lot of our efforts that we’ve been investing in now are going profitable. Our online part of our business is growing as much as 60% year over year. We remain incredibly bullish on the area and the category. As a part of our core package goods businesses as we launch online; derivative and ongoing episodic content as a part of those, as well as what we are doing in the mobile category, the social networking category with our Pogo business -- all of them are robust and all of them are growing.

In terms of distribution, with the way we look at a lot of what’s happening in the future is we’ve got probably about a billion PCs that are out there in the world. There’s probably over a billion flash installs that are out there. Very rapidly, the PC is becoming the largest gaming platform in the world -- just not in a packaged good format. And as you look at what that means in terms of distribution of product, we think it’s incredibly exciting because it’s going to open up the market to new demographics, new countries, and new types of game play and again, as John emphasized, we’ve been investing in that for years now and this is the year where we turn to profitability and start putting the pedal down, so we remain aggressive and bullish in that area.


Your next question comes from the line of John Taylor with Arcadia.

John Taylor - Arcadia

I wonder if I could just follow-up on that and then ask an ARPU question -- so if you are thinking the direct digital business is going to be profitable this year, can you give us a sense of what you think you spent on it last year to get up to speed, so that it can start to produce this year?

Eric F. Brown

Well first off what we were trying to [piece] out, JT, was that with the exception of our investment in our Lucas partnership, really all aspects of our online investment are turning to profitability this year. It’s a comment we made on the call a quarter ago and one that we emphasized in our prepared comments earlier today. Basically we are out of that net investment period and as you’ll recall, I believe we described that number being a little bit north of $150 million in net investment last year, and a number not terribly dissimilar, although we didn’t put a number out there for the year before, so what we’ve been investing in is both content development and distribution infrastructure development, technologies that support our ability to do microtransactions, ad serving, programs where we generate direct to consumer sales, downloadable games, et cetera. And we are largely through that. That doesn’t mean there won’t be opportunities to invest further but we think we are making the conversion from, if you will, a net drain to a net positive and as John’s comments earlier on, we expect that to expand and be an increasingly important part of our company in years to come.


Your next question comes from the line of Douglas Creutz with Cowen & Company.

Douglas Creutz - Cowen & Company

Thanks. When you were talking about your gross margin guidance, I think you said you expect to have a more favorable mix of owned IP this year than last year -- given that you are shipping both Harry Potter and G.I. Joe this year, and I don’t think you had any comparable movie-based titles last year, where is it in the SKU plan comp that you see the IP Fitness [IT mix] turning more in your favor? Thanks.

Eric F. Brown

I think the key thing is the distribution business -- specifically we are expecting $400 million or so less revenue in FY10 in distribution compared to FY09, and so that revenue is being made up with owned EA properties, which carry with it much higher gross profit margins. And so we have across all the labels, for example, Sims 3 coming out of the play label. That’s an extremely high gross profit margin title in FY10 that we didn’t have in FY09, and we have a number of others that fall into that category. So it’s essentially the significant mix away from distribution/peripherals into owned intellectual property and software.

John S. Riccitiello

Some highlights I would make on the owned intellectual property side, obviously The Sims is a gigantic contributor for us year over year. We did not have a Sims 3 title in fiscal ’09.

If you look at sports, that’s invariably for us almost exclusively in terms of large volume sellers, almost exclusively licensed properties and we are opening the year with what we believe is a very strong entry from sports, which is owned intellectual property with EA SPORTS Active.

Now Fight Night, while there are licensed characters in it, is largely, and I think can be fairly viewed as primarily being an owned intellectual property. We’ve got a couple of titles from our Bioware Studio, long regarded as one of the best studios in the industry for many, many years, with Mass Effect 2, which is a sequel but not for EA. Microsoft launched the initial Xbox 360 title, and Dragon Age. Our own [inaudible] Studio is bringing us Dante’s Inferno, and there’s a number of other titles.

So we are tilting towards owned intellectual property. We track percentages pretty carefully and it’s a contributor to our margin growth.

Next question, please.


Your next question comes from the line of Anthony Gikas with Piper Jaffray.

