美商藝電 (EA) 2003 Q1 法說會逐字稿

Good day, everyone, and welcome to the Electronic Arts first quarter in fiscal year 2003 earnings conference.

Today?s call is being recorded.

For opening remarks and introductions, I would like to turn the call over to the Executive Vice President, Chief Financial and Administrative Officer, Mr. Stan McKee.

Please go ahead, sir.

Great, thanks, this is Stan McKee.

Thanks for joining our call.

I?m here with Larry Probst, Dave Carbone, Karen Sansot, and introducing Warren Jensen, my replacement, who will be taking over the reins in a couple of weeks.

Before I start with the remarks, I will read the customary Safe Harbor statement.

During the course of this conference call, we may make forward-looking statements regarding future events or the future of financial performance of the company.

We wish to caution you, these statements are only predictions made as of July 25th, 2002, and actual events or results may differ materially.

Refer to your form 10-K for the period ended March 31, 2002, on file with the SEC, for a discussion of important factors that could cause the actual results to differ materially from those discussed today.

Those risk factors include, among others, delivery and subscriber acceptance of our online products.

We make these statements as of July 25th, 2002, and disclaim any duty to update them.

So now for the quarter, revenues overall consolidated were $332 million compared to $182 million last year.

That?s up 82 percent.

Net income has reported $7.4 million compared to a loss last year of $45 million.

And earnings per share were 5 cents compared to a loss last year of 33 cents.

On a pro forma basis consolidated, this excludes just the amortization of intangibles, net income was $9 million compared to a loss last year of $41 million, and earnings per share were 6 cents compared to a loss last year of 30 cents.

Breaking that down, first EA Core, our revenues were $312 million compared to $166 million last year.

That?s up 88 percent.

Net income was about $22 million compared to a loss last year of $16 million.

And earnings per share were 15 cents compared to a loss of 12 cents last year.

For EA.com, on the same pro forma basis, revenues were $19.8 million compared to $16.4 million last year.

We had a net loss of about $12.8 million compared to a loss of $24.8 last year, so that?s a reduction in the loss of about 50 percent.

And earnings per share or loss per share for dot-com were 9 cents compared to a loss last year of 18 cents, also a reduction of about 50 percent.

So the highlights for the quarter, I guess the real highlight is business is good.

We shipped our SKU plan, 12 SKUs, we had great growth in the quarter in what is typically our slowest season of the year.

We had successful launch and sell-through for World Cup.

We?ve sold over 2 million units of that, so we met or slightly exceeded expectations there.

Of course, that?s a once every four year type of product.

Medal of Honor, Front Lawn on PlayStation 2 was a huge hit.

We sold about 2 million units of that in the quarter.

The sell-through has been great, it?s been at the top of the charts everywhere.

Another standout was The Sims Family, which sold about 2 million units, led by The Sims Vacation, which was the last expansion pack that we shipped, right at the end of the fourth quarter.

But combined, that family sold about 2 million units.

Chart performance was great across the board in North America.

We were four out of the top ten on PlayStation 2, with a 27 percent share.

We had two out of the top ten on XBox, one on GameCube, three out of the top ten on PC and we were the top three and five out of the top ten on PC on a year to date basis, still maintaining a share in the low 20 percent level.

In Europe, we?re also charting very well.

We have three out of the top five on PlayStation 2, led by Medal of Honor and World Cup.

Our market share there was up 23 percent.

Then on PC, we had five out of the top ten, with a 24 percent share there.

In terms of online traffic and time spent continues to grow for EA.com, according to Media Metrics latest data we?ve seen is from May.

Total visitors were just under 13 million, which leaves us clearly in the number one position among game sites.

Total minutes spent on the site were 5 billion, out of a total of about 11.5 billion on all game sites.

That?s about a 43 percent market share.

And those, we?re still number one on the internet in terms of minutes per user per day.

And our total minutes put us at the number four place in the entire internet in terms of total minutes spent on our site.

Other highlights, events, really, E-3 early in the quarter was a huge success.

We had a great showing of products across the board and just foretold of what?s to come during the year.

We also announced that we had acquired a development company called Black Box Development Studio, about 100 people.

That will actually close this month, but announced last quarter, adding to our internal development talent.

So very quickly, looking at the market update, I won?t go through the hardware unit ships or any of those things, those are pretty well available on NPD [Tryst] data, but just a couple of observations.

Clearly, the hardware price reductions that took place in May caused a very significant increase in hardware sales.

When you took the jump from April sales up to June sales, both PlayStation 2 and XBox were more than three-times the unit sales in June compared to April.

And it?s almost three-times for GameCube.

It?s difficult to quantify what effect that had on software sales, but obviously it was a positive one.

So if we look at installed bases right now, on a year to date basis, I?d say we?re a little bit ahead of expectations.

PlayStation 2 at about 10 million, XBox, this is through June, buyer numbers anyway are about 2.4 and GameCube around 2 million.

Other observations, again, just taking this from the NPD [Tryst] data, tie ratios right now on PlayStation 2 and XBox are about five-to-one, slightly higher.

GameCube is about four and a half-to-one.

So these are both tracking very nicely.

Looking at software dollars, we?re currently running, I would say, ahead of expectations for the market for the year.

Just to give you some numbers here too in total, console market year-to-date is up about 50 percent in terms of dollars.

If you add the handhelds to that, it?s up a little over 40 percent.

PC market up only about 3 percent, which is about what we expected.

So the total market is running about 30 percent above same time last year.

We had talked about numbers in the 20 to 25 percent range kind of for the year.

In Europe, we?ve seen very strong market as well.

Hardware sales have been really strong compared to calendar 2001, same period.

And last year it was kind of lackluster.

PlayStation 2 remained at a very high price point until September of last year.

So we?ve seen that significantly higher.

Hardware unit sales during the quarter in Europe, PlayStation 2 was up about 175 percent in the quarter year-over-year.

So the installed based in Europe is up to around 7.5 million.

GameCube had a successful launch in May, of course at a lower price point, following on the lowering of the price by XBox.

