Highlights From ERTS's Q2 Conference Call: Largest Quarter for Digital Direct Revenues in EA's History; Guides In-line

November 10, 2009 1:53 PM EST

Electronic Arts (NASDAQ: ERTS) reports Q2 EPS of $0.06, 1 cents below the analyst estimate of $0.07. Revenue for the quarter was $1.15 billion, which compares to the estimate of $1.12 billion. Shares are down 6.50% today.

Highlights From ERTS's Q2 Conference Call:

• Electronic Arts sees FY10 EPS of $0.70-$1.00, versus the consensus of $0.89.
  
• Electronic Arts sees FY10 revenues $4.2-$4.4 billion, versus the consensus of $4.26 billion.
  
• (ERTS) Our non-GAAP revenue for the quarter was a record for Q2, and we delivered our largest quarter for digital direct revenues in EA's history. Our Q2 revenues exceeded Street expectations.
  
• In a sector that has struggled for growth in recent quarters, our non-GAAP net revenue is up 13% fiscal year-to-date. So far this fiscal year, EA has outperformed on share in a down retail market.
  
• In both Europe and North America, EA was the number one overall publisher in the quarter, number one on the PS3, Xbox 360, and PC, and number two to Nintendo on the Wii. We have improved marketing, and we are seeing continued growth in digital revenue streams. We are aggressively managing costs.
  
• Although we performed well in the first half of the year, we are cautious on the second half of the year.
  
• Industry packaged goods software sales are down approximately 12% year-to-date. We believe October was another down month.
  
• Retailers remain cautious and report that foot traffic remains slow. In a tough economy, the consumer is not showing up at retail as consistently as we would like. EA's P&L is highly dependent on Q3 and Q4.
  
• FX, while positive for our revenue reporting, does not fall through to our operating margins. Taking these considerations into account, we have decided to add a bottom range to our guidance. While we have not given up on our $1.00 EPS target, we believe it is prudent to guide to FY'10 non-GAAP revenue between 4.2 and 4.4 billion and non-GAAP EPS to between $0.70 and $1.00.
  
• Calendar year-to-date, packaged goods software sales are down 12% in North America, and we estimate minus 13% in Europe. While the recent hardware price reductions are driving higher console sales, the improvement is not enough to get the industry back to flat software sales for the calendar year.
  
• We now expect packaged goods software to be down mid-to-high single-digits in North America and Europe combined. This is well below our initial expectations for the year.
  
• We do not believe the calendar '09 packaged goods weakness is a permanent condition. Two factors give us confidence. We believe there is still room on the console price points. In the last cycle, the bulk of console sales occurred at $149 or below. Secondly, the console add-ons coming in 2010 will bring new consumers to the market. These factors will drive growth and extend this cycle.
  
• As recently as five years ago, we estimated that digital was less than 10% of the global industry. Today, we estimate digital is 35% of the total. Our sense is that the various digital businesses will grow at 20% or higher this year and for the next several years.
  
• We've decided to narrow our slate further in preparation for FY'11. We are implementing a thoughtful, targeted action that will reduce titles, close several facilities, and decrease head count by approximately 1,500 positions, of which 1,300 will be included in a restructuring plan.
  
• (CFO) Our non-GAAP net revenue was a record for Q2, driven by FIFA 10, Madden NFL 10, The Beatles Rock Band, and Need for Speed SHIFT, all selling north of 2 million copies in the quarter.
  
• In our digital businesses, we achieved an all-time record quarter with 138 million in non-GAAP net revenue, up 23% year-over-year, driven by Battlefield 1943. Subscription revenue was 32 million.
  
• Wireless revenue was 50 million, up 9% from a year ago, primarily due to revenue generated on the iPhone.
  
• Non-GAAP net revenue was 1.147 billion, up 2% year-over-year, driven by the growth in digital revenue. At constant currency rates, net revenue increased 6%. Frontline non-GAAP net revenue was 609 million, flat with prior year.
  
• For the first half of the fiscal year, our revenue was up 13% year-over-year. Moving to the rest of the income statement, non-GAAP gross profit margin was 48.4% versus 50.9% a year ago, down as expected due to less wholly owned IP revenue and more distribution revenue from The Beatles Rock Band. Operating expenses. Non-GAAP operating expenses were 536 million, down 72 million or 12% year-over-year.
  