Anthony Gikas - Piper Jaffray

Good afternoon, guys. Thanks for taking my question -- it sounds like you are not too concerned with the recent hardware sales trends but in Japan, we’ve seen the Wii sales falling off for several weeks now. Do you think that that trend could follow here in the U.S.? And if so, is there any evidence that suggests that current Wii households might be gravitating towards a 360 or a PS3, and how would that change your business model?

And then just a quick housekeeping -- what was the SKU change as a result of the realignment of the business?

John S. Riccitiello

The first one is I think you would really be hard-pressed to come up with too many analogies that you would take from Japan to the west in terms of the underlying dynamic. The demographic circumstance in and around Japan is very, very different. The title slate and what performs there is very, very different and frankly the environment around which they -- [what you need] to really look at the game industry is different. I’m not suggesting that there can’t ever be a hiccup or a negative for the Wii in North America, but at least so far other than one month of sell-through, remember that the Wii is up in North America calendar year-to-date, by a significant amount. You know, the bumps in and out on a particular month does not overly concern us.

In terms of the trend to the 360, again I think the Wii is still strong. The 360 has shown increasing strength in Europe and frankly, I’m not sure if surprising is a strong enough word for the strength of the performance in Japan. You know, just a few years ago, no one would have ever anticipated they would find traction there, and they have. And I think that’s testimony to strong efforts they have made on local development partnerships.

So smart business practices yield good results and they have managed to find that there, but no, I don’t think we are seeing Japan as a good bell weather indicator. If I were to look to Asia for some things that are starting to look robust in North America and Western Europe, I might point more to Korea and China for the types of business models John Pleasants described a few minutes ago. The more casual microtransaction based games, the lighter persistent world titles. Subscription titles of all stripes are starting to show more traction in the west, and while we don’t pick them up in our NPD reports, are increasingly important for the future of our industry.

Eric F. Brown

In regard to the second portion of the question about SKU and title count under the new methodology compared to the old methodology, last quarter using those old definitions you would expect a title count of high 40s, SKUs, SKU count mid 120s. Under the new methodology, we are dropping or excluding expansion packs and we are picking up country title pairs for the MSGs, and so that actually leads to a higher number of titles, so low 50s there, and a lower number of SKUs, principally due to the loss of the count of the expansion packs, call it mid 115, 120 range in terms of the SKUs under the new definition.

John S. Riccitiello

Just for clarity, I think it’s important to be 100% certain you understand -- we did not increase the number of titles we are shipping nor did we decrease them after we made our reset in Q4. Versus what we had planned for the year, we are down on SKUs and titles like/unlike measure, between 15% and 20%. So the title count and SKU count like/unlike measure is down. That’s where we are accruing the majority of our cost savings and that’s how we have been afforded the most important part of our cost reset.

Now, we’ve chosen to change the way we report because we and others don’t typically report their online SKUs, like Battlefield 1943 or Battlefield Heroes or any number of other titles that don’t carry a packaged goods component with them. We made the call that those titles are increasingly important to the future of the industry and it’s worth including them in our title count. At the same time, many of our expansion packs are increasingly download only -- some are both and for some of the download only components, the actual SKU count would be very, very high and be misleading of the underlying realities of our business. So we’ve tried to come up with a simpler presentation for those that follow our business carefully and we think the title count presentation we are providing you now is perhaps the best single measure to track, if you will, the amount of productivity coming out of our R&D investments.

We can move on to the next question, please.


Your next question comes from the line of Colin Sebastian with Lazard.

Colin Sebastian - Lazard Capital

Thanks. Good afternoon. One clarification, John -- I think you mentioned two subscription games coming out later this year. I wasn’t sure if you identified what those are or if those are still to be announced. And then also, you mentioned again the extended hardware cycle and I know at least one of your competitors has already talked about making some R&D investments up front ahead of the next generation, so from your perspective, I’m curious if you think now is the appropriate time to do that.

John S. Riccitiello

So you’ve listened very carefully -- we did not identify the two subscription services and we think they are consumer propositions first and we want to use the best possible public relations to bring those to market in a way that will benefit the titles. We will certainly be communicating what they are on or around the next call, so it’s not a deep dark secret -- it’s just sort of managing our marketing the best we know how.

