美商藝電 (EA) 2003 Q2 法說會逐字稿

Good day everyone, and welcome to the Electronic Arts second quarter and 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 Director of Investor relation Ms. Karen Sansot.

Please go ahead ma'm.

Hello!

Thank you for joining us on our second quarter fiscal 2003 earnings conference call.

Today in the call we have Larry Probst, Chairman and Chief Executive Officer, John Riccitiello, President and Chief Operating Officer, and Warren Jenson, Chief Financial and Administrative Officer.

Before we begin, I'll remind you of the Safe Harbor statement.

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

We wish to caution you that these statements are only predictions made as of October 24th 2002, and that actual events or results may differ materially.

We refer to your form 10-K for the period ended March 31st, 2002 and our form 10-Q for the period ended June 30th, 2002 on file with the SEC and our earnings press release of today for 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 October 24th, 2002, and disclaim any duty to update them.

And now I would like to turn the call over to Warren Jenson.

Great.

Thanks Karen and thanks everyone for joining us today.

It is a real pleasure for me to be with you.

Before jumping into a detailed explanation of our income statement and balance sheet, I would like to share with you a few highlights for the quarter.

First of all, this was a record quarter for our company.

Revenues reached $453 million, up 89%.

Trailing fourth quarter revenues exceeded $2 billion for the first time in the companies' history.

Our operating margin was 15.7% versus a loss last year.

An operating cash flow on a trailing four-quarter basis exceeded $450 million.

Secondly, the quality of our product has never been better.

Madden and NCAA Football both received reviews of 5/5 from Gamepro, and they were the number one and number two PS2 titles in North America for the quarter.

Medal of Honor Frontline had a rating of 5/5 from Gamepro, and was the number 6 PS2 gain in North America and number 1 in Europe.

NASCAR Thunder, was rated 4.5/5 from Gamepro.

Third, EA Sports continues to be the strong leader.

Madden 2003 sold almost 3 million units in the quarter, 16% more than the previous September quarter and was the number 1 selling sports game.

NCAA Football was the second highest selling sports game and sold over 1 million units, a 170% more than last year.

Combined, Madden and NCAA had 80% of the football market, and while not in Q2, we believe that NBA LIVE is presently outselling our nearest competition by a factor of 2.5-1 on the PS2.

And then finally, the holiday season ahead of us promises to be our biggest yet.

We are launching 35-40 SKUs in the quarter including several strong EA Sports titles.

FIFA Soccer, NBA LIVE, and NHL.

Also on top of that, our movie [inaudible] is launching alongside the biggest holiday movies of the season.

James Bond Night Fire, The Lord of the Rings, The Two Towers, which by the way is off to a great start this week, and third Harry Potter and the Chamber Of Secrets for the first time on next-gen platform.

All in all, a great quarter with more on the way in the months ahead.

The next few minutes, I would like to discuss the second quarter in detail.

In principally I will focus my remarks in three areas.

First, I will talk about the income statement, second the balance sheet, and then third our guidance.

Following my remarks, Larry will spend a few minutes on our industry outlook.

Then Larry, John, and I will open it up to your questions.

On to the income statement and revenue.

Consolidated revenue for the quarter, were a record 453 million, up $213 million or 89% year-over-year.

North American revenue was up 85%, while Europe had an incredibly strong quarter.

Revenue reached a $117 million, up a 119%.

Now a look at the core business.

Core revenue increased 93% to $435 million.

On the title basis, core revenue was driven by Madden 2003, as I said shipped having shipped almost 3 million units, NCAA 2003 having shipped over a million units, The Sims along with Medal of Honor, NASCAR 2003, Kingdom Hearts, and Battlefield 1942 were also strong performers.

In Europe, Medal of Honor Frontline was the number one selling game on the PS2.

If you look at the platforms, the increase in core revenue was driven by our performance on both PlayStation 2 and the PC.

The PlayStation 2, on PS2 we were the number one North American publisher with four of the top six titles, Madden, NCAA Football, Kingdom Hearts, Medal of Honor Frontline.