Just prior to that, through June, they?d sold over 600,000, sold through.

XBox had a weak launch in February, lowered their price, and that picked up after the price being lowered.

But our estimate of that sell-through is around 400,000 to 500,000 through the end of June.

In terms of software sales, in Europe PlayStation 2 was up over 200 percent in the quarter, and on a year-to-date, it?s up over 250 percent.

Of course driven by just a lot of market momentum there, plus the greater installed based of PlayStation 2.

PC market is actually up as well, in the quarter estimated to be up, these are in value terms, 17 percent compared to the same quarter last year, and 13 percent year-to-date.

Which leads me to just one other observation to make, there?s been a lot of discussion recently about concern about pricing, software pricing in the market.

A couple of data points.

Medal of Honor, which can be described as certainly a big hit, it going out at full price and is selling through very well, as are the other top selling products in the market on that platform and others, from both EA and from our competitors.

On the PC side, this is all according to the PC data reporting, average prices in the quarter and year to date are up, actually, in North America, and the same thing is true for Europe.

Europe is showing even higher average price increases in the PC market compared to last year.

In the U.S., those numbers are about, according to PC data, about 8 percent.

So prices are holding very nicely, and as we?ve said, the premium products, we think, will continue to sell well at those prices.

Moving to the revenue line, breaking those down a little bit, revenues up 82 percent.

We expected a big quarter.

We had many more SKUs than we did last June quarter.

We had 12 compared to 3.

We knew we had World Cup coming, and we?d actually told the street that we thought we?d have revenues increasing at a 50 percent plus rate.

Growth drivers of course for the quarter, World Cup, over 2 million units sold.

But that performed pretty much to expectations, maybe slightly above.

Most of our products met or exceeded our plan.

So it was just market momentum.

We have of course new platforms in the market compared to last year, and price reductions on the hardware earlier in the quarter.

We had strong catalog sales, particularly for products like Bond on multiple platforms, and The Sims family that I talked about.

Then our AL business was up pretty significantly, 88 percent.

That?s just due to a number of ALs that we have compared to last year, ones like Lego and Crave.

But the real big, the incremental drivers over our expectations as well were first Medal of Honor, significantly exceeded plan, two million units worldwide, and importantly, it?s a high margin product, it?s 100 percent owned intellectual property.

The other one that exceeded expectations were The Sims family, led by The Sims Vacation, as I descried that family of products sold over 2 million units in the quarter as well.

That?s also very high margin product.

So a significant portion of our over-plan revenues came from that wholly owned IP with high margins.

Of course, that drove higher gross margins in the overall business.

And then online was up about 21 percent, as I said, and that was almost exclusively due to advertising, which comprised about, it was up about 37 percent compared to the year prior.

On a geographic basis, all the territories performed very strongly.

North America was up 68 percent, growth drivers there, PlayStation 2 being up 120 percent.

We had twice as many SKUs, four versus two last year.

Medal of Honor was the leading driver there, but also Freak Style, Bond, World Cup and Tiger added to that.

We had new platforms, XBox and GameCube, and we also had sales on handhelds which we didn?t have last year.

So we had a total of six SKUs that were platforms we didn?t have last year versus, well, we didn?t have at all last year.

So those accounted for about $20 million in revenues.

And our AL business was up again for new affiliated labels that we?ve added.

Europe was up over 100 percent, World Cup accounted for about half of that growth.

That drove growth on three platforms that were existing, PlayStation 2, PC and PlayStation 1.

But also there were sales on XBox and GameCube.

Medal of Honor also number one in Europe.

PlayStation 2, business was up over 200 percent, driven by World Cup and Medal of Honor.

Greater installed base there, obviously, due to the hardware price decreases and many more sales since last year.

PC business was up almost 50 percent, largely driven by World Cup.

And then of course we had new platforms in Europe as well, and the same six SKUs that were incremental on those platforms.

Asia-Pacific was up 50 percent.

World Cup accounted for about two-thirds of that growth, with PlayStation 2 being up over 100 percent, driven by World Cup and Medal of Honor.

And Japan, it was up about over 80 percent, and that business was driven by World Cup and Formula One.

As I mentioned, gross profit percentage was up significantly, compared to last year and actually much greater than our expectations beginning the quarter.

It was 57 compared to 51.

Breaking that down, the core business was at 55.5, compared to 48.3 last year, and that was a delta of about 7 percentage points.

EA.com was at 85, compared to 78 last year, also a delta of 7 percentage points.

Looking at the core business, mix is always a factor here.

PlayStation 2 was 40 percent of our revenues in the quarter compared to 28 last year, so that brought the average up.

And then XBox and GameCube, higher than the old platforms, those contributed another 10 percent of our revenues, compared to none last year.

What really was the driver of the higher margins was the higher average margin on PlayStation 2, and that was driven largely by Medal of Honor.

So that was a big piece, almost 50 percent of the total PlayStation 2 sales in the quarter.

Higher average margin on PCs, significantly higher, and that was also a higher percentage of our own intellectual property and that was from, The Sims family, led by Sims Vacation, but also Medal of Honor.

Allied Assault was big, and when you compare that to last year, the biggest seller on PC was Black and White, which was a relatively low margin for a PC product.

Then once again, we had higher margins on the affiliated label business as we?ve been saying for the last few quarters, a higher percentage of that business is more of a co-publishing model that we?ve been driving over the last couple of years.

On the EA.com side, really just a mixed issue where advertising accounted for a higher percentage of revenues than it did in the prior year.

Operating expenses, just moving quickly through the P&L, you know, it?s reported $184 million compared to $161 million last year, up 14 percent.

When you take the amortization of intangibles out, from the pro forma basis as we?ve been reporting, it?s $182 million compared to $155 million.

That?s up about 17.5 percent.

Core business, the growth there was about 37 percent, and EA.com was down 26 percent.

So the growth in the core business was mostly in marketing and sales, where we actually had, expenses were up over 80 percent above the prior year.

Most of that increase, or about 60 percent of that increase came from advertising, and most of that was from Medal of Honor and World Cup.