In terms of the extended cycle or making investment in next generation, it’s possible we are both saying the same thing, and I presume you are talking about some comments from one of our French competitors very recently.

I think there is always going to be new aspects, new handhelds and new peripherals and new things that are coming out that involve investment from companies like ours. And there’s I think an increased rate of change provided for by first parties -- I mean, I would look at frankly the iPhone as a new platform in the handheld industry. So if you are looking for excuses and/or -- not really excuses; if you are looking for good solid reasons for investing in R&D against new platforms, the market is providing us that.

However, I would point out that what traditionally is viewed as a new platform is when the industry in a consolidated or collective way, steps forward with a more powerful CPU or GPU, GPU/CPU combination, more processing power, traditionally married to different choices on medium. Those can be cartridged CD or DVD, and those big changes are not something that we are seeing the need for in an immediate term, nor do we expect it in the medium term.

So what I’m talking about is frankly we can do high definition gaming today that you can show off on the best available monitor, that you can spend thousands of dollars for, and that’s already provided for.

I think that arms race, while I can never say that it’s done, the relevance of doing that faster and faster as it had been traditionally done in the late 80s and 90s, seems to have subsided, and so we are projecting relative to the core tech we developed for, for that to be a very extended cycle.

I think we can move to the next question, please.


Your next question comes from the line of Jeetil Patel from Deutsche Bank.

Jeetil Patel - Deutsche Bank

Great, thank you. I guess you guys talked about a low to mid-single-digit growth rate for the industry for this year -- I guess can you just -- in your guidance, can you just frame I guess where is the opportunity by platform to gain share as you look at this year -- Wii, 360, PS3 -- and that’s probably good enough. Thanks.

John S. Riccitiello

Well, just one framing -- we haven’t guided to -- I am going to ask John Pleasants to pick up on some of this but we haven’t guided to a revenue forecast that is suggestive of significant share growth, but I will tell you that a couple of the platforms, I think they have much stronger representation and one I would point out would be the Wii, and maybe John can expand on that.

John Pleasants

Again, we have put a big focus obviously on quality titles across the board. As John noted, we have a great Wii lineup. Q1 comes out of the gate strong and we continue from there. In Q1 alone, we have active, which has been talked about, My Sims Racing, which is a fantastic racing product, Harry Potter, the two Wii bundled products in conjunction with Nintendo marketing, which is Tiger and Tennis, and the continuation of the sequel of the boom box title.

As we look across the chart of the 20-plus, 20 to 22 titles that we are launching, they all seem incredibly strong. Last year on internal forecast, I think we had two titles that we were hoping were going to break a million, and this year we certainly have many more than that on the Wii. We have six or seven titles we think can break into that kind of category.

So we feel really bullish on the Wii. That said, it’s hard to just isolate on one -- you know, we feel equally strong across all of our individual platforms. One that’s been mentioned that we don’t often talk about in the traditional sense is online -- again, I mentioned earlier that we are doing over 50% growth in online, so if you look at the total gaming category overall, we’ll certainly be gaining share both on a domestic and on a global basis online.


Your next question comes from the line of Daniel Ernst with Hudson Square Research.

Daniel Ernst - Hudson Square Research

Yes, good evening -- thanks for taking my call. Two quick questions, if I might -- one on the balance sheet, simple calculation days inventory, up to 56 versus 32 last year this time, so up both on a relative and an absolute basis. Can you comment on whether that’s a build-up of inventory on retail order softness or is that a build into your strong lineup for the June quarter?

And then secondly on the outlook for the coming year, obviously sports looks good with -- on the Wii and Active and Tiger Woods and the new tennis game, but Madden and Need for Speed obviously down materially year-on-year in the year you just reported and what’s your outlook for the coming year for those kind of anchor SKUs for yourself? Thanks.

John S. Riccitiello

Can you repeat the second part of that question? You were talking about our outlook for the year and you referenced Madden and Need for Speed -- can you clarify that a little bit?

Daniel Ernst - Hudson Square Research

Yes, Madden and Need for Speed, in the year you just reported, down year-on-year for the fiscal year ending March ’09 and what do you see for those two kind of anchor SKUs for the coming fiscal year?