Globally PS2 revenues reached a $159 million, up 73% year-over-year.

PS2 revenues represented approximately 35% of total revenue.

On the PC, PC revenues reached 83 million in the quarter, up 53% year-over-year.

In North America, EA published five of the top ten selling PC games, those included The Sims, Sims Unleashed, Sims Vacation, Battlefield 1942, and Medal of Honor.

In Europe, EA won five of the top PC titles for July and August.

Those included The Sims, The Sims Hot Date, Sims on Holiday, Medal of Honor, and FIFA World Cup.

Looking at the other platforms GameCube and Xbox, sales from these platforms together represented roughly 14% of total revenue in the quarter.

Revenue from the affiliated label products reached $96 million, up over a 142% driven by the strength of Kingdom Hearts and Battlefield 1942.

Now looking at EA.com, EA.com revenue increased 23% to $19 million.

Ad revenue was $8.6 million, up 22% year-over-year.

Sequentially ad revenue dropped 17% given a difficult advertising environment.

Sub.-revenue was $7.6 million up 6% year-over-year.

Now back to the consolidated results and gross profit.

Gross profit in the quarter was $255 million up a 108%.

Our consolidated gross margin increased to 56% versus 51% in the quarter a year ago.

Our margin improvement was driven by -- our margin improvement was driven by product mix as a higher percentage of our revenue was from next generation products relative to last year.

Also a higher percentage was from new releases on the PC versus catalogue sales on the PC.

Secondly, higher margin was driven by lower -- lower royalty rates, as we had a higher mix with EA on intellectual properties led by The Sims and Battle of Honor.

Third, we had an increased mix of higher margin co-publishing products, and finally lower console royalty rates due to higher volumes.

In total, operating income for the quarter was $71 million, an improvement of a $123 million versus a loss of $52 million a year ago.

Our operating margin for the quarter was 15.7%.

This improvement was as a result of our being able to leverage virtually every line on our income statement.

While gross profit was up a 108%, total operating expenses increased only 5%.

At the same time, we invested in marketing and advertising for both Madden and NCAA Football, which drove significant volumes.

Net income was $50 million versus a loss of $33 million.

Diluted earnings per share were 34 cents versus a loss of 24 cents per share a year ago.

On a trailing 12-month basis, our net income was 237 million, and as I mentioned on the same 12-month trailing basis our operating cash flow was $455 million.

Now, we'll look at the balance sheet.

Cash short-term investments and marketable were $927 million at quarter end.

Our gross accounts receivable balance was $265 million.

Reserves against this balance were $125 million or 47% of growth.

While in the prior September quarter, our AR balances or reserves were $69 million or 40% of gross receivable.

Ending inventory was $37 million versus 24 million at June 30.

This increase as you might expect, was driven by a buildup in inventory in anticipation of the October releases, a both need for speed NHL and also NBA Live.

Inventory results were buildup in advance of the holidays for certain key titles to avoid holiday production bottleneck.

Our inventory days were 16.

Other current assets, which include both prepaid royalties to the console manufactures and develop our advances increased to a 159 million versus a 118 million at June 30.

The increase is the result of our inventory build and also development advances associated with holiday titles.

Now, I would like to turn to our guidance and first to our third quarter fiscal '03 guidance.

Please remember that the following guidance is our best thinking asset today, but there are obviously plenty of unknowns and several things that could happen, which could cause our actual results to be materially different.

That said, for our fiscal third quarter, we expect to shift between 35-40 SKU's.

We expect consoldative revenue to be between 1.075 billion and 1.175 billion, an increase of roughly 30-40% over the prior year.

Consolidated EPS on a GAAP basis to be between a $1.52 and a $1.60, an increase of 65-74% year-over-year.

We expect pro forma consolidated EPS to be in the range of a $1.52-1.60, an increase of roughly 48-55% year-over-year.

In the third quarter, we expect to shift the following SKU's.

First, Harry Potter and the Chamber of Secrets on seven platforms.

