美商藝電 (EA) 2009 Q3 法說會逐字稿

Good day, everyone, and welcome to Electronic Arts third quarter fiscal year 2009 earnings conference call.

Today's call is being recorded.

At this time, I'd like to turn the call over to Ms.

Tricia Gugler, Vice President of Investor Relations.

Please go ahead.

Welcome to our third quarter fiscal 2009 earnings call.

Today on the call we have John Riccitiello, our Chief Executive Officer, and Eric Brown, our Chief Financial Officer.

Before we begin, I'd like to remind you that you may find copies of our SEC filings, our earnings release and a replay of this webcast on our website at investor.ea.com.

Shortly after the call we will post a copy of our prepared remarks on our website.

Throughout this call we will present both GAAP and non-GAAP financial measures.

Our earnings release provides a reconciliation of our GAAP to non-GAAP measures.

These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results and we encourage all 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 trailing our 12-month segment shares, our Q4 releases, and summary of our financial guidance.

During the course of this call we may make forward-looking statements regarding future events and 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 February 3, 2009, and decline any duty to update them.

Now I'd like to turn the call over to John.

Thanks, Tricia.

Earlier today, we announced our third quarter results came in below our expectations and that we have significantly reduced our financial outlook for fiscal year '09.

On today's call, I will discuss our performance for fiscal year '09, including our cost cutting actions.

I'll outline the key conclusions we draw from the year.

I will then outline our outlook for the industry in 2009 and EA's plans and financial guidance for fiscal year '10.

Eric will review our holiday quarter results, discuss our cost cutting initiatives in more detail, and provide specific guidance for fiscal year '09 and '10.

I'll wrap up with a few closing thoughts and then we'll open it up for Q&A.

We're disappointed with our holiday quarter and our FY '09 performance.

These results point to three conclusions which are incorporated into our strategy going forward.

First, we need to improve our approach to bringing key titles to market.

Consumers have become more cautious and we need longer lead times on marketing and, in some cases, more productive investment resources.

In short, we need to start earlier and focus more.

Second, in this environment we believe our operating expenses are too high and need to come down.

Third, the Nintendo Wii is even more important than one year ago.

It is a clear leader in this cycle.

In calendar year '08 we were number three publisher in this platform in both North America and Europe, but we need to move further up on the charts.

Now I'd like to cover our holiday quarter.

First, a few comments on the industry.

Industry software sales in the holiday quarter were up 15% in North America and we estimate 10% in Europe.

These holiday quarter results, while below industry growth rates recorded earlier in the year, were solid.

The Nintendo Wii delivered the strongest performance among the console players.

We also saw continued strong growth in various subscription and micro transaction businesses showing the ongoing strength and potential of direct-to-consumer business models.

This strong sector performance and the shadow of very challenging macroeconomic environment is yet another solid data point suggesting our industry can fair well in tough times.

In Q3, EA significantly missed its numbers and revenue came in approximately $150 million below street estimates.

Although this is difficult to tease apart, the macro and the micro, a significant portion relates to our own performance.

Clear and simple, our titles did not perform to our expectations.

With the exception of FIFA, we did not deliver the blockbuster titles (inaudible) we expected.

Competitively, EA had only one of the top five titles in North America versus typically two or more.

We were depending on new IP in a year where consumers were even more cautious with their dollars and one of our anchor titles, Need for Speed, did not deliver fully on our expectations.

From a macro standpoint, we saw certain retailers reduce inventories below historical and expected levels, particularly in North America.

During the holiday quarter we saw a significant discrepancy between our sell-in and sell-through.

This is a consequence of key retailers bringing down inventory levels.

This is a circumstance we do not expect to be repeated in the future.

In addition, the strengthening of the US dollar negatively influenced our Q3 sales by approximately $55 million.

Adding to this our expense base was geared for a business that assumed much more revenue resulting in a significant shortfall in our profitability.

While we began cost cutting aggressively in Q3, we could not get ahead of the revenue shortfall to achieve our target profitability in the quarter.

Before I move to the future, let me spend a moment on some of the positives our team has accomplished so far this year.

We did make some progress on some important initiatives that will create value for EA for years to come.

First, new IP.

We launched Dead Space, Spore, Warhammer online, Mirrors Edge and a number of Hasbro games and while we expect to benefit in the future from increased sales from these franchises, generally games with a 2 on them sell better and do sell better with a lower R&D budget.

Second, quality.

Overall, we made significant strides in driving innovation and quality into our games.

Our 2008 slate was better than our 2007 slate.

We had 13 titles rated at 80 or above versus seven last year, a statistic we're particularly proud of.

This is two to three times that of other third party publishers.

Third, we expanded our kids and family business.

We built our own IP with MySims and Boom Blox and a partnership with Hasbro we added several key titles including Littlest Pet Shop and [Urban Strike], and finally digital direct, which includes online and wireless, was up 27% year-to-date to more than $300 million.

Our successful POGO business hit an all-time high of 1.7 million paying subscribers.

We successfully launched a new MML, Warhammer online, and added a number of titles and countries to our growing online, Asia online business, and EA Mobile has generated $141 million in revenue so far this year, up 29%.

Over the holidays we had six of the top 20 iPhone games.

With that I'd like to turn our attention to the future.

In the past, we highlighted two focus areas of our strategy, drive hits in our core business and grow our direct-to-consumer businesses.

To these pillars, we add two more, manage expenses aggressively and increase focus on the Nintendo Wii platform.

First, drive hits in our core.

We plan to match strong quality with strong marketing, particularly for our top 10 titles.

Operationally, we expect to improve the way we go to market with our titles, starting earlier to create positive buzz in demand.

Consistent with this strategy, we have made a decision to move titles, including the Sims 3, Godfather 2 and Dragon Edge for the PC from Q4 FY '09 to FY '10.

These titles have high potential based on consumer research and early reviews from critics.

In the case of Sims 3, we're moving this title to June 3 to give us additional time to build the worldwide marketing campaign a title like this deserves.

With Godfather 2, we're moving it to Q1 FY '10, providing a better launch window and more time for longer lead marketing.