• We ended the quarter with 8,828 employees versus 9,671 a year ago. 21% of our employees are now located in low-cost locations. Non-GAAP operating income was 19 million versus an operating loss of 35 million a year ago.
  
• The increase in GAAP loss per share year-over-year was primarily the result of higher deferred revenue associated with the deferral of Xbox 360 revenues starting in FY'10.
  
• Gross accounts receivable were 840 million, up 125 million from last year or 17%, due to the timing of our release schedule. Reserves against outstanding receivables totaled 194 million, up 26 million from a year ago.
  
• Reserve levels were 10% of trailing six-month non-GAAP revenue, up 1% from a year ago. As a percentage of trailing nine-month non-GAAP revenue, reserves were 8%, up two points from last year. Inventory was 250 million, down 78 million from a year ago. Ending deferred net revenue from packaged goods and digital content was 792 million, up 368 million from a year ago due to the additional
  deferral for all console and PC online enabled games.
  
• On a GAAP basis, we expect revenue of 3.6 to 3.9 billion. On a non-GAAP basis, we expect revenue of 4.2 to 4.4 billion. We expect an increase to full-year revenue of at least 100 million due to changes in
  foreign exchange versus our original FY'10 assumptions.
  
• We expect GAAP gross profit margins of approximately 49.5 to 52% and non-GAAP gross profit margins of approximately 57 to 58%.
  
• Operating expenses: We expect GAAP operating expenses to be approximately 2.5 billion and non-GAAP operating expenses of approximately 2.1 billion. Operating expenses are being reduced as a result of our cost containment but increasing as a result of the weaker U.S. dollar.
  
• We expect GAAP diluted loss per share of $1.20 to $2.05. We expect non-GAAP EPS of $0.70 to $1.00.
  
• We expect that non-GAAP other income and expense will be approximately 15 million. On taxes, we expect a GAAP tax benefit of approximately 30 to 40 million for the year. On a non-GAAP basis, we expect to report taxes at 28%. For share count, please use 324 million shares to compute the GAAP loss per share and 326 million shares to compute non-GAAP EPS.
  
• As we look forward to the second half of the year, we have strong emphasis on Q4, with plans to release several major titles, including Mass Effect 2, Dante's Inferno, Battlefield Bad Company 2, and Army of Two: The 40th Day. This will result in substantially more revenue in Q4 compared to prior years. Of our remaining fiscal year revenues, we expect roughly 60% to fall in Q3 and 40% to fall in Q4.
  
• Please note that the guidance does not reflect the Playfish acquisition. The FY'10 non-GAAP EPS impact of the Playfish acquisition is essentially neutral. There will be a dilutive GAAP EPS impact in FY'10 of approximately $0.15 to $0.25 per share. In fiscal '11, Playfish will be non-GAAP EPS accretive to EA.
  
• FIFA 10: We shipped this game the last week of the quarter in Europe, selling 4.5 million copies. The sell-through at retail in Europe is 31% ahead of last year's FIFA 09 on a comparable-period basis, and we are outselling Pro Evolution Soccer four to one. FIFA has the highest quality rating for a sports game on this generation of consoles and is EA's biggest European launch in history.
  
• Madden NFL 10: We sold 3.9 million copies in the quarter. After a disappointing August that had Madden down 19%, sell-through in September grew 8% year-over-year, with more than 60% growth on the PS3, according to NPD. Madden sales are now up 5% year-over-year on the Xbox 360 and PS3 combined.
  
• Need for Speed SHIFT: We sold over 2.5 million copies on consoles in the quarter.
  
• Dragon Age Origins: Last week we launched Dragon Age Origins with a great campaign backed by robust downloadable content. The early read on sell-through is strong.
  
• Next, we set a goal to improve our share on the Wii platform. Fiscal year-to-date, EA is the number one independent publisher on the Wii, with share of 21% in North America and we estimate 14% in Europe, up 8 and 10 points, respectively. Our non-GAAP Wii revenue is up 50% year-over-year.
  