PS2, GameCube, Xbox, PSX, the PC, Game Boy Advance, and the Game Boy Color.

Please remember that last year, Harry Potter sold 9.5 million units on four platforms.

This year it's our on next-gen consoles for the first time.

Lord of the Rings the Two Towers on PS2.

Again just shipped this week and off to great start, and the Game Boy Advanced, we plan to ship in November, this is obviously a brand new title for us.

Bond, Night Fire on PS2, GameCube, Xbox and the PC.

Medal of Honor Frontline on GameCube and Xbox, Medal of Honor Team Assault-Expansion pack on the PC.

FIFA Soccer on PS2, GameCube, Xbox, PS1, and the PC.

Tiger Woods on PS2, GameCube, Xbox, and PC.

We are also targeting the Sims Online to launch in early December.

Already shipped in the quarter include the Need for Speed, Hot Pursuit-2 on PS2, GameCube, Xbox and PC.

NBA Live on PS2, GameCube, Xbox, PS1 and the PC version will ship in November.

NHL on the PlayStation-2, GameCube, Xbox and PC, Knock Out Kings on Nintendo GameCube and SSX Tricky on GameBoy Advance.

Now, I would like to turn to our full year fiscal '03 guidance.

Before jumping specifically into the numbers, I would like to offer two top level highlights: First as a consequence of the Sims Online shipping a few weeks later in the quarter, we do not expect that EA.com will reach breakeven in the fourth quarter.

That said for the full year we are raising our consolidated revenue in EPS guidance for the year.

Again for the year we are raising our consolidated revenue in EPS guidance.

As I just mentioned we have raised consolidated revenue in EPS guidance for the third quarter and today, we are confirming Q4 consensus estimate of 437 million of consolidated revenue and pro forma EPS of 31 cents for the fourth quarter.

Now to the details of our full year fiscal 2003 guidance, we expect for the year to ship between 70-80 SKUs.

For EA in total or on a consolidated basis for the year we expect to consolidated revenues to be between 2.3 and 2.4 billion, an increase of 33-39% over the prior year.

We expect consolidated GAAP EPS to be between $2.24 and $2.32 an increase of 215-227% year-over-year.

We expect consolidated pro forma EPS to be within the same range of $2.24 and $2.32.

For the core business we expect core revenue to be between 2.2 and 2.3 billion an increase of 34-40% year-over-year.

For EA.com, we expect full year revenues to be approximately a 100 million.

And as a result of this Sims Online shipping later in the quarter than we had originally expected, we expect full year of Pro forma losses for EA.com to be roughly 50 million.

In summary on a consolidated basis, raising guidance for Q3, confirming consensus for Q4, and we're raising the full year numbers.

Before I summarize my portion of the call today, I'd like to take a moment and just say a couple of things.

First of all, I want to say thanks to Stan Mackee.

I'm very fortunate to have inherited a wonderful and a terrific finance organization.

Stan has left EA with a solid balance sheet and I know from a lot of people around here Stan's contribution will certainly be missed.

But just let me say from my standpoint, thanks to Stan.

Secondly, over the past few months, I'd had the chance to really tour many of our operations around the world, and I'd to thank every one in the organization and the finance organization for their help and support over the past couple of months.

I felt very welcome and you have made me feel very welcome.

Now in summary for the call, this was a record quarter for EA.

The quality of our products, the strength of our publishing organization has never been better.

And finally, we are looking forward to a terrific holiday season.

Now, I'd like to pass the call to Larry, who will cover our market outlook.

Larry.

Thank you Warren.

I'd like to do a couple of things.

I'd like to review where we are in both the hardware and software market year-to-date and I'm going to focus my remarks on the North American market with a little bit of information about Europe as well.

Also, talk about how we see the year finishing between now and December 31st and then provide a preliminary look at how we think the market will evolve and grow in calendar year '03.

So, to begin and this is a twist information reported through the end of the month of September PlayStation 2 has sold just under 4 million units year-to-date 3.95 million, that's up 31% over the same period last year, XBox has sold 1.44 million units Nintendo GameCube 1.09 and amazingly the PlayStation 1 has sold 1.32 million units, which is actually a 1% increase over last years numbers in the 7th year of that platform being in the market, truly remarkable.