With Dragon Edge, we're moving the PC launch to Q3 FY '10 to coincide with the console launch, giving us the opportunity to make a bigger splash with this epic BioWare RPG title and, of course, the BioWare team will continue to polish this game for even greater quality.

Other potential hit titles are also getting a new approach.

For example, we've completely reworked the development model for the Need for Speed franchise.

We are moving this franchise to parallel development in separate studios, allowing for a full two-year development cycle for each annual title.

These are just a few examples of our committment to improving our position in the global top 5 and top 10 which is where we see the strongest returns for EA's core business.

Second, aggressively manage expenses.

As you know, we have been working to reduce our cost base given the uncertain macroenvironment, changing industry trends and our recent performance.

We're planning FY '10 operating expenses at approximately $2.1 billion, which is a $500 million decrease from previously expected FY '10 run rates.

This is a substantial expense reduction and it's a consequence of tough calls in head count, SKU count, facilities, variable spend, and CapEx.

Eric will discuss the cost reductions in more detail.

Third, capitalize on the progress we have made on the Wii.

We have a spectacular slate for FY '10 which will be supported by a Wii focus advertising campaign.

We're starting FY '10 strong with Tiger Woods PGA Tour, EA Sports Active, EA Sports Tennis, Boom Blox 2, Harry Potter, and MySims Racing all in Q1, and it gets better each quarter.

Fourth, drive our content direct-to-consumer.

This is a strategic initiative that is very important for the long term.

In FY '09 we made $150 million online investment with limited associated revenue.

In FY '10 all significant online spending except for the Lucas Arts BioWare Star Wars MMO will be generating positive income.

These investments are working.

We expect over $500 million of direct [additional] revenue in fiscal year '10.

Now to our outlook for the industry and for EA.

For the industry, we believe we are roughly midway through what is shaping up to be an extended console cycle.

As you know, calendar year '08 was a very strong year for the game business, the software sales up over 20%.

We enter calendar year '09 with a 50% increase in the hardware install base with more room to move on hardware pricing, and we expect to exit the year with a larger console base as compared with the same point in the previous cycle.

We're entering calendar year '09 optimistic about the industry, but tempering our optimism somewhat to reflect the continued global economic recession.

For calendar year '09 our projections assume no major uptick in the broader economic environment and software sales growth in the mid single digits for both North America and Europe.

We plan our expense base, assuming conservative revenue growth which we believe is prudent in these times.

On FY '10 revenue we're assuming no growth in segment shares despite the move of key titles like the Sims 3, Dragon HPC, Godfather 2 and Harry Potter.

We planned our core titles conservatively even though we have a stronger slate and we plan to push our top 10 titles harder this year.

We also assume that our co-publishing and distribution revenue will be down approximately $300 million in FY '10.

These assumptions result in revenue projection of $4.3 billion in FY '10, or 5% less.

Our expenses match this conservative view on revenue.

Every expense category will be down with the exception of variable marketing.

We expect FY '10 operating expenses to be roughly $2.1 billion, down significantly from our run rate.

Net this translates to roughly $1 in non-GAAP EPS in F '10 which is approximately a 10% non-GAAP operating margin.

These targets are achievable and appropriate given the macroenvironment.

Now I'd like to turn the call over to Eric.

Thank you, John, and good afternoon, everyone.

For Q3 we delivered non-GAAP revenue of $1.74 billion which is flat to last year and non-GAAP diluted EPS of $0.56 versus $0.90 a year ago.

On a GAAP basis, revenue is $1.65 billion, up 10% year-over-year, and a GAAP diluted loss per share was $2 versus a loss per share of $0.10 a year ago.

This quarter, our GAAP EPS includes one-time charges for good will impairment and a tax valuation allowance which together comprise $1.91 in GAAP EPS loss.

I will touch on these in more detail shortly.

Key titles in the quarter were FIFA 09, our best selling title with 7.8 million copies, up 4% year-to-date over last year's FIFA 08.

In Europe we estimate it was the number one title across all platforms in the holiday quarter.

Need for Speed Undercover sold 5.2 million copies, down 7% from last year's Need for Speed ProStreet.

Sell-through was up in Europe year-over-year but down in North America.

Littlest Pet Shops sold 2.8 million copies on the Wii, NDS and PC, a great start for a new IP.

It charted in the top five on the NDS in both North America and Europe in the holiday quarter.

In addition, Dead Space, Mirrors Edge, Madden NFL 09 and NBA Live 09 each sold over 1 million copies.

Madden 09 was the number six title across all platforms in North America for calendar year '08.

From EA partners, Rock Band 2 and partnership with MTV Harmonics sold 1.9 million copies and Left 4 Dead in partnership with (inaudible) sold 1.8 million copies.

In our digital direct businesses we generated $116 million in revenue, up 28% year-over-year, with strong performance across all units, including POGO.

Warhammer online now has over 300,000 paying subscribers in North America and Europe.

Wireless revenue was $50 million, up $11 million from a year ago on the strength of (inaudible) sport.

Digital download games in micro transaction revenue was $21 million, up 75% due to further expansion of our online distribution capabilities.

I would now like to spend some time discussing Q3 in more detail.

Please note all of the following references to third quarter results are non-GAAP unless otherwise stated.

Non-GAAP revenue was $1.74 billion, flat year-over-year.

At constant currency rates, revenue increased 4%.

The growth was primarily driven by our distribution business and subscription revenue.

Our core package business goods slowed considerably in December.

By geography, North America non-GAAP revenue was $910 million, up $49 million or 6% primarily due to our distribution business.

International non-GAAP revenue was $832 million, down $41 million or 5% driven by adverse FX.

At constant currency rates revenue was up 4% primarily due to FIFA 09.

Moving to the rest of the income statement, non-GAAP gross profit was $821 million, down $138 million or 14% year-over-year.

Non-GAAP gross profit margin was 47.1% versus 55.3%.

The decrease is primarily attributable to approximately 6 points related to a higher mix of distribution revenue and lower margins in our co-publishing business and approximately 2 points related to an increase in price protection and returns reserves.

At quarter end we had increased exposure in the retail channel that required additional reserves.