Of course, that was driving sales that increased 88 percent.

Balance was in higher marketing expenses just to support growth both in North America and Europe.

G&A expenses were up 16 percent, that?s just nothing in particular there, just general growth in the business and following on a year when there was very low growth of 3 percent in that area.

R&D, in total for the core business, was up about $10 million or 18 percent.

W have just more head count, supporting more SKUs.

Also we?ve been trending and continue to trend to more in-house development.

Again, this follows on a very slow growth of those expenses last year of only 4 percent.

Amortization of intangibles is down 900,000 compared to 3.2 last year, again, core business.

And that?s due to the accounting change 142, which went into effect, where pure goodwill is no longer being spent, just amortization of intangibles going through the P&L now.

We adopted that as of the beginning of the fiscal year, this quarter.

At EA.com, expenses were down 26 percent, or down about $12.8 million.

Sequentially, that is compared to the fourth quarter of this past year, we?re down $4.3 million.

And the aggregate, compared to the peak quarter, which was the fourth quarter of fiscal year 2001, we?re down over $20 million.

And this is due to the restructurings we did in Q3 and Q4 of last year.

We?ve reduced head count in that whole area by about 300 compared to the peak.

And as we?ve said, we?re continuing to look at efforts to integrate that business and look for ways to continue to lower costs and drive to profitability.

Spending is down in all functional areas, sales and marketing is down $2 million, G&A down $1 million.

But as previously discussed, the biggest reduction in overall expenses in the dot-com business came from R&D, which includes product development, network operations and customer relations.

And we?ve significantly reduced the number of products that we were trying to support, we?ve been integrating the platforms when we acquired Pogo over a year ago, as we?ve discussed.

We had a duplicate platform to some of the other things we were working on and products.

We?ve successfully integrated those, and that?s allowed us to reduce those costs down significantly.

Again, in the amortization of intangibles line, that?s down $2 million from last year, also for the same reason of a change in accounting for goodwill.

Other I&E is up very slightly, biggest item in there, interest income, is actually down very slightly, just due to much lower interest rates.

And then there are some small factors that go both ways, but it?s up just a small amount there.

Income taxes, no change, still 31 percent rate.

Minority interest, that is the Square Soft?s share of the income in the EA Square joint venture in Japan.

A few quick comments about the balance sheet.

Cash, $827 million, that?s up $30 million since March, about $366 million since last June.

We expect to continue to generate significant cash during the year.

Net accounts receivable is at $118 million compared to $190 million last year, compared to $77 million last June and $190 million in March.

So it?s up from last year just due to the sales increase.

Our DSOs are actually down, they are 30 compared to 37 last June and 36 in March.

Accounts receivable reserves are $128 million.

That compares to -- that?s up about $44 million or 50 percent from last June on higher sales volume.

As a percent of accounts receivable, it?s about 52 percent, which is slightly below what it was last June, which was about 52.5 percent.

As we?ve said many times before, it always tends to be highest in June quarter where sales are still the lowest quarter and we expect that trend will continue in the future.

Inventories, 24 compared to 24 in March, so they?re flat since March.

Up from last June about 50 percent compared to, and that?s on sales that are up 88 percent.

Inventory days are at 20 days compared to 26 in March and 25 last June, so those are even better.

Other current assets, and that consist of pre-paids, deferred income tax and other current assets, that?s up about 29 since March, down 16 from June of last year.

The vast majority of that comes from a VAT, value added tax receivable, that?s just a timing thing, that?s about 17 out of that.

We have an additional $4 million in pre-paid taxes, and then deferred income taxes were $7 million.

So that accounts for virtually all of that change.

Then the decrease since last June is really almost totally from deferred income tax reduction, again, just a timing issue.

Buildings, FF&E, no change.

Investments and affiliates, no change.

Intangibles and other - mostly goodwill intangibles, it?s down just $4 million since March, and that?s amortization of intangibles.

So moving to the forward-looking statements, first the market outlook.

Last call, we said we thought calendar year would be, software market would be up 20 plus percent, 20, 25 percent.

As I mentioned earlier, it?s now tracking ahead of that, around 30 percent.

So we think the market will end up in the 25 to 30 percent range for the year.

In terms of hardware, PlayStation 2, Sony has basically said it would ship about 18 to 20 million hardware units this fiscal year.

That would bring the number up to the mid 40 million range by the end of the fiscal year, so March of 2003.

We expect the U.S. number to be in the 8 to 9 million range, that?s up from our previous expectations of 7 to 8.

And that would effectively double the installed base from prior year.

In Europe, installed base right now is about 7.5 million.

We expect that during the year, there will be 7 to 9 million ships in PlayStation 2.

So compared to the prior year, it?s going to more than double the installed base by year end, bringing it up to 13 to 15 million.

XBox, we expect, as I said earlier, about 2.5 million units in the U.S. we believe right now, expecting another 2 to 4 million by the end of the calendar year.

That will double the installed base from where it is now.

And then in Europe, installed base of about 400.

Calendar year estimate for that is somewhere in 1.5 to 2 million total.

Of course, that?s versus none last year, by calendar year end.

In GameCube, U.S. about 2 million.

We expect 2 to 4 million in calendar year 2002, so again, doubling the installed base from where it is now, maybe even doubling to tripling it from where it is now.

Europe of course has strong launch there, as we talked about, with about 600,000 through June.

We expect a total by the end of the year of something like 2.5 to 3 million.

So very strong market momentum, both now and going through the year.

You know, our challenge, as we look to what we?re doing, our focus is on execution.

The market is there with a lot of strength.

Our overall objectives are the same as they have been, to be the number one console company, number one on PC and number one on online.

On the console side, we?ll ship, repeating what we?ve said before, about 65 to 70 SKUs with 20 plus on PlayStation 2, XBox is 10 to 12, GameCube 14 to 16.

We?ll continue to drive our leadership on PC, as I said, market share in the low 20s.

We?ll push to maintain or grow that.