On to the balance of the year forecast for the year, the calendar year in North America, we believe PlayStation 2 will sell between 8.0 and 8.5 million units, taking their installed base at the end of the year to 15.3-15.8 million.

Xbox we think will sell between 2.8-3 million units for the year taking their install base to between 4.2-4.4 million.

Nintendo GameCube we think we will sell 2.5-2.8 million units during the year resulting in an install base between 3.7-4.0 million.

And PlayStation 1 should sell about 2.5 million units taking the install base over 30 million in North America.

Now the outlook for calendar year '03, again this is preliminary, we are very early in the planning process and we will be refining these numbers as we go forward.

And again this is not company guidance this is industry information.

PlayStation 2 we expect it will sell between 9.0-10.0 million units next year.

Both Xbox and Nintendo GameCube were ranging around between 2.5-3 million units; those units could higher depending upon how aggressive they are and the timing of price cuts but with timing of cuts in calendar year '03.

Now on to the software side of the business, PlayStation 2, and again this is year-to-date report by Tryst resultant of some PC data information here, year-to-date through September and these are retail dollars, Play station 2 has sold $1.244 billion that's a 115% increase over the same period last year, Xbox is just under $4 million at $397.5, there is no comp. there since they didn't ship till later in the year last year.

Nintendo GameCube had a $284 million sold through again no comp from the previous year.

PlayStation 1 is at $402.7 million sold through September down only 36% business is about $870 million sold through, that's increase of about 2% over the same timeframe last year.

So for the year, we expect the market to be strong over the next 70 days as we get to and through the holiday season.

To date the PlayStation 2 business is about $2.5 billion sell-through business, which would represent 82% growth year-on-year, with the Xbox business is about $800 million that represents 250% growth but again that's against a much shorter period through the introductory launch period last year.

Nintendo GameCube we think is between $575-600 million for the year, which represents about a 300% increase again versus a stub year last year.

PlayStation 1 we think will be 600 million about a 40% decline year-over-year, and the PC business we think it will be at about 1.45 billion, which represents about an 8% increase year-over-year.

Now looking forward into the calendar year '03 and again I want to reiterate away this is not company guidance.

We'll do that in a subsequent conference call but we think the Play station 2 business can grow 25-30% next year in North America.

We think both the Xbox and Nintendo GameCube businesses can grow 20-25% in North America.

We think those numbers can be higher in Europe, since Europe will be in year two of those cycles with both Nintendo GameCube and Xbox.

We think the PC business will grow 5-8% again next year and so we think these -- numbers are on a conservative end of range, we think they represent good growth for the industry in calendar year '03 and provide excellent opportunity for year to continue to drive top-line and bottom-line improving in our fiscal year '04 and we will be providing more specific company guidance and we are certainly looking at subsequent conference call.

With that, we'll open it up to the questions.

Thank you.

This question and answer session will be conducted electronically.

If you would like to ask a question you may do so by pressing "*" "1".

Again if you would like to ask a question you may do so by pressing "*1".

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

We will take our first question from Tony Gikas with US Banc Corp.

Please go ahead.

Hi guys, Congratulations on a great quarter.

Thank you.

Couple of questions.

Affiliated label sales in the quarter were up significantly.

What was the drivers there and then the PlayStation 2 having what looks like about 2/3 of the market share right now.

Any you know, change to your skew plan over the next year or two?

I'll take the second one first.

PlayStation 2 is clearly the market leader, we expect that trend to continue, that's going to be the key strategic platform for us obliviously through the balance of this fiscal year and as we set our skew plan for next year, that will continue to be the case, that will be our primary platform of focus and I would say that you can expect a skew plan that calls for 20-25 new titles on PlayStation 2 next year, similar to the number that we were planning on publishing this year.

In terms of the question on AL which, by the way we tend to call that co-publishing around here because we've -- we have lot more than just distribution in involved int these.