Operating expenses.

Before getting into the details, let me point out a couple of factors that affect a number of line items in our Q3 P&L.

First, only a small portion of our cost reduction program was implemented in time to affect our Q3 results and, second, for bonus, we recorded a credit of $12 million this quarter versus an expense of $80 million last year.

Marketing and sales.

Non-GAAP marketing and sales expense was $245 million, up $37 million.

Excluding the impact of bonus, (inaudible) sales was up $51 million primarily due to more advertising spend for larger slate of titles in Q3 versus Q3 last year.

General and Administrative.

Non-GAAP G&A expense was $71 million, down $13 million.

Excluding the impact of bonus, G&A was roughly flat year-over-year.

Lower facility and personnel related costs were offset by increases in bad debt expense and contracted services.

Research and Development.

Non-GAAP R&D was $271 million, down $29 million.

Excluding the impact of bonus each year, R&D was up $32 million year-over-year primarily due to our VGH acquisition.

Restructuring charge.

During the quarter we recorded $18 million of restructuring expense, $13 million from the plan we announced on December 19.

Below the operating income line, non-GAAP other income and expense was $14 million, down $18 million from a year ago due to a decline in interest income and increased foreign exchange losses.

Income taxes.

On a GAAP basis, we recorded a provision of $324 million which included a $244 million valuation allowance charge that we are required to record against deferred tax assets that are deemed currently unrealizable for accounting purposes.

This determination is based on historic GAAP losses which includes the revenue deferral.

In addition, the Q3 tax provision includes the reversal of deferred tax benefits recorded in the first six months of the year.

We will be able to realize these assets when we return to GAAP profitability.

On a non-GAAP basis we recorded taxes at 28%.

GAAP diluted loss per share was $2 versus a diluted loss per share of $0.10 a year ago.

Please see our GAAP to non-GAAP reconciliation in our earnings release.

This quarter our GAAP EPS also includes one-time charges for goodwill impairment and a tax valuation allowance approximately $1.91 in GAAP EPS loss.

Non-GAAP diluted earnings per share were $0.56 versus diluted earnings per share of $0.90 a year ago.

Our trailing 12-month operating cash flow was $82 million versus $267 million for the prior period.

Even though we lowered our outlook, we expect to be slightly cash flow positive for the year.

Turning to the balance sheet, cash and short-term investments were approximately $2.0 billion at year-end or quarter end, up $134 million from last quarter due to cash generated from operations.

Marketable equity securities and other investments were $302 million, down $338 million from last quarter due to declines in the market value of our strategic investments.

During the quarter we recognized a pre-tax loss of $27 million in the P&L related to our investment in The Nine.

At quarter end, after the writedown we had a net unrealized gain of $128 million comprised of a $132 million unrealized gain at [Ubi-soft] and $4 million unrealize loss on (inaudible).

Gross accounts receivable were $1.1 billion, relatively flat to last year and consistent with our revenue.

Reserves against outstanding receivables totaled $303 million, up $44 million from a year ago.

During the quarter, our sales reserve rate was 16% of revenue versus 11% a year ago.

The increase year-over-year is related to higher price protection and return reserves recorded in the quarter as a result of greater inventory in the channel.

Inventory was $295 million, up $117 million from a year ago.

Excluding our EA partner inventory for which EA has limited exposure, inventory was up $55 million primarily due to a broader slate of titles.

No single EA title represented more than $15 million in net exposure.

Goodwill was $808 million after the impairment charge.

During the recorder, we recorded a $368 million non-cash charge for goodwill impairment related to our (inaudible) business.

Although we took a charge, this highly profitable business is meeting our expectations in FY '09 and we expect continued strong growth in the years ahead.

Ending deferred net revenue from packaged goods and digital content was $512 million, down $83 million from a year ago primarily due to revenue mix.

Now to our outlook.

Before we get in to our guidance, I'd like to provide more detail on our cost reduction plans.

We started this work back in October as we discussed in our Q2 call.

The focus on rationalizing our SKU plan and scrutinizing all operating capital budgets for FY '10.

As John indicated earlier, we went into our FY '10 planning process with a goal of matching operating expenses with a more conservative projection of revenue.

We moved up the timing of our internal budget processes so that we could adjust our SKU plan, allowing us to take out costs sooner rather than later.

We now expect total non-GAAP operating expenses of approximately $2.1 billion in fiscal '10 down $500 million from our prior expectations for FY '10.

This is down $300 million from the $2.4 billion run rate we had at the time off our Q2 earnings call in October.

We also expect to benefit from savings in FY '09, ending the year with operating expenses of approximately $2.25 billion.

We made reductions in five different areas.

Let me discuss each briefly.

First our product portfolio.

We increased the hurdle rate for new titles.

This resulted in a 30% reduction in the number of SKUs we plan to launch in FY '10 versus our previous plans.

Excluding our EA partner business, we expect to publish approximately 50 titles and 125 SKUs in FY '10.

The 125 SKUs compares with 145 in fiscal '09.

Had we not shifted certain titles from FY '09 to FY '10, the delta would have been even greater.

Second, personnel costs.

We're reducing 1100 people or 11% of our work force.

This includes head count at all levels, staff, managers, directors and VP's and above and across all functions and geographies.

Most of the reductions are in high cost locations.

We expect three-quarters of the reductions to be completed by fiscal year end.

We are also eliminating merit increases in fiscal '10 and, finally, we continue to take advantage of low cost locations.

At the end of FY '09, we expect to have 19% of our employees in low cost locations versus 13% a year ago.

Third, facilities.

We expect to close 12 facilities up from the nine we communicated on December 19.

Fourth area, other variable spend.

We reviewed all operating budgets, including contracted services and T&E, resulting in significant cuts for fiscal '10.

We plan for every expense category to be down year-over-year with the exception of direct advertising spend.

And, finally, capital spending.

We expect to reduce our estimated FY '09 CapEx spend of $110 million by approximately 40% in fiscal '10.

Net, these actions will yield half a billion dollars of savings from our previously expected FY '10 run rate.

