Our Take: EA Q2 FY 2018 Results

A minor loss now means printing money later.
The EA Q2 FY 2018 results came out yesterday and as we predicted, EA continues to make positive gains in every financial category that matters.  In this “Our Take”, I will pull out the highlights and talk about their impact on the current market.

Baseline Financials

Summary – EA reported a loss for the quarter but describes it as “strong”.  This is due to the loss being expected and the attachment rate of other products and services being higher than expected (poised for long term growth).  EA’s financials historically contain large gains and minor losses.  This seems counter-intuitive.  Why plan for a loss?  The following analysis will describe why it was a good quarter for EA, despite the negative net income.

 

Exhibit A – Net Revenue Between Packaged and Digital Products

Summary – (Note: This is not a quarterly graph but instead a fiscal year over year graph.)
EA is predicting a FY18 that continues the trend of increased digital revenue with a corresponding decrease in packaged revenue.   Expect this trend to continue as more people gain access to real high speed internet and accept digital downloads as the mainstream consumer method.  It is important to understand this is not just simple game sales.  Digital revenue continues to trend upward due to EA’s corporate strategy to be more in line with a service model (where games are a platform to sell additional content via digital storefronts).  As the world becomes more digital, it’s easy to understand why EA is pursuing a service model.  First, digital sales have a higher profit margin (compared to physical package sales).  Second, digital service models provide continual revenue that the traditional growth and decline model does not.  Expect this trend to continue over the next several years.  If this trend breaks, it will be because of poorly accepted products, not because of technology.  Digital services are here to stay.

 

Exhibit B – Digital Net Bookings by Platform

Summary – (Note: This is a FY quarter over quarter comparison of net bookings by platform.  You have to read the report to understand the difference between net revenue and net bookings, but they are similar.  Essentially, net bookings has some deferred revenue in it that can’t be claimed in the current quarter.)

EA’s Q2 FY18 outperformed the equivalent quarters of the previous two years.  When the trailing 12 months are included, it becomes a little more clear that EA is having an exceptionally good year, even when compared to previous successful years.  A couple things stood out here:

• PC net bookings are up compared to FY17 & FY16.  I expect this to slowly rise over the next few quarters/years since publishers are pushing product back into the PC market.  It’s also worth mentioning that building a gaming PC is no longer the expensive endeavor it once was.  PC and console technology are trending together with the current generation of hardware (Xbox One, PS4, Switch) being closer to traditional PC hardware than ever before.  Exclusivity is not nearly where it was years ago and development costs for creating a PC version are down (due to the hardware between PC and console being similar).
• Console net bookings are up…a lot.  This quote from the prepared remarks stands out as well: “Revenue and earnings were above our guidance, highlighted by continuing digital growth and strong ongoing execution to deliver for our players around the world.”  The takeaway here is that digital sales and digital services are being utilized by the console consumer at a rate faster than ever before.  PC certainly adopted the digital download approach first, but EA isn’t shying away from the same model on console.  Even with all this booking they still reported a loss (this quarter).  That loss, however, lays the groundwork for gains later.

Exhibit C – Digital Net Booking by Type

There is one big takeaway from this slide: Digital Services (subscriptions, loot boxes, extra content) generate more cash-flow than full game downloads.  The year over year growth from FY17 to FY18 is staggering.  Consumers can criticize EA for moving to digital services in the form of content, loot crates, and cosmetics (an argument can be made it “poisons” the game experience) but it’s hard to argue with results.  EA has no reason to change strategy, at least at this point in time, because their strategy is working.

Exhibit D – Highlights from the Transcript

Blake J. Jorgensen – Electronic Arts Inc. – Executive VP & CFO

“We’re pleased with the performance of our business through the second quarter, which added strong digital growth to the dependable results we expect from our sports titles. In particular, we saw a notable shift to digital purchases in our sports titles and strong growth in our Ultimate Team of event-driven live services.”

Summary – Blake is echoing what we’ve all been hearing for the past few months: digital purchases are working on all game types, including sports.  The other interesting note is that he used the word “dependable” when describing sports titles.  Sports games are not risky in terms of ROI.  They sell to the same reliable demographic every year and EA knows how many they are going to sell, generally speaking.

Andrew Wilson – Electronic Arts Inc. – CEO & Director

“In The Sims 4, monthly average players are up more than 40% year-over-year, and anticipation is high for the console game launching in Q3. As these communities and many others in our top franchises continue to thrive, our subscription services like EA Access and Origin Access are bringing more players from across our network to join in.”