• John, you've made some comments back in October when the Playfish acquisition was first being rumored that really kind of compared the social gaming landscape as it stands now versus the Mobile landscape back when you guys bought JAMDAT. I was wondering if you could maybe flesh that out and give us a sense of how you expect this space to evolve relative to what we saw in Mobile over the last few years? (A)What I said was I think when you look at the social gaming space, I think you see a lot of new IP and original IP and not a lot of established brands. I think you haven't seen brands kind of make their way into that space yet. And it was very reminiscence of when we acquired JAMDAT. And what was great about that was they were able to take their own original IP, continue working on that, but then capitalize on EA's IP. And when you look at their performance now, seven of the top 10 games on Verizon, eight on iPhone, you can see a bunch of EA IP in there. You see Madden, you see FIFA, you see Command & Conquer, and I think when you look at the social gaming, we're very happy with the original IP that Playfish is bringing to bear. We're also excited, and so are they, at the large portfolio of IP that EA owns that they're going to be able to capitalize on in that space as well.
  
• Just overall, John, your strategy when you started was really to kind of build up the title pipeline and really build out a bunch of titles. And you're kind of going back from that strategy a little bit and just focusing on what you consider the hits and the best opportunities. Just to get that margin level up from the 7 to 10% currently, do you think you still need to have some titles selling north of 2 to 3 million units, some new titles? And do you think that's achievable as you look out to next year? Do you have some real opportunities to maybe surprise people and come up with some titles that really drive the top line and margins next year? (A)Well, first off, just for clarity's sake, I don't think we ever talked about increasing the number of titles at EA, even going back to when I first joined on my first earnings call. We talked about driving quality. What we felt we were lacking in that point was titles that had the potential to deliver 5 million units or better. And we didn't feel that we had the strength, particularly in the EA Games Label, where some of our IP had become a little stale, and where we didn't really have a pipeline of new intellectual properties. I'm happy to say that Frank and his teams have really get addressed that. When you think about intellectual property franchises like Battlefield, Need for Speed, what we have with Mass Effect, Dragon Age, et cetera, I think we've really got a strong a portfolio of titles that can deliver - probably not annually for all of them, but for several of them - and put us where we need to be in terms of margin structure. And that was exactly what we've talked about, and I'd say that we're sort of halfway through the process of realizing that outcome. In terms of guidance on F'11 titles, I would say that I'm very pleased with the slate we have coming together for F'11. But we're going to reserve time in the February call to talk more about the specific titles. I will point you, though, at least to the near term, to the first quarter of calendar '10 and in the Games label alone we've got Army of Two: 40th Day, we have Dante's Inferno, we have Mass Effect 2, which promises to be a blockbuster, and Battlefield: Bad Company 2, which as Frank had mentioned in his commentary, I think has every right to see itself as a rival to the number one FPS game that one of our competitors is releasing next week. So we're feeling really good about it.
  
• John, we all know that sales of Nintendo consoles, especially the new ones, have been weak, but there's currently an install base of over 50 million consoles out there. Can you talk about what you can do to actually reinvigorate sales among this install base? Thanks.(A)So to be honest with you, I think the Wii platform has been a little weaker than we had certainly anticipated, and there's no lack of frustration to be doing that at precisely the time where we have the strongest third-party share. I think driving revenues up on that platform from where we are already are, which is up substantially from where we are a year ago, we're reaching out to Nintendo to find ways to partner to push third-party software harder. I frankly think they need more beats in the year than they get out of a first-party slate to be able to have the Wii software platform perform as well as they would like. And we're building the products that are, I think, the most highly rated on the platform, and at this point in time generating
  the most revenue of any third-party platform. I would point out, by the way, the 50 million number of course included Asia or Japan, and I don't think any of the Western companies are likely to participate much at all on the Wii platform in Japan. So at least the addressable we see is just a little bit below 40 million, so that's still an important opportunity.
  
• Just as a follow-up, is there anything specifically that you've changed in your marketing strategy to maybe address this market that's changed a little bit versus your previous expectation? (A)Well, one of the things I think we have learned is when we really tackled it, exclusive major league marketing, we can create a gargantuan hit, as we have with EA Sports Active. I would say one of the things we've been disappointed with, on the other hand, is - I would personally tell you that I think the Wii entry this year on Madden is very, very strong. But absent Wii, Madden is actually up as a franchise year-over-year. Wii is where we're missing it. And so I really do think that the opportunity exist to find different ways to partner with the first party in this case to sort of help establish in the minds of the consumer legitimacy of some of these other brands when they're going out multi-platform, because very, very, very few multi-platform titles are succeeding on the Wii so far. And collectively, Electronic Arts and
  Nintendo need to tackle that. I will also point out that being the market leader on the Xbox 360 and the
  market leader on the PS3, a relative shift in that direction isn't exactly a bad day for us.

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