For the restructuring component, which includes facilities closures and severance, we expect to incur total charges of $65 million to $75 million over the next 12 months and the reconciliation between GAAP and non-GAAP.

Now for our guidance.

Please refer to our press release for revenue and EPS guidance for both fiscal '09 and fiscal '10 and a reconciliation of our GAAP to non-GAAP financial measures.

Our revised fiscal '09 revenue outlook is $900 million below the low end of our previous guidance.

The difference is attributable to, number one, approximately $500 million shortfall as a result of weaker than expected sales due to macroeconomic and EA specific issues.

Secondly, approximately $300 million related to the shift of titles to fiscal '10 and, third, approximately $100 million due to the strengthening of the US dollar.

In addition, we expect GAAP and non-GAAP gross profit margins of approximately 50%.

We expect GAAP operating expenses of approximately $2.95 billion and non-GAAP operating expenses of approximately $2.25 billion.

On taxes, on a GAAP basis we expect tax expense of approximately $250 million to $275 million, and expect to record non-GAAP taxes at 28%.

For fiscal '10 we expect GAAP operating expenses of approximately $2.4 billion and non-GAAP of approximately $2.1 billion.

We expect GAAP gross profit margins of approximately 57% to 59% and non-GAAP gross profit manche ins of approximately 58% to 59%.

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 FY '10 versus much lower bonus funding assumption in fiscal '09.

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.

A dollar 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 significantly from last year as a result of steep declines in interest rates.

Taxes on a GAAP basis, we expect tax expense of approximately $40 million to $60 million and expect to record non-GAAP taxes at 28%.

Foreign exchange assumptions.

FX rates have been volatile this year and we expect that to continue.

For purposes of guidance, we are using current spot rates.

To the extent the US dollar continues to strengthen against the Euro and the British pound, we will have downside revenue and EPS exposure.

To the extent the Canadian dollar strengthens against the US dollar, we will also have downside EPS exposure.

That concludes our guidance and outlook commentary.

With that, I'll turn it back to John.

Thanks, Eric.

Before we take your questions, I want to close with a few thoughts.

First, we are optimistic for the industry in the year ahead.

Second, we've hit the reset button on our cost structure.

We have not lowered our ambitions, we have mapped our cost structure to a more conservative revenue projection.

We've made the hard calls, now it's all about execution.

And, finally, we have been and will continue to be focused on game quality and innovation.

Our FY '10 slate is very promising.

Let me tell you about some of the titles I'm particularly excited about this year.

In Q1, EA Sports will drive our Wii initiative with the debut of the new tennis franchise and with EA sports Active, a new fitness product.

Also from EA Sports is a return of our acclaimed Fight Night franchise.

At the end of Q1, Harry Potter and the Half Blood Prince releasing in conjunction with motion picture from Warner Brothers.

The main event is a launch of Sims 3 on June 3, a brand new experience with a host of online features.

I'd urge you to check out the new Sims website.

In Q2, we will launch Need for Speed Shift.

This is the first title under our new approach to development.

Our Nintendo title, Need for Speed Nitro, will follow in Q3.

In July and August we will deliver the one-two punch of NCAA football and Madden NFL.

In Q3 we will launch Dragon Edge, an epic new IP from BioWare.

We're introducing Brutal Legend, a heavy metal action fantasy starring Jack Black, and NBA Live, a franchise that's made a big rebound with critics and consumers, will be back with a leap forward with the dynamic DNA online future.

In Q4 Battlefield Bad Company will be back on console from our (inaudible) studio in Stockholm.

BioWare will release Mass Effect 2 on multiple platforms and the [Redwood Shores] team that gave us Dead Space will launch a brand new intellectual property based on Dante's Inferno.

In addition, our partners at MTV Harmonics have announced a new music title based on the Beatles to be released in our FY '10.

With that, we would be happy to take your questions.

Operator, we would like to open the call to questions.

Thank you.

(Operator Instructions) The first question comes from Jeetil Patel with Deutsche Bank.

Hi, guys.

You got 14% fewer SKUs coming out in fiscal '10 versus fiscal '09.

I guess can you walk us through from the down 14% of the SKUs to the flat to plus 5 -- call it plus 5% on the revenue side.

I guess what are you implying in terms of productivity versus change in FX and then also just your pricing assumptions for the industry as a whole?

So there's a lot of pieces to your question there.

I'll do my level best to wrap them up in one answer.

First off, your point to point comparison on SKUs I think is a tad misleading because it incorporates the move of some SKUs literally right from the end of fiscal '09 into the beginning of fiscal '10, so I actually think your low teens estimate understates the shift in SKUs or the reduction in our investment in new R&D.

The second observation I would make is in terms of mapping that to revenue growth, I'd start at the strategic level and point out that we are very purposely reducing the number of skews in particular, secondary and tertiary SKUs and/or titles that are too close to the breakeven point to justify being developed and launched, so we believe we're making a move to enhance our ability to focus, create bigger hits in the marketplace and all things being equal, generate at least as much if not more revenue.

Now things frankly are not all equal and I think you need to take this question apart carefully.

If I were to do this from a modeling perspective from the outside in looking at Electronic Arts, I would probably start with the observation that we've highlighted today on the call that our distribution revenue is down approximately $300 million year-over-year.

I think that's a very important starting point, and that's a lower margin business and one of the reasons our gross margins are up so sharply is a reduction and not as a percentage of our revenue.

From there, there's half a dozen different ways you might want to cut it, but if you were to cut it like we did, you'd look at it by label, and if you started with sports, you'd see that our business is up approximately $100 million year-over-year.

Just over 100% of that are new titles we're launching in the year like Fight Night and EA Sports Active.

We've actually developed a plan with our TC titles being down slightly.

In terms of our games label, that is actually down approximately $100 million year-over-year.

That is a function, excuse me, $200 million year-over-year.

That is a function of the EAP reduction/distribution reduction being primarily concentrated in our games label and then if you take a look at the slate of titles that we've got, basically Dragon Edge and some of the titles we've mentioned on the call mapping against a slightly lesser slate in the prior year we believe that's approximately $100 million net up.

