Financing an Interactive Project The Truly Creative Endeavor

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Financing an Interactive ProjectThe Truly
Creative Endeavor

• University of Southern California
• August 29th, 2005

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What you will hear from me today

• My Background
• Electronic Arts Overview
• Digital Media The Competitive Landscape
• Overview of Interactive Industry Distribution
  Model
• Financials Needed To Fund A Project
• EA Example Financials to Green Light a Project
• Questions

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My Background

• BA in History
• MBA, emphasis in accounting
• CPA, Deloitte Touche
• Worked in the interactive games business for over
  20 years
• At EA going on 16 years
• Corporate Finance, controller 5 years
• Head of EAD distribution business (2 years)
• Head of MA (2 years)
• CFO/COO for EA.com (3 years)
• CFO, Worldwide Studios (3 years)

Prepared tax returns in grad school to pay for my
gamer PC
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Electronic Arts

• Founded in 1982
• IPO in 1990
• Revenues of approximately 3.2bn
• Nearly 5,000 employees
• Structured with three divisions
• Publishing sales, marketing, distribution
• Studio research development
• Online Pogo brand, online technology platform
• Direct distribution in over 70 countries
• 2nd largest employer of software engineers in the
  Silicon Valley

Rapidly Changing Competitive/Technology Landscape
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Electronic Arts WW Studios

• 9 Primary Studios - 4 smaller satellite Studios
• EAC, Vancouver BC, EAX WWS HQ, Vancouver, BC,
• Tiburon Orlando, Florida,
• EALA Los Angeles,
• EAUK Chertsey, England,
• Maxis, Redwood City, EARS Redwood City,
• Criterion/RenderWare Guildford, England,
• EAP Asia, RWS, UK
• Satellite Studios Chicago, Japan, Montreal,
  Warrington - UK
• 4,000 employees peaking to 5,000 at high points
• 34 titles (140 SKUs) ? FY08 200 SKUs

Rapid Growth, New Technology, Changing Model
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Relative Market Size

• Compared to other consumer-focused media
  sub-sectors, the video games market is now a very
  large market

US Market Size (B)(1)

• Source PriceWaterhouseCoopers Entertainment and
  Media Outlook, June 2004
• Dashed lines represent console and PC games
  total includes online and mobile games

Moving From the Game Room into the Board Room
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Distribution, Sales Marketing
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EA Publishing today

• Four primary regions NA, Euro, Asia-Pac and
  Japan. Online hybrid of Studio/Publishing
• Responsibilities market, sell and distribute
  packaged goods globally. 1,300 employees.
• Publishing partners with studio on game
  development
• Market and consumer insight are critical in
  developing X
• Collaboration produces higher quality games and
  increases segment share

Marketing is Integral to a Successful Game
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Publishing Drivers and metrics
Publishing can maximize profitability through
volume generating retail/marketing campaigns,
pricing and cost control
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Class of Trade North America
Mass Merchants Werent on the Radar Screen 5
Years Ago
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Mass Merchants

• Retail Profile
• General merchandise (food) at everyday low
  prices
• Consumer Profile
• Lower income, value shopper, skewed towards
  females
• Merchandising Strategy
• Item/price retailing
• Modular focus
• Product assortments customized by location
• Retail and TV advertising focuses on brand image,
  then items
• Customer traffic builds businesses
• Premium video game business is under glass value
  is emerging as live sell
• PC business is a modular presentation
• First to market a challenge street dates are
  the norm
• Retail Marketing Wins
• Strong Sunday insert presence
• WalMart implemented pre-sell gift cards, shrouds
  on key releases
• WalMart invested in television donuts
• Live sell of PC and Video Games presented in
  displays

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Specialty

• Retail Profile
• Best in class servicing day one, week one demand
  for new releases in your neighborhood
• Consumer Profile
• Early adopter avid gamer game trader/renter
• Merchandising Strategy
• Presell all new releases in-store and online
• Store associates are experts on new releases
• Offer everything that will sell, new and used
• Focus on in-store POP, funded by suppliers
• Recent adoption of Sunday inserts to promote new
  and used products
• Retail Marketing Wins
• Strategic investment against in-store
  presentations for December
• Enthusiastic participation for EA Sports in-store
  tournaments
• Consistent presence in-store and online as
  presell vehicles for new releases