We have a very strong lineup coming for the rest of the year, including products like SimCity 4, Command and Conquer Generals, Harry Potter, the next Sims expansion pack.

We have a great strength in our catalog.

I talked about The Sims family and the strength in Q1 going forward in the year.

Our focus on online is to drive it to profitability, focusing on the big subscription drivers, Earth and Beyond and The Sims online, it continues to drive costs down.

And then overall focusing on development of new intellectual property, we have, as you can see, been getting great operating leverage that we generate from such very high margin products like The Sims and Medal of Honor.

We will continue to push that through the year and into the future.

So for EA.com, as we know, there are two key drivers to that business, ad sales and subscription.

And we talked about the traffic we?re generating on the popular channel, Pogo channel, and that?s supported by ad sales.

We?re making good progress towards monetizing that.

As I have said before, we?re very close to a breakeven on that business as a standalone business.

Subscription business, Ultima Online continues to thrive with over 200,000 subscribers paying, very profitable as a standalone product.

And as I said before, this is the model for the subscription business, for the rest of our subscription business.

We?re focusing on the key titles, as stated in the previous calls, continuing to drive down costs, as I said before, the quarterly expense run rate in Q1 was actually $20 million below the peak a few quarters ago.

We?ve had losses that have been lower in every quarter since that fourth quarter of fiscal 2001, continuing to push to continue that trend.

In terms of guidance for the year, it?s essentially the same as we gave on the last call.

The Sims online is on track for shipping in the third quarter of the fiscal year.

Earth and Beyond is right at the end of this quarter, it could be into early Q3, but it?s in a very tight time slot here.

If it does go in Q3, the financial impact on Q2 is very minor, given the intended number of units shipped out, and the way we recognize revenue, which is deferring the subscription revenue that?s part of that packaged goods product.

We still expect revenue growth during the year to be in the 50 to 60 percent range, with most of the growth in the second half, and most of that coming from subscription revenue.

And subscription package goods sales, as we sell in package goods sales, particularly for The Sims online.

As stated in the last call, in terms of ad revenues, we expect that there will be very modest growth during the year, given the market environment and the size of the market.

I think kind of another factor in there right now, we as you know derive a lot of our revenues from AOL as AOL sells all the ads that go into the AOL EA.com part of the site.

There are some uncertainties there in changeover.

So that just adds a little uncertainty, but doesn?t change where we are with our expectations for the year at this point.

Expected expenses for operating expenses, 15 to 18 percent lower for the year, compared to last year.

And also pro forma loss in the mid-30s, which is what we had said in the prior call, and still targeting to break even in the fourth fiscal quarter.

So everything is pretty much the same for dot-com.

For the core business, top line growth for fiscal 2003, in the last call we said we expected low to mid 20 percent.

We?re now increasing that guidance to the high 20 percent level.

This reflects both the increase in Q1 and higher growth expected in Q2 and Q3.

Gross margins, last call we said we thought the gross margin percent would be about the same, maybe slightly higher than fiscal 2002.

We now believe that we will end the year with at least a 1 percentage point higher gross margin than we did in 2002.

As far as operating expenses, we think growth will be in the kind of low to mid teens, which is the same as we said on the last call.

Operating income, which we said on the last call we expected to be up 40 to 50 percent, we?re now increasing that to 55 to 60 percent.

By quarter, as we stated in the last call, fiscal 2003 very different than fiscal 2002 in that fiscal 2002 was very backloaded, due to the new platforms, GameCube, XBox shipping late in the year, November in the U.S. and in Europe, in the case of XBox, in the fourth quarter .Consequently, our distribution of SKUs last year was heavily back loaded as well.

In fact, Q4 was our biggest growth quarter last year, over 50 percent.

And as stated in the last call as well, fiscal year 2003 is now very frontloaded, and that?s due to the SKU release pattern.

So in Q1 we had four times the number of SKUs as the prior year.

Q2, that number is 50 to 60 percent higher than last year, Q3 about the same.

In Q4, the number of SKUs is less than half what we had previously.

So the trends are pretty much the same as given in the last call.

We expect Q2 to be up even higher, 60 percent plus growth rate.

And more growth in the second half, but more being allocated to Q3 as opposed to Q4.

Looking at the quarter then coming up, besides the financial guidance, we expect to ship somewhere in the range of 20 to 24 SKUs during the quarter.

Just going down by title, since there are multiple SKUs per title here, NCAA Football, which has actually shipped, there are three, PlayStation 2, GameCube and XBox, we have Madden 2003 coming on six different platforms, PlayStation 2, GameCube, XBox, PlayStation 1, PC and Game Boy Advanced.

NASCAR is coming on three different SKUs initially, or in the quarter, and then a fourth will probably slip over into October, so that?s PlayStation 2, XBox and PlayStation 1 and GameCube.

NHL on PlayStation 2, XBox, GameCube and PC.

Need-for-Speed, PlayStation 2, XBox and GameCube, with some fall-over into October on PC.

We have The Sims Unleashed, which is the next expansion pack on PC.

Freak Style on GameCube, Shocks on PlayStation 2, a racing product out of Europe.

And as we talked about Earth and Beyond is scheduled right at the end.

And as products kind of on the cusp, I put Earth and Beyond, as I?ve discussed.

A couple of the Need-for-Speed SKUs that are right on the cusp as well.

So by platform, we?ll end up with about six on PlayStation 2, five on XBox, five on GameCube, four on PC, one on Game Boy Advanced.

So just a great lineup, great reviews and great enthusiasm right now by consumers in terms of pre-orders and retailers as well.

Looking forward past the quarter, we have Harry Potter, the new one coming with the movie, that?s Chamber of Secrets coming out on seven different platforms.

Lord of the Rings on PlayStation 2, SimCity 4, The Sims on PlayStation 2, Bond - a new Bond product, Night Fire - on four different platforms.

Command and Conquer Generals on PC, and that?s all in addition to the rest of the great sports lineups.

So we?ve got just a tremendous lineup coming beyond the quarter.

So with that, I will conclude the formal remarks, turn it over to questions.

Operator, if you could please poll.