The third piece is Sims/Play label which we have up net $300 million year-over-year and the easiest way to think about that is everything is roughly the same except we've added Sims 3 and two movie titles, one Harry Potter and one we have yet to announce, which is a net clean up of about $300 million, so that pretty much ties out to our $4.3 billion growth rate or the revenue estimate for the fiscal year.

If you ask about FX, you could call FX an underlying industry growth a tie-out.

Of course we did these things with much more detail than I'm describing now, and that's essentially what happened for us.

In terms of assumption on industry pricing, I'd make a couple of comments.

The first of them is a close study of the industry performance in Q3 yields some, I think, fairly important conclusions.

Perhaps most important is the quality sells and sells at a premium.

As you can see if you study the NPD charts or the equivalent from Europe, you'll see that the top 20 charts is denominated in titles with very high ASPs suggestive of the fact that the consumer chooses quality over price despite the fact that there was inventory in the channel with some discounting at the bottom end of the chain.

So the consumer, even in a tough economic environment, chooses quality over price and they always have in our sector.

Secondly, for reasons that I'm certain you understand, we're not in a position to give particular guidance or information while pricing later in the year.

That is the conversation between us and our customers, and something that needs to stay there given the current environment and frankly a good business environment.

The next question will come from Edward Williams with BMO Capital Markets.

John, just to follow-up on Jeetil's question a little bit.

If we look at the unit assumptions on some of the key franchises, key annual franchises, Madden, NBA, Need for Speed, am I correct to assume that you're assuming those franchises at least on a dollar basis are going to be down a little bit?

And then as we look at things like the Sims that have non-annual launches, how are you looking at those products performing in FY '10 versus their prior launches?

So in the case of, everything you've mentioned in your list of sequels, you're correct.

We have them slightly down.

That's our base scenario.

Of course that's not what we're setting out to achieve but we believe that's a prudent forecast in today's environment.

In terms of the rest of our slate, some of which we have great references for like Sims 3 and others where we really need to look longer back in history at our competition like a Dragon Edge to see how that might perform in the marketplace with some competitors titles in the past year being more close to that in its performance and, in general, we've used I said more conservative than not reference points, so I'm not going to give you particular unit volumes on the call for any of our titles but we haven't assumed anything sort of pops into the top 5 or anything has got any sort of extraordinary revenue outcomes associated with it.

We're hopeful that that will happen in the year but that has not been our experience in the last 12 months, and we've chosen to take a realistic perspective on what's going to happen and what we can count on.

The next question will come from Justin Post with Merrill Lynch.

Thank you.

John, can you talk about where you are on the margins for each of your labels and how much you think you can get improvement next year, and how do you measure your investment because you are investing for 2010, '11 and '12?

Are you going to try to balance that versus delivering on the dollar next year?

Well when you ask about margins there's really two margins you're probably thinking about.

One is our gross profit percentage and the other is our operating margins pre-overhead and I'm not going to give you the specific numbers on them but trust we've been through a very diligent planning process and we're very close to all of those numbers.

I will start by telling you that the gross profit business, gross profit percentages in all three businesses are very healthy.

The Sims/Play label is very strong driven by a heavy mix of PC associated with the Sims 3 launch.

The sports label is strong and robust, particularly as we move into more owned or near owned intellectual properties such as EA Sports Active, and the games label has always had strong gross profit margins as a consequence of being heavily denominated by owned intellectual properties.

So gross profit in all three businesses looks healthy in the coming year.

The primary driver in terms of differentiating these businesses on an operating margin basis is R&D investment, and what you can see for both the sports label and Sims/play, we're calling it play now but Sims/casual, these have R&D numbers below 20%.

They are very strong businesses, R&D is tight and aligned with where they should be for businesses of this scale, and we're very pleased with the return on investment in R&D that we've had and expect to achieve in the coming year.

We continue to see, and I'm not going to give the specific numbers on this, higher R&D as a percentage for our games label.

It's by far our largest unit and if I were looking at that, I would make a couple of observations as to the why.

One is we've looked very carefully at our investment per title and overall, in both so sharp improvement year-over-year.

We feel very good about the productivity and efficiency that's been driven into the games label by its leadership team.

Strong, aggressive moves.

A large part of our year-over-year expense reduction, head count reduction has come from a disciplined plan developed by Frank Gibeau and the team on the games label.

I would also point out to you that the primary driver of R&D as a percent to revenue is in fact revenue, and one of the challenges we've had is this is a part of our business that for so many years has relied on the annual success of franchises like Medal of Honor and Need for Speed and, as we mentioned on the call, Need for Speed was slightly down and year-over-year we're now absent Medal of Honor franchise both in FY '09 and FY '10.

What you see happening in the year is the rise of key franchises like Need for Speed to a new development plan, Battlefield through some very aggressive development smart move, Dragon Edge which we believe has the potential to be an epic multi-sequel title for us as does Mass Effect and others within the portfolio.

So right now, I would tell you that gross profits in the games label strong, as a percentage of revenue where we would like it to be, R&D relatively high, but that's a function of where we are in the turnaround of that business from a series of years where some of our property slipped some and I could not feel stronger about the title plan in F '10 being just the anecdote to that problem and it's a case where I look for up side if there is up side in our plan.

I hope that answers your question.

Moving on to Ben Schachter with UBS.

Given the change in the macro and some of the changes of the Company, can you talk about how you're looking at acquisitions differently today than you were in the past, and then also if you have any thoughts on PS3 development and where you're thinking on that platform?

Thanks.

This is Eric.

I'll take the first part of that question.

Regards to M&A, our position today is very similar to what we discussed in the last call.

We're taking a very measured view.

We're not looking at large scale M&A.

You would look to us to do a couple small deals in the foreseeable future of the next couple of quarters.

We're very focused on the operational aspect of our business.

We've just pulled forward our planning process.

We've slimmed down and we're becoming more concentrated and we'll spend more time at least in the short-term there, so the position today is pretty much what we had on the call with you late last year.

So on PS3 development, actually I would tell you that the way we look at development is really in three buckets, if I exclude MOGO and POGO for minute.