Specialty Helps Set Opinions/Word of Mouth
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Consumer Electronics

• Retail Profile
• Technology leadership
• Consumer Profile
• Early adopter older, more affluent consumer
• Merchandising Strategy
• Hands-on environment
• PC and Video game categories are live sell
• Weekly Sunday inserts
• Online/brick and mortar integration
• High/low ad pricing
• Solution-based retailing
• First to market aspirations for PC and video game
  category
• Retail Marketing Wins
• Strong Sunday insert presence
• Need for Speed sponsorship at Best Buy
• Best Buy focus title success

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Top 10 Videogame Retailers North America
Retail Account
December Month end
Top 10 Accounts Comprise Majority of NA Sales
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Retail Accounts Covered - Europe
Over 25 Key Buyers Per Country, No Overlap Across
Countries

• Only 6 out of 50 accounts have cross border
  chains
• Only Media Market has any cross border buying
  function

Complex Distribution Channels in Europe
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European Supply Chain
7 Warehouse and Transport Solutions, Low
Co-ordination
Retailers Own Distribution Centres
Centralised Majors
Distributors
Indies
Store-front direct
Customers
One Stop Manufacturing
Distribution Solutions
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Development Financials Funding a Project
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Studio Finance Wearing a VC Hat

• Studios allocate resources based upon biz model
  drivers
• Product Title SKU including internal or
  license IP
• Market Platforms Unique demographics,
  pricing, and performance by territory and genre
• Team Unique core competency, track record,
  availability
• Long-Term Upside Franchisable IP, lowers
  early risk

Scarce Development Talent High Opportunity Cost
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VC Model

• A VCs goal is to maximize return on investment
• Factors a VC considers
• Product Must have a compelling proposition for
  the customer
• What are the key differentiators, competitive
  advantage
• Market opportunity Is there enough upside, given
  the risk
• What is the market upside, is it a global IP?
• Team You bet on people
• ? People are the key to executing on any plan

Financial Measures are the lingua franca of
Business
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Financial Metrics

• Revenue Basis for starting investment pitch
• Gross Profit Foundation for covering development
  costs platforms and licenses
• Development costs Resources to be invested
  what is it going to take to make the game?
• Studio Profit Key internal measure of success
  target 50
• Exec Producer HC Whos leading the team and
  how big is the team

PLs Measure the Effectiveness of our Allocated
Resources
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External Development Process
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External Development Deals

• External development supplements internal
  resources
• Deals generally involve a series of payments to
  an external party (called advances) and royalty
  rates that allow the external party to earn out
  the advances (recoupment)
• Advances should correlate to level of effort
  (cost )
• Advances can be expensed immediately or
  capitalized (put on the Balance Sheet in the
  Prepaid Royalties account)
• Royalty rate is generally applied to net
  shipments
• Deal Structures
• Flat rate - one royalty rate over contract life
• Tiered or stepped rate structure
• Pre-recoup / Post-recoup rates (Not using going
  forward)
• Pre-recoup / Post-recoup with tiered rates (Not
  using going forward)
• Effective Royalty Rate - (Total amount paid to
  external developer/Net Shipments)

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Deal Example

• Example - Modeling The Next Big Thing

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Studio PL / DCF
NBI
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Example Summary PL
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Example Summary PL (continued)
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Some Deal/Model Questions

• Have I captured all the development spending?
• Incremental, fixed costs
• Direct, O/H, other Touch Costs, Tools,
  licenses, capital equipment, taxes, misc.
• What is the appropriate profitability measure to
  use and corresponding hurdle rate
• Have I left enough buffer for the unexpected?
• What is the quality of my talent, their skills,
  ability to execute?

In the rock, scissors, paper game of a biz
model Cash flow trumps the Balance Sheet and
Income Statement
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Factors to consider

• Be inclusive consensus building where
  appropriate
• Understand your own biases
• Consider non-financial factors/inputs
• Ground your analysis on good fundamentals
• Expect the unexpected and its usually bad
• Be objective gather the facts all the facts!

Trust that inner voice instincts are important
too!
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Q A