Thank you, sir.

Today?s question and answer session will be conducted electronically.

If you would like to ask a question, please press star one on your touch-tone keypad.

We will take as many questions as time permits and proceed in the order that you signal us.

Once again, that is star one if you would like to ask a question.

And our first question will come from Sound View Technology Groups, Sean Milney.

Please go ahead.

Quick question.

Stan, you gave some pretty detailed outlook in terms of market commentary and raised your software growth outlook.

Could you talk a little bit ? but then you gave pretty a wide spread on your XBox installed base expectations for the U.S.

Any thoughts there?

And are you changing any of your product release schedule based on those console installed base expectations?

The range on XBox, first of all, was consistent with what I?d said before, we just got kind of more ? today, we started off saying we thought they?d sell 3 to 5 million in the U.S. during the year, and so now we?re saying 2 to 4, because they?ve got some installed base and some sales already.

So it?s just hard, I don?t think, it?s hard to pin that down.

I think the real message there is that it?s going to be significantly higher than it was in the prior year and even than it is now.

So we?ve got a significant increase in the installed base and we expect by the end of the year, compared to what it is now, and compared to what it was at the beginning of the year.

Just a quick follow-up.

There?s been a lot of talk about Sega continuing to make a move in sports.

Can you talk a little about your advertising plans for Madden as we head into the fall?

Are you stepping up in terms of advertising support?

Any color on that would be great.

Sean, I can tell you that we?re going to advertise Madden extremely aggressively.

The launch of Madden is without question the biggest sports product launch in the history of the company.

We have really high expectations for the product.

It just received a 5-rating the in the official PlayStation magazine, which is the first time ever that a football game has gotten a 5-rating.

So it was rated higher than NFL2K3.

And we just sat and met with almost every major retailer in the country in the last few days at the IEMA conference, and I can tell you that the pre-booked orders on Madden are far, far, far exceeding what Sega is generating on NFL2K3.

So we think it?s setting up exactly the way we planned it.

We?ve got a really high quality product and we are going to very, very aggressively defend our number one position in that category.

We think we?re going to win big.

Moving on, we?ll take a question from Mike Wallace, with UBS Warburg.

I have a question about, everyone?s kind of looking for holes in the market and what?s going on.

Is the economy having any impact so far?

I know we?ve had a nice fight from the hardware price cuts.

Are you worried at all, are retailers saying anything about the overall economy and maybe on the margin affecting the business, or are you just not seeing any of that?

The retailers that we spoke with in the last few days are really bullish about this category, much more so than just about any other category in their stores.

If you look back historically during some other challenging economic times, the late 1970s, early 1980s and the early 1990s, those were boom periods for this industry.

And we?ve had this discussion before.

In tough economic times, people tend to spend more money on home entertainment, and that?s right up our alley.

And I?m sure you recall that last year, same time, and all the way through the fall, we were getting the questions about the economy, recession and all that.

We were given the same answers, and as we got through the holiday season, it was like, you know, recession?

What recession?

Sims Online, when does that go into beta, and have you thought about or announced any pricing structure yet?

The answer is on the pricing first of all, that there has been no official announcement.

There was some discussion in the last call about what the thinking was going to be, so just the product will go out at retail as a patch goods product.

Don?t know what the price will be yet, but it will be either $39.99 or $49.99.

It will include a free month?s worth of subscription in that.

The subscription price is also going to be tiered.

This was also discussed in the last call, but it?s still not finalized.

But the tiers relate to how much you sign up for or pay for up front.

So there will be an ability, if you?re month to month, it?s one price.

For example, it may be $12.99 at a one-month pay-as-you-go, going down to $10.99 and $9.99 if you?re prepaying for, say, six months.

So that?s the thinking.

It?s not firmed up yet.

To be more specific on the beta date, we?re looking for a beta approval date in the month of September, and we?re tracking toward that at this point.

Okay.

Medal of Honor being so successful in PS 2, are you doing any other platforms for that?

Yes, as you know, it?s already available on the PC.

We?re scheduled to ship both an XBox version and a Nintendo GameCube version in our Q3.

We?ll take our next question from Heath Perry with Credit Suisse First Boston.

Great.

Can you, Stan, just to make sure that I got it right, the 60 percent growth that?s expected in Q2, that?s a revenue number?

Yes.

Motor City Online, can you talk about what subscribers look like there and kind of what expectations for that are going forward?

Yes.

The subscriber base of that is modest, but it?s been holding.

It?s running between 25,000 and 30,000 and has been since shipment or shortly thereafter.

In terms of maintaining the product, it?s fairly low cost to maintain it.

So believe it or not, those 25,000 to 30,000 are pretty close to break-even.

There are no plans right now to try to ramp that up.

We think that it?s a relatively niche kind of a product.

But for now, we?re continuing to maintain it and we may try to get it up over the hump so it?s actually making money.

Got you.

Larry, given all the time that you?ve just spent with all your retail partners, were there any surprises, positive or negative, or things that came out of those meetings that maybe you weren?t expecting?

The feedback that we heard about Madden relative to NFL2K3 was a surprise to me.

The ratios in terms of how large the pre-book on Madden is relative to Sega?s product, the size of that ratio startled me, actually.

The other thing that we heard, which is really good news, is that NCAA Football is off to a tremendous start, and in the first week is achieving sales similar to what Medal of Honor did in the first week.

So that?s really encouraging and a little surprising as well.

Didn?t hear any negative surprises.

We?ll now take a question from [Arvind Bakia] with Southwest Securities.

[Arvind Bakia]: Good afternoon.

A couple of questions.

First, I?m wondering if you can talk about what is the catalog as a percentage of total sales this quarter.

And second question is, you talked about software pricing holding up, can you talk about what are your assumptions particularly for the December quarter in terms of software pricing?

I?ll take the one on the software pricing, and we?ve been pretty consistent about this.

We believe that our front line new releases can hold a $50 price point.

So for all the key titles that we have scheduled between now and the end of the year, the suggested retail price is going to be $50.