We think of it as online games like what we're doing with our BioWare or Lucas or Lucas BioWare partnership around the Star Wars property, or what we're doing with Warhammer or what we're doing with some of our MSGs.

A second bucket is what we're doing with Nintendo Wii which is a major focus for us in the coming year and the third category is Xbox 360 and PS3.

The reason we put that into one bucket is the lion share of titles developed for these platforms are common.

Of course we work with each of the first party platforms on unique titles and might take advantage of particular features of the platform and we're very proud to have great marketing partnerships around key exclusive titles both on the PS3 and Xbox 360 but, in general, think of us as having those three buckets, PS3, Xbox 360, bucket one, bucket two is the Wii, and bucket three is online, and in terms of title count, and an emphasis, we have roughly an even balance between PS3, Xbox 360 being one bucket in terms of number of titles just over 20, and just over 20 on Nintendo Wii.

So in terms of our console, you might argue that we're evenly balanced between the against if you will the install base.

Nintendo is the leader.

They're getting half our emphasis in terms of title count.

This question comes from Brent Thill with Citigroup.

Thanks.

John, just on the international business, it seems to me really lagging the growth you're seeing in North America.

What's causing this dislocation and what do you think helps turn it around?

I actually think what you're probably seeing more than almost anything in our international business is really two factors, they sort of make it look a little bit different.

One is a very substantial shift in FX which on a back translation basis causes our international businesses to look small or relatively small in growth rates.

Of course during the year, when the dollar was dropping and the euro was rising which is precisely the opposite and we look like our international business was generating outsize performance.

The second factor is the primary beneficiary of our Rock Band business was in North America.

It was a gigantic revenue contributor to the business in North America in the tail end of our fiscal '08 and all of fiscal '09.

Normalizing for these two and looking at them and say for example, market share performance they are very, very similar.

And this question comes from Daniel Ernst with Hudson Square Research.

Yes, thanks, good evening.

Thanks for taking the call.

On your Nintendo Wii strategy, to date you've done a couple of things to get at that, one being the Boom Blox new IP and the other being taking franchises that you've done well with and making them I guess Wii-centric with your All Play feature and also with Face Breaker you had (inaudible) and it sounds like you're kind of doing the sale thing for the coming fiscal year with the Need for Speed having a different version, I think Nitro is its name, for the Wii.

Can you talk about how you think you're going to be doing it differently this coming fiscal year such that you're more successful relative to what you've done so far, thanks.

So basically, yes.

You live, you learn, you adjust and improve.

And so this year's title slate is a significant improvement from last year because we learned what didn't work last year, which we're not (inaudible) and we're emphasizing hard those things that do perform.

In situations within our EA Sports portfolio, we had outside strength on titles like Tiger and FIFA where we are bringing those back in new and enhanced ways and titles where we had lesser performance we're adjusting to learn from those experiences.

But I actually would highlight a couple of things to more directly answer your question as opposed to staying up in the theory level.

One is we are going strong right out of the box with EA Sports.

EA Sports Active is taking advantage of the world's fascination with fitness, the strength of the Wii Fit platform with a spectacular title in my judgment at least that's coming out in our first quarter and, in fact, I'm heading up to Vancouver tonight, the development studio for our EA Sports Active business.

If you go to the web you can learn a little bit more about it.

Peter Moore has been vocal on it with a number of press announcements.

He's the President of our sports label.

It looks like a very strong entry to me and frankly a brand new category for Electronic Arts.

The second thing coming out in the quarter is we are launching our tennis SKU -- our tennis title initially Wii only and following up with other franchises.

This takes a spectacular advantage of the unique controller.

I probably don't have to go too far to explain why that controller in your hand feels more like a tennis racket than perhaps other controllers might.

In addition to that, we are taking a big step forward with our Sims label.

The MySims franchise has been very successful on the Wii platform.

We're bringing three titles together and we're aggressively marketing them.

They've been among the most successful IP on the platform.

We're going to market them aggressively really as a range and this is a premium range where really the only player in premium range idea against the Nintendo platform have been Nintendo themselves.

We're coming at this with a very strong entry, one of our best development teams feels really, really good.

The third thing we're doing and we had great success with last year and we're doubling down, we're basically getting 12 months business instead of 6 is our Hasbro business.

Our Hasbro business has been a strong entry there.

The fourth thing we're doing and I'd really like to put kind of a fine point of this is we're bringing core intellectual properties to the franchise in categories we think have legs on the Wii platform.

A good example of this is Dead Space.

We're bringing a Wii title to market this year and it is absolutely going to be the quality and fear factor that you got on the PS3, Xbox 360 and PC SKU this past year.

So I can go on a little bit more with other titles to reference and points to make, but I would tell you we're also increasing our committment to marketing exclusively with marketing dollars focused on the titles for this platform, marketed more as a range than individual titles, so I think we've learned how to build better quality products for this platform.

We've learned how to develop products that appeal more to the specific consumers and bring consumers to this platform with our own intellectual properties that really lived on other platforms but of course there is a lot of cross ownership when generating incremental sales for the Wii, and we're going to top that off with a stronger marketing campaign.

So in a way I suppose it feels like we took two good steps forward last year, we got three more this year.

The next question comes from Colin Sebastian with Lazard Capital Markets.

Thanks, good afternoon.

First of all, in terms of the product portfolio there were a number of your core franchises that you didn't talk about for the next fiscal year.

I'm curious, first of all, if there are any franchises that didn't make the cut and then, secondly, are you implementing any new technology in the development process to improve game quality or save on costs or are you happy with the tools you have at your disposal?

Thanks.

So, yes, there were titles but I don't think you'd think of them as core titles that didn't make the cut.

We clearly made some moves on titles like Playground and Boogie and others, but one of the things we've elected to do on this call is to not dwell a lot on what we're discontinuing.

We thought we would rather say this is more about the numbers.

There's a lot of personal emotion that gets wrapped up in individual games.

We've just been through and in the process of managing our way through 12 facility closures and 1100 person lay off.

Basically, just for purposes of sensitivity, we think it's better to keep it at that level.

In terms of tools, we've actually made some good progress.