John S. Riccitiello

So I’ll take the second part first and then I’ll have Eric pick up on the balance sheet question. In terms of our core anchor SKUs, we couldn’t be more pleased with titles like Madden, FIFA, et cetera. I think it’s fair to say that a couple of our titles had their legs cut off a little early, as we went into the jaws of pretty uneven economic times in our Christmas quarter, started strong, hit great numbers, maybe not quite as great as we would otherwise have liked. One of our problem titles last year was Need for Speed and we had communicated intention to bring the Need for Speed franchise into a scenario where each of the -- we were basically alternating between studios so we can get a full development process as opposed to half a development process in between title launches. And the first of these titles, if you will, it’s own individual full development cycle, is what we are launching with Need for Speed shipped right at the end of Q2.

So in terms of anchor titles, I think those that are [inaudible], Need for Speed, FIFA, Madden, feel very, very strong. Another couple of the anchor titles that I think are worth noting would be titles like Dragon Age, which feels very good to us coming from a Bioware studio. I think it’s impossible to talk about anchors without mentioning Sims 3. It has been one of the most important titles in the history of our company and the title that Rod described earlier in the call, looks very strong.

I am particularly bullish about EA Sports Active -- look, that’s a -- there’s a lot of variability for how that could actually turn out but it has the potential to be a long-established franchise for EA over the years to come. And one of my personal favorites is Brutal Legend, which is a title coming out for the [Double Fine] Studio and it’s a title featuring Jack Black. I could wax on about the underlying fiction and game play behind that but it’s a very innovative title. It’s going to make a lot of noise this fall. And now I will turn it to Eric on the balance sheet.

Eric F. Brown

With regard to the first portion of the question in inventory, so we finished Q4 FY09 with $217 million of inventory versus $168 million in Q4 last year, so that’s an increase year over year of about $49 million. All of that year-over-year increase relates to our EA distribution business, for which we have very limited economic exposure. So in our non-EAT business, our inventory levels were flat as of year-end FY09 compared to FY08. The other thing to note is that we had a title launch very early on in our fiscal Q1 FY10, Godfather II, so there’s probably a bit of inventory build at the end of Q4 FY09 in regards to that.


You have a final question from Sean MacGowan with Needham & Company.

Sean MacGowan - Needham & Company

Could you talk a little bit about your outlook for your own music, your own participation in the music category for the balance of the calendar year?

John S. Riccitiello

Right now, I don’t know what you mean by our own. I would say that if you are referring to something independent of Rock Band, we have a partnership with MTV Harmonix and that’s our bet. We feel very good about that and I would point out that this year we are launching The Beetles, which is at least by some measures, the world’s greatest band in history. I am sure there will be a debate on that with your kids but it certainly impresses me and in every reaction I have seen to the title, both in my offices and through consumer research, has been exceptionally strong. So we feel really bullish about that.

I would argue that titles like Brutal Legend, while not competing in the, if you will, the music simulation marketplace, are strongly music themed, which I think we’ll see where NPD ends up classifying it but it plays out very much like a music game but instead of sort of mastering the notes for score or for the adulation of your fans, you do it to melt the face off your opposition. It’s a slightly different game play proposition but I assure you it will be compelling to our audience.

Beyond that, we haven’t made announcements nor committed anything we can talk about with you today.

Tricia Gugler

Operator, we’ll take one more question, please.


All right, thank you and we’ll go to Eric Handler with MTM Partners.

Eric Handler - MTM Partners

Thank you very much for taking my question. I know you are not giving quarterly guidance but maybe you could talk directionally about how we should think about the June quarter, maybe relative to some of the other quarters during the year?

Eric F. Brown

We’re not going to parse it at any fine level of detail. I think that what we have done is we have highlighted all of the key Q1 launches and we started out with Godfather II in April and we’ve gone over the half-a-dozen or so Wii titles that we have in Q1. Overall I would say that we have a slightly more first half loaded year compared to FY09 and that was by design as we reconfigured some of our ship dates.

Tricia Gugler

Okay, thank you all for joining us today and we look forward to seeing you at E3 in June.


Thank you again, ladies and gentlemen. That does conclude our call for today.

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