And as Stan said in his comments, if you take a look at the best selling products in the industry, right now, they?re all at that $50 price point.

So looking at the June [Tryst], for instance, because I think nine out of the top ten PlayStation 2 titles are at a $50 price point, the only one that?s not is Grand Tourismo, which is at a budget price of $20 or $25.

So the market right now is holding that $50 price point.

We fully expect that to carry through into the September quarter, the December quarter.

Our plan is to stay with that $50 price point on all the key new releases that we bring to market.

And my expectation is that you will see similar behavior from most of the third party publishers as well.

[Arvind Bakia]: Hypothetically, let?s say the market does go down.

Are you then implying that that will have some impact on your projections?

We don?t see the market going down in pricing.

[Arvind Bakia]: Okay.

And last question, in terms of the guidance with this upside from consensus, looks like about 13 cents, and EPS consensus right now I think is about $1.79.

Fair to assume that your guidance is going up by at least that much for this year?

Yes.

More.

U.S.

Bank Corp.

Piper Jaffrey, Tony [Gikus] has a question.

Couple of questions.

Just housekeeping.

Stan, I think you said on the call, EA.com break-even in Q4.

Did you mean calendar Q4?

No, fiscal Q4.

Fiscal Q4.

Is that a change from your previous ?

No, that?s exactly what we said last time.

Okay.

And a couple of other housekeeping.

The strong gross margin in the quarter obviously some product that drove that.

Is there anything else going on, are manufacturing costs perhaps more attractive than we thought?

Secondly, research and development was a little higher in the quarter.

Should we expect that trend to continue?

And then the last question, the cash position is getting to be pretty significant, and projecting it to grow to well over a billion dollars by the end of the year.

Any ideas on what you?re going to use that cash for?

Is there any stock buy-back or potential dividends the company could announce?

Okay, well, starting off with the gross margin percent, no, the primary factor that?s driving that increase in gross profit margin was the high margins on the hot products that we?ve had this quarter.

So if you take Medal of Honor and The Sims, if I look at the two, The Sims family of products, they accounted for a big increase over our plan, or delta from our plan.

And those products combined have a margin of about in the high 70s to 80 percent.

So that alone, that overage is what increased our gross profit percentage.

We finished with a higher gross profit percentage than we expected to because of that, the strong performance of those products.

Manufacturing costs are stable and consistent with expectations.

They haven?t changed.

Cash position, you know, it?s the same answer we?ve given before, is that we look at the cash as being a strategic asset and it is something that is available to use for strategic reasons.

Whether that means making an acquisition that makes sense for us, it could be stock buy-back, although we?re not contemplating that.

But it?s really looking for opportunities, or when opportunities come up, it enables us to take advantage of them.

So we?ll continue to do as we have on the acquisition side, and that is, we look at things and if they make strategic sense for us and make financial sense and we check all the boxes that we normally look for, we?ll do it.

And no current plans for a dividend

R&D in the quarter?

R&D was up a little bit.

It?s going to be up for the year, and as I said before, I think that when we look at the year, it?s going to be mid to high teens up.

I think that will be the case for the year.

One of the, of course, benefits that we have when we have the greater leverage that we?re getting from a very strong market and very strong performance of our products, particularly the high margin, it enables us to make additional investments in product that will help drive our future growth.

So we?re continually looking at those opportunities as well.

So it may be that we decide to do some of those this year, which could drive those costs a little bit higher.

We?ll move on to Jill [Krutik] with Salomon Smith Barney.

I was curious if you?d give us a sense of what share of titles you anticipate at the premium price level in the second quarter, and heading into the holiday period?

Thank you.

As I look at the list that Stan went through during his opening remarks, I think every one of our Q2 releases, every significant Q2 release, is at the premium price point.

We have the same expectation for Q3.

And Deutsch Bank Securities, [Getille Batelle] has a question.

[Getille Batelle]: Congratulations, guys, great quarter.

Had a couple of questions.

First of all, you saw that a four to one leverage in terms of revenues versus op ex in the quarter.

What do you think is achievable as you look out here in fiscal 2003?

Do you think those same levels of operating leverage is available, or do you think it will be something like two to one or so in terms of ratio?

Secondly, did you guys have any sort of benefit from the Euro in the quarter also?

And then I have one follow-up.

In terms of operating leverage, I can?t speak to the ratio without sitting down and analyzing it.

But I think to the extent that we?re increasing the top line growth for the year, you?ll see, you?re not going to see our operating expenses grow faster.

Although notwithstanding what I said in the previous question, where we may make a few additional investments in R&D, but overall, our operating expenses are not going to grow anywhere near where our total expenses grow.

So we will have some leverage going forward.

I just quantify it by quarter.

But I doubt if it?s going to be four to one, because we obviously had a spectacular quarter.

In the short term, when you have a very strong hit product that?s a high margin, your expenses aren?t going to change.

So you get a tremendous amount of leverage there.

The Euro, yes, there was some benefit in the quarter in Europe.

And I believe that number was about 7 percent or so.

[Getille Batelle]: And looking at NCAA Football, it obviously has gotten off to a strong start here.

Obviously it seems like it?s doing much better here on the PS 2, this generation versus PlayStation 1.

What do you think it does over the long haul?

Do you think it becomes a Madden-like franchise in terms of unit potential?

And secondly, what type of gamer does that address?

Is it a similar demographic as the Madden demographic, or is it a completely different market altogether?

I think it?s a similar demographic.

It?s clearly not as broad a demographic, because we don?t sell as many units.

But you?re right, last year it was a really positive surprise for us, it exceeded expectations.

And it looks like it?s going to once again exceed expectations and probably exceed what we have in our internal plan.

So it?s becoming a more important franchise.

I can?t imagine it ever getting to the status of a Madden in terms of number of units sold in a particular year.

But it?s becoming increasingly important, and it?s a reflection of the effort and focus that?s been made by the Tiberon team, which is the same team that builds Madden.

They?re just spending more time and they have higher quality resources against the NCAA product.

The quality reflects it and the sell-through reflects it.