One of the things we've done is consolidated around the core engines, for example, in the games label, we're using core engine tack and spreading it across a number of titles in our (inaudible) Studio, we're doing something very similar with our (inaudible) studio with an engine we title Frostbite.

We have propagated effectively a technology that you first saw in our NBA Street franchise, it's now used in a number of our games title, sports titles, which is how individual NPCs and player characters are animated.

At this point in time, the lion share of our titles, in fact well north of 80% of our titles have some level of common code that can be considered core, so one of the reasons we're able to put together such a strong slate for F '10 while reducing expenses is because we're taking advantage of some of these things.

I would add the only thing we're doing in terms of tools is a technology that we use to create builds, push builds, automate, testing, and enable distributed development in QA both in house and offshore.

This is all working better and the net result of that is we're expecting more of these processes to lower cost locations versus we are today looking to the end of FY '09.

The next question comes from Tony Gikas with Piper Jaffray.

Hi, good afternoon guys.

Say, you're giving guidance on fiscal '10 relatively early and I'm wondering what gives you such confidence with the consumer and the environment that we're in and sector sales that you're willing to give guidance this far out, and in the latter part of the cycle do you feel like sales are easier to predict or do industry sales become a little more variable?

Well first off, I almost have to reframe your question a little bit to answer it accurately.

Given our business circumstance, what we saw in Q3 and our expectations rolling forward and what we learned in calendar '08, we specifically pulled forward our full planning cycle up a quarter, so it's not about visibility.

It's about completing the process and we've completed the process a quarter earlier that put us in a position to guide a quarter earlier.

One of the key reasons we did this is that we learned that one of the things we weren't doing as effectively as we might is long lead marketing planning.

Essentially, some of the most important decisions on our launch plans for our key titles was being held in favor of a planning process that needed to be locked down in sort of the February/March time frame.

We did this because we wanted to get the, if you will, our budgets locked so we can in fact get into marketing execution 90 or 120 days earlier.

A key learning, we restructured our entire planning process around it.

In terms of where we are in the cycle, you'd referenced that we're at the tail end of the cycle.

I would actually suggest that that's probably not correct or at least that I have a different take, and if you listen to the commentary from both Sony and Microsoft in recent weeks at CES and other venues, they've commented they expect an extended cycle as do we, so we think it's more of the middle of the cycle than it is the end of the cycle.

And in terms of predictability, I'd tell you how we've managed to develop our revenue forecast is based on sort of nothing blowing out past sort of reasonable base judgment expectations and when you're using that as a base model for how you forecast, it's frankly a little bit more predictable.

So we've introduced predictability into our forecasting by taking a slightly different approach.

The other thing to add-on to that is that looking at FY '10 versus FY '09 we talked about the revised view of the distribution business.

We're expecting that to be down, but we also have titles that we've moved from what used to be in FY '09 to FY '10.

We touched on those.

Sims 3, Harry Potter, these are net year-over-year pick ups, so we've got kind of confidence and visibility on those revenue streams and also for fiscal '10 we're going to get a full year of Warhammer subscription revenue, we talked about the fact that we're already at 300,000 subs, that's a very ratable and more predictable business so that's new for FY '10 compared to fiscal '09.

Next question, please?

Certainly.

The next question comes from Mike Hickey with Janco Partners.

Hi, guys.

Thanks for taking my questions.

I was curious if you could narrow it down a little bit on your fiscal '10 sales (inaudible) if you could identify what you think will be your top five titles ex-EA Sports and EA Partners, and then I have a follow-up, please.

Ex-EA Sports and EA Partners?

Yes.

I never do a top five without Madden or FIFA in it, but the top five without Madden or FIFA is almost a trick question but clearly Dragon Edge is there, Sims 3 is there, Need for Speed Shift is there, Bad Company is there and probably Harry Potter Half Blood Prince would be next on the list.

That would get us to five.

One of the nice things about some of those Dragon Edge PC, Harry Potter Half Blood Prince, and the Sims 3 are fairly easy for us to forecast and to feel confident in given the state of development that these are in.

Next question.

Certainly.

The next question comes from John Taylor with Arcadia Investment.

Hi.

I've got a couple as well here.

So it looks like you're on track to do a little over 400 for the fiscal year in direct-to-consumer and you're kind of forecasting a 500 number, so I'm wondering kind of how you're thinking about that growth rate as you go into fiscal '11 and are we likely to see that accelerate and, if so, by how much, kind of wondering maybe when out there we might see a billion dollar kind of potential for that so that's first one.

The second one is you talked a lot about cost management and it's given the market, given all of the variables it's awful hard to forecast unit sell through and what consumers are going to do so you guys could control cost.

I'm wondering if with the mix shift to Nintendo and everything else that's going on what the implied break even unit delta might be.

You don't need to tell us what the average is, but I wonder kind of how much it's come down by as you're thinking about that, and third is real easy, what are you assuming your Wii market share is likely to be in fiscal '10?

Thanks.

Well I'll take the first and the third and I'll give Eric the breakeven question I didn't quite track.

So in terms of, sorry about that J.T.

So in terms of the direct digital, one of the things I would point out to you is that mid 20s growth rate that you've projected for our direct digital business based on what we've told you and putting the pieces together is very close to our own expectations, but I would tell is very close to our own expectations but I would tell you that I generally don't think of it as a composite other than preparing for earnings calls.

Really what it is is POGO, it's mobile, it's MMOs, it's a series of MSGs, it is ultimately a new MMO that we're going to be launching in joint partnership with Lucas Arts.

So it's a series of businesses that feel like they've got good tail winds that are growing, POGO and mobile in particular.

It is secondarily a series of things that are really discontinuous that are adding to our business.

Good examples of discontinuous is late last summer the launch of Warhammer, the revenue stream where it was only a cost stream.

When we launched our next MMO, it will be, we believe, a much larger revenue stream where it was only a cost stream.

And we talked about Battlefield Heros, our Need for Speed online, the number of launches we've got in Asia which we really don't have time to get into on the call today, but these are discontinuous activities that the generate big steps forward in revenue.