Summary – The Sims are still going strong.  I admit, I haven’t touched a Sims game in ten years.  This one surprised me.  It was also one of the biggest reasons they came in over expected guidance.

Christopher David Merwin asks about the Battlefront II Beta Feedback and Andrew Wilson Responds:

CDM: “And then just secondly, for Star Wars Battlefront, I was hoping if you could maybe talk a little bit more about how the beta went and what type of feedback you got from the community during that process, and maybe any changes that you’ve made to the end game modernization mechanics since the beta.”

AW: “There was, of course, the conversation around loot boxes which is not a Star Wars Battlefront II-specific
conversation, but more one that the industry is having with players across the global community. And we are engaged in that conversation, engaging with our players on a daily basis as we think about that. There’s really 2 conversations going on there. One is about value and — in a world where a player pays $60 for a game, will there also be value in the ongoing digital ecosystem that comes for many years. When we think about value, we look at Star Wars Battlefront II and we say we start with a game that’s nearly 3x the size of the last game, we take what much of the content that would’ve been gated behind a Season Pass, and we offer that to the community for free. So we feel very good about the overall value proposition focused on keeping the player community together. Then as we think about players that are playing the game for many years post-launch and the digital ecosystem in the event-driven live services that they participate in, it comes down to the second conversation, which is does the digital ecosystem offer the opportunity for an individual player in the community to pay to win. And balance and fairness inside of gameplay is very important to our community, and it’s very important to us. And it’s kind of a benchmark by which DICE builds games. And we have seen that in the many DICE games — multi-play games we’ve built over the years. When we think about this, it really comes down to what are the things that you can earn, what are the things that you can buy, and how do we manage progression through that process? And while we will be making adjustments based on feedback from the beta, which is great, we’ll continue a daily dialogue with our players to make ongoing adjustments for many years to come as this event-driven live services continues, we feel very good about the fact that you can earn almost everything in the game. And more importantly, key elements that drive progression can only be earned in the game. But there will be an opportunity for players who come in to also enhance and extend their experience through the ongoing digital economy. And we believe that what we’ve got with a core base game of 3x the size, what would have previously been gated behind Season Pass is now free for all users, with a focus on keeping the community together, and an event-driven live service that we expect will continue for many years to come that is built around player choice and focuses around a world where players can earn everything they need to progress through the game is the right way to balance this. And so we feel very good about that, and we’ll continue to stay connected with our community as we move through the coming weeks, months and years.”

This is the most interesting, and influential comment (from a player’s perspective), in the entire report.  It speaks volumes about how Andrew Wilson (and EA in general) are responding to the loot box “fiasco” from the Star Wars BFII beta.  More importantly, it reveals how EA will be building games in the future and how they will (likely) monetize those game beyond the $60 purchase price.  I want to give some credit where credit is due: Andrew Wilson recognizes that paid DLC (season pass) creates division in game communities AND that pay-to-win (probably) isn’t good for customer retention.  Changes are coming (and we knew that) but this is the CEO directly addressing this issue.  All the backlash and responses on news/blog sites did have an impact.  That’s very important because, for consumers, it points to the fact that at least some CEOs and executives are paying attention to the market.  Without saying “we went too far,” Andrew Wilson goes to lengths to explain to the investor why they are modifying the original design.

[Update 11/24/2017 – We now know, thanks to amazing research by SkillUp, that Andrew Wilson was one of the primary developers of the modern “pay-to-win” loot box progression system.  As CEO, he has made it a cornerstone of his legacy.]

Loot boxes will still be a part of SWBFII and Andrew Wilson defends that by saying that the rest of the content (maps, modes, characters) will be “free” moving forward.  Free is a loaded word.  Nothing is free and obviously EA intends to monetize the game with digital loot boxes.  Future content is paid for via loot boxes and he freely admits that the season pass is essentially replaced by these “live services.”  I don’t want to give EA a free pass here.  There is a lot of concern, in the general gaming community, in the way the game is altered to incorporate the loot boxes.  Ultimately, the product will be judged when it is released and the market will reflect that.

[Update 11/24/2017 – The changes to progression in SWBFII’s retail release were minor, to say the least.  EA received significant consumer backlash due to the payment model and loot box progression system.  In a surprise move, with pressured from Disney, EA pulled the entire monetization system hours before the SWBFII launch (with a note it will return).]

In closing, I’ll leave you with this statement from Andrew Wilson:

“At EA, we believe that entertainment is a fundamental human need. We also believe that games, by their ability to drive social connection, self-actualization and competition, are the single best form of entertainment.”

Do you believe, when it comes down to the player experience, that EA is following this statement?

 

All images and statements sourced directly from EA.  Link