Edward Williams with Gerard, [Clauer] and Madison has our next question.

Good afternoon, just a couple of questions.

Stan, could you comment, when we look at your revenues over the course of this fiscal year, what we should expect coming from EA Sports as a percentage of total revs?

Historically, sports have accounted for 45 to 50 percent of our revenues.

I don?t expect a big change this year.

I haven?t really looked at it as we?re increasing the total numbers for the year to see if that changes at all, because we clearly have things like Medal of Honor that are going to contribute more than we originally expected it to.

And probably The Sims as well.

So I think it?s going to be up in that range.

Larry talked about the performance, the early performance of NCAA Football, the very strong at least reaction to Madden.

So I don?t have any basis right now for changing our historical pattern.

If I sit down and walk through and try to analyze the numbers, there may be some slight change.

But I think it?s going to be somewhere in that ballpark.

And what about if we looked at owned intellectual property, where has that been, and given the success of The Sims and Medal of Honor, where could that be?

Also don?t have that breakdown in front of me.

But the other part of this is, we have great growth, not only there, but we?ve had significant growth in licensed properties as well.

So two of our strongest performing products last year were, in fact, our strongest performing product was a license, being Harry Potter, and then Bond on multiple platforms is very strong selling.

Then coming up, both of those will be repeated with new products this coming year, and then we?ve got products like Lord of the Rings, although not on as many platforms, coming out of the box.

So I think in general, if I look at the margin projections that we?re looking right now, that we?ve probably got an edge growing towards slightly more on the intellectual property ownership side, because that?s driving the margins.

But I haven?t sat down with our new numbers and tried to analyze that yet, either.

I can take a look at that.

Yes, we will definitely move the needle towards wholly owned intellectual properties this year.

We talked about the success of Medal of Honor, we?ve got two more versions of that coming.

We have The Sims online, we have another Sims data disk in Q2.

And there?s a really highly anticipated Command and Conquer Generals product in the early part of Q4.

So all of those wholly owned, Medal of Honor doing better than expected.

So a higher percentage of sales will be generated by wholly owned intellectual property.

And offline, we can figure it out and give you specific numbers.

Okay, thanks.

And then another question is, what?s the total number of SKUs that you have in development now, and the total number of teams that you have internally?

I would say the number of products in development is probably something like 70 or 80 SKUs, in that range.

It may be higher than that, only because if you look at what?s left to come this year, plus next year, see a lot of our products for next year are under development.

It?s probably a little bit higher than that in terms of just being under development now.

Some of them are almost done.

And some are just getting started.

My guess, we can also go back and look that up, but my guess would be that it would probably be slightly higher than that.

And in terms of specific number of teams, I don?t know the answer to that.

But about 70 percent of our products are going to be done by internal resources.

We will now hear from David Farina with William Blair.

Good afternoon.

Just to kind of change the subject here, all the talk about options and dilutions and just receiving your interim report the other day, your dilution, according to [SFAS] 123 is fairly significant.

As that policy changes and we have to report options on the P&L, what are you guys going to do differently?

What?s your policy going forward on options?

We don?t know.

Obviously we are looking at this with great interest.

Until we see what the requirements are, assuming that it gets passed, whether through legislation or accounting standards changes, we?ll wait and see.

There is no determination that I know of in all these discussions about what the methodology of computing options expense are.

We don?t know at this point if it is enacted, when it will be enacted.

So I think we just have to wait and see and evaluate the situation when something happens.

It will undoubtedly affect some of the things that we do or the way we do it or the way we calculate it.

But I think at this point in time it?s just speculation, so we don?t have a specific plan to talk about.

But in terms of the way that we run the day to day business, regardless of how we have to treat the accounting on options, we?re going to continue to run the company the way we?ve always run the company, and that?s to build great products and do a great job of distributing them and marketing them on a worldwide basis.

We?ll now move to Jeff [Belenski] with Baer Stearns.

A few questions.

On the affiliate label business, can you give us a little more guidance on that business for modeling purposes?

Could this quarter?s level be a good run rate proxy for the year?

As we look at affiliate label business, it?s going to come in for the year at around, probably in the range of 12 to 14 percent of our business, of the core business.

That is probably slightly below.

Historically it?s been 15, 16, 17 percent.

That?s primarily because of very strong growth in the core business.

We think that the business, the affiliate label business, will grow nicely during the year, you know, 20 to 30 percent.

But in general, overall, some of the other elements are growing faster.

So in terms of margin, that?s kind of the percentage of revenues.

In terms of margins, the margins have been creeping up.

I?ve been talking about this for the last several quarters.

And it?s been primarily because we?ve moved more of that line to what is more of a co-publishing kind of line.

Historically, affiliated label business has been strictly distribution with distribution margins only.

Those tended to run in the 15 to 20 percent range, gross profit margins.

More and more of our products here are what we?re calling co-publishing, where there may be, where we actually do the publishing, rather than just the distribution.

In some cases, we may make some advances as well for those for the product, like taking the product when it?s finished and actually paying for development.

At that point in time, when the gold master is completed, things like that.

So what that does is increase the average margin by about five points, if I look at it this year compared to last year.

And it was a similar number last quarter.

So for modeling purposes, on the average, rather than 15 to 20 percent, we?re really moving more towards and average of 20 to 25 percent.

Okay, one more question.

On The Sims online, could you quantify the initial demand for this product, or how are you going to I guess deal with overwhelming demand as you ship into retail?

Is retail taking pre-orders for the disk?

Well, first of all, this is early for pre-orders, because we?re talking about shipping this thing in the December quarter, kind of mid-quarter.

So we wouldn?t be typically taking pre-orders at this point anyway.

In terms of, I don?t think we?ve given out or we?re certainly not prepared to say what the number is yet.

Because we?re still planning what that?s going to be, both from a demand side, which we think as you said will be very, very strong, but also taking into consideration the load on the service, if we ship too many at once and have too many people trying to sign on at once.

So we?re working through a lot of those issues right now.

So I don?t have a number to give.