I'm not here to tell you that I've got a prognostication of when it's a billion dollars, but I would tell you that a major contributor to that will be our BioWare Lucas Arts joint venture MML, that will have an awful lot to do with that last step to a billion dollars.

Eric do you want to take the breakeven point?

Yes, I won't give any kind of a quantitative change on the breakeven point for Wii SKUs but I'd offer the following three observations.

One, as we look to FY '10, we're going to be getting the benefit of some learning curve so FY '09 was the first year of all play mode and sports and we'll have the benefit of that behind us and we tend to do better when we iterate in terms of the efficiency.

Secondly, we're developing expertise in certain of our own studio locations in terms of Wii development so, again, we're advancing the learning curve there and third point, we touched upon this earlier, we're expanding our generic pools and technologies library so that we can, for example, QA and find a Wii specific product more efficiently than we would using more manual processes, so we feel that these three things are going to make us more efficient in terms of overall Wii output.

So in terms of Wii market shares, let me tell you that overall what we got into on the call is about 5% revenue growth and hence no market share growth.

Of course, our goal internally would be to gain at least a market share point in the year.

So let me give you first an observation on how to foot to that and maybe the easiest way to foot to that is that on our distribution business we lose about $300 million and then we've taken three titles and moved them into the next year which adds about $300 million.

So what does that tell me, if you're up 5% in a 5% industry you're flat.

So our internal models in aggregate don't show market share growth in terms of our guidance for FY '10.

Having said that, we do have high hopes to see growth on the Wii given our title slate in the year which is stronger than last year and to be honest with you, I don't think we would be satisfied if we didn't pick up something there and, of course, that is important given that some of the legacy platforms, like the PS2 where we've enjoyed strong share over time, are in decline.

So we want to see market share growth there.

I'm not giving you specific numbers.

I know I'm not answering your question directly, but I didn't want to make sure you got an understanding of what's required for our $4.3 billion is really the new IPs that we moved out of '09 and '010 offsetting the decline in distribution versus the hold share.

The next question will come from Heath Terry with FBR Capital Markets.

Great.

Thanks.

Just on the three titles that were shifted, are those shifts purely marketing related or should we also think there was a development component to this?

And then when you look at the Wii platform strategically, is there a structural difference either because of the customer base or the game play format or Nintendo's development skill that causes you to plan for EA's ability to gain share on that platform to be limited, or can you ultimately with the right strategy get to an equal share with your other platforms?

So I'll take the second question first, in terms of Wii.

On the Wii, I would say it is structurally different in a number of ways relative to the PS3 and Xbox 360.

One is the prevailing premium price is $10 a unit less than it is for Xbox 360 and PS3 games.

Secondly, development is typically a third to a fourth as much for a Wii game than it is for a PS3 or an Xbox 360 game and that's really a function of the capacity of the hardware and the fact that it's not a Hi-Definition gaming box so we're not producing the amount of art for Hi-Definition games.

Third, there are differences in terms of the way the consumer perceives the brands.

I think there's little doubt that Nintendo has an enviable position in terms of sort of brand reputation relative to its own platform with its consumer base and that's one of the reasons in the coming year we decided to make such a strong emphasis on quality.

You'll see we're taking great advantage of their new hardware addition with motion sensor and what that's going to give us is the kind of game play we think will rival Nintendo on their own platform and we're bringing marketing together in such a way that we think we can get noticed in ways that no other third party will.

In terms of the three shifts I would tell you that we were in a position should we have wanted to or needed to, to ship all three titles in Q4 of FY '09 so they were ready to go at one level or another, but I will also tell you that in each of the three cases, holding the title does allow the team to push it a little harder for polish, and I'd like to give you the perspective on each of the three in terms of what was the fundamental motivation for the move.

In terms of Sims 3, frankly we see this as being one of the most important launches in our Company, its history and certainly in the coming fiscal year.

When we looked at what we've done in terms of all of the marketing preparation and what we learn from the Q3 results in North America and Europe, we felt we could do better to build a marketing campaign worthy of a title of this high quality, so this was really about investing more time and effort to be even more innovative on marketing.

In the case of Godfather 2, to be honest with you we looked at the title.

The title feels very solid and it will appeal to its audience well and it was likely to ship as we originally planned it and it was very cluttered, price reduced, excess inventory channel both in North America and Europe in a heavy competitive environment.

We didn't think it would get its best shot of success in Q4.

In Dragon Edge frankly this will sound almost upside down but sometimes too much quality can make you reassess your options, so with Dragon Edge this is truly an epic game both in scale, quality and innovation and we felt that we could mount a better campaign consolidating Dragon Edge PC with console later in the year and, yes, that will allow them to polish it even more, so each of them have their own story.

Operator we'll take one more question.

And that question will come from Doug Creutz with Cowen & Company.

Thanks.

You guys talked about how you're going to lengthen your time to market for the advertising campaign.

I think clearly that means more dollars.

What's changed to make you think that's the appropriate strategy and why do you have confidence that spending more in advertising will yield better revenue for your games?

Thanks.

Just for clarity sake we did not tell you that we're spending more necessarily.

We said we would spend it differently, and what gives us confidence in this is frankly some work that we did within our marketing teams that basically took apart our marketing campaign one by one, month by month, sometimes week by week, program by program, compared them to competition, where our spending lived relative to pre-launch, launch and post-launch windows, the types of vehicles that were used to create buzz and demand in each of those windows, how it was spaced out over time in terms of launch windows in the Christmas holiday and came to conclude that we were underspending in the pre-launch months and demand generation and that had an impact in terms of buzz and demand for the product at pre-sale levels than before, and that we were spiking a little bit too much right on top of the launch and so those were some of the conclusions.

We made other deeper conclusions associated with revenue mix, how promotions work.

We went to school on ourselves and came back with a different answer than the one we field in the marketplace in 2008 and felt we had a better opportunity if we did it differently.

Not wanting to essentially ignore our own learning, we took a look at our Q4 slate and felt that it was too late to do what our earnings from Q3 '08 and prior to that had taught us and so we adjusted our SKU plan launches to reflect our current learning.

Okay, thanks everyone for joining us today.

And that does conclude today's conference.

We do thank you for your participation today.