But it?s not going to be, when I say if we phase it a little bit, it?s not going to mean phasing it over six months, it?s going to be phasing it over a month or two, of what would otherwise be an initial ship.

What we did talk about on a previous call was the number of subscribers that we expect to have by the end of the fiscal year, and that?s sort of in the range of 350,000 to 400,000 subscribers.

And did you say that the packaged good product revenue will be booked at EA.com, as opposed to the core?

Yes, it is.

That?s because it is an online product only.

And basically, what it is, it includes a free month of subscription and it?s just a means for us to get the disk in people?s hands.

So it?s purely a dot-com product, it?s not playable as a single, standalone product.

We treated Ultima like that, we treated all the products that ship as a standalone product, I mean, as an online only product.

One more question on pricing in terms of keeping the $49.99 price point out there, will you compete on price in football, if your competition goes out at a lower price?

We don?t expect that to happen.

All indications are that Sega will price their football product at $50 or around $50, $49.95.

So we don?t expect them to break price.

And I don?t expect Microsoft to break price either, on the XBox platform.

So the answer is, we think that all of the new releases in that category are going to be $49.95.

We?ll take a question from John Taylor with Arcadia Investments.

Hi, good job and congrats on the S&P 500, too.

I?ve got a couple of questions.

Larry, could you talk a little bit about what the average ad spending is likely to look like behind the big properties you?ve got going in the December quarter, and how that compares to what you spent kind of on average last year?

I don?t know if I can give you an average per title, because it?s different on each product, depending on the competition we expect and the revenues we think we can generate.

I will tell you that in general, we?re going to spend more this year than we spent last year, and probably more, you know, if you look at Madden versus Madden or NBA versus NBA, we?re going to spend more this year than we spent last year.

It?s just going to be dependent upon how competitive the environment is.

Last year, we didn?t have all that much competition in the football category or the basketball category, at least when we shipped our products.

That?s going to be different this year.

We fully understand that.

We?re going to spend more aggressively.

Maybe what I?m getting at is, you?ve got a bigger number of movie related properties going this year than you?ve ever had in a limited time frame.

How has that impacted the average spending?

Well, again, it?s going to be up.

Although last year we had a Potter product and we had a Bond product.

And the one addition this year is Lord of the Rings, so instead of two, we have three.

So if you take a look at how much we?re going to spend against movie licenses, it?s a bigger number.

And it?s probably, I don?t want to give you a percentage, because I don?t have it in front of me, I just know that it?s a bigger number.

Okay.

Can you give us an update on what the cumulative sales of Harry Potter is at this point?

We can probably dig up the number for you, I know it?s north of 10 million at this point.

If you give us a few seconds, we can probably figure that out.

It?s in that range.

Okay.

And then talking about gross margin a little bit, this year you?re benefiting from the huge impact of proprietary properties.

And it looks like average selling prices are going to hold pretty stable.

Next year, I?m sure we?re all going to be asking whether they?re going to hold stable and whether there?s going to be some margin erosion on that front.

I?m wondering, do you have something in your back pocket that is a gross margin stabilizer next year that might reverse either a smaller percentage of proprietary IP or average selling price erosion?

I don?t think there are any tricks here, but there?s the one thing that will continue to increase I think over time will be this average AL margin for one thing.

Because now more and more, the things we?re doing are in the co-pub category.

And as we move, what we?re trying to do, as we said earlier, is to move more and more towards owned intellectual property, which has a higher margin in it.

So there?s a lot of focus on that, yes, we do have a few high visibility movie licenses.

But our focus, and I said this earlier in my remarks, was, overall we?re just driving to identify and develop and cultivate new wholly owned intellectual property.

So that?s the direction we?re going, and over time, that will cause margins to be higher.

The other thing where we might get a little bit of a pickup is in the cost of goods, as we get further into the volume rebate program with Sony.

If we can take good advantage of that and get some leverage out of that, we might be able to bring the manufacturing costs down a little bit.

And of course, if online kicks in the way we hope it does, then that will be a benefit as well, when you mix it all in.

Sure.

PlayStation as a platform, I think the $49 price point took everybody by surprise.

I realize that your Q1 revenues were boosted by World Cup.

But have your expectations for the relative strength of the PlayStation 1 business changed at all?

Are you any more confident in a lower erosion rate there than you might have been before?

I?m kind of surprised at how well PlayStation 1 has done calendar year to date.

And we?ve got a limited line of products for PlayStation 1 and perhaps they will exceed our internal expectations in forecast.

But I think it?s pretty encouraging to see how much hardware they?ve continued to sell and how relatively small the drop-off has been on the software side.

So I think that?s actually good news.

We have some of our key titles on that platform, the Maddens and [Fifas] and Potter and NBA.

So maybe we can get some mileage out of that than we had originally expected.

Just quantifying that just for a second, the PlayStation, according to [Tryst] software dollars were off 35 percent year-to-date, and we?ve been talking about 65, 70 percent, is what we expected.

Have we got time for one more question?

Thank you, and that last question will come from Goldman Sachs, Chris [Debiasi].

Please go ahead.

I was wondering, given the bullish comments from some of the retailers, seeing if they?re doing anything different as far as allocating more shelf space, either to the game sector or you guys, or are they increasing their marketing dollars, given their bullishness?

I think they?re trying to squeeze some extra space in their stores for this category.

I think that trend started last year when XBox and Nintendo GameCube launched.

This is the first time they?ve had three viable systems competing in the category.

So the process started last year, they started to expand space, and this is one of the best performing categories in their stores.

So I think they?re going to look for ways to expand the assortment and devote a little more space to this category as we get into this holiday season.

That?s what we?re hearing from them and I fully expect them to carry through on those plans.

Great, thanks.

That concludes the call.

We?ve run over a little bit, but we started late.

So we know there are some follow-on questions that people have.

And we will be taking those kind of in order here, and please bear with us, we?ll get to all of you.

Thanks very much for joining us on the call.

We will be signing off and talking to some of you later on.

Thanks very much.

And once again thank you everyone for joining us today, that does conclude today?s presentation.