The key driver for the increase were two titles; one was Battlefield of 1942 which has sold extremely well on a worldwide basis and then Kingdom Hearts which is in partnership with our Square in North America which has done well in North America and I believe is no. 2 for us in the quarter in terms of platinum.

So, got a couple of winners on the top of the charts are doing well for us.

Just a two other real quick questions.

The PS 1 continues very strong and was relatively flat year-over-year.

How long you plan to stick with that platform and then the last question, can you give us a quick market share update on the U.K. and Europe?

With regards to PS 1, I think, we have 4 or 5 titles in this skew plan for this year.

I suspect that the number will decline and be closer to zero in our fiscal year '04 skew plan.

I am not ruling out the possibility that we might do 1 or 2 but it's going to be closer to zero that is to five.

In terms of European market shares, this is John again.

In the quarter, we reported on our PC our estimate is 17.7% for the second quarter '03, which is up 15.3 year ago.

Our market share in the PlayStation is 12.8 in the quarter up from 9.6 in the prior fiscal '02, Q2.

Our PSQ market share we estimate had 17.3 which is up from 12.5 in the -- it was a relatively fallow period a year ago.

Xbox's market share no comparison but a 9.4 in the quarter and GameCube a 12.5 in the quarter.

Our position on the PC and PS 2 were both no. 1 overall and we believe our position on the other platforms it was a number one third party.

So, I believe that was what you were asking for.

Yes, thanks.

Our next question comes from Margaret Blades with Salomon Smith Barney.

Hi and thanks.

On Sims Online, I was wondering if you could just describe the current models that your envisioning for that and realistically, how quickly you'll know if your hopes for that game on the online model are going to play out and secondly, I was curious if you would tell us when you think software sales for this cycle are going to peak?

Thanks.

This is John.

I'll take that, with Sims Online, and I'll let Larry hazard his way into the peak of a question.

We -- our business model for this at this point of time is an anticipated price of $49 of retail with a month free subscription included so it's essentially a $39 PC product with a month free included assuming a $10 monthly subscription.

That price was actually a little bit lower on the subscription and what is prevailing for similar products in the market place like Dark Age of Camelot, Everest Quest, and a few other where they are between $11-13 a month.

We brought an end to that price range because we believe that there is potential long-term for a mass market for a product that's popular as Sims's has been, in terms of playing that game online and giving the demographics to target audience.

You know, in terms of how this product's going to take, you know, that's why we're running a BETA and in fact that's why we pushed it back a few weeks relative to where it was before, to get further information on the BETA.

We want to hear what the consumer's got ot to say and get as much learning as we possibly can and mark the strongest points we possibly can.

You know, as a group we are bullish on it, we recognize it's risky, but we're bullish on it.

The experience is a wonderful one and if anything can break to the mass market for subscription, we think this game is the title.

With regards to when we think the software market peak is dependent upon multiple factors and if the key factor is when the hardware price point goes to $99.

Typically, the peak software year is one year later than the peak hardware year.

So we believe the peak hardware year will be when the price point first goes to $99 and the following year should be the peak software you have.

It is also impacted by when people think the next generation hardware will be launched into the market place and you can make the argument that might be 2005 and or it might be 2006.

So cutting to the chase.

I could make a very compelling argument that the peak software year is 2004.

I can make an equally compelling argument that it is 2005 and we just have to see how that plays out.

And we'll take our next question from Arvind Bhatia with Southwest Securities.

Good afternoon guys.

Great quarter.

Thanks.

There has been a lot of talk about the retail buying patterns having changed a little bit in the most recent times.

Obviously with such strong numbers you might not be seeing it but, are you seeing the gap between the haves and have nots continuing to increase a phenomenon that we've seen in the past?

Or you don't think there is a major shift in the retail buying patterns?

This is John and a first thought is I can remember exactly this question five years ago at this point in the cycle.

You know by and large what happens, as you start moving up in the cycle is, everybody gets optimistic about everything being ahead.

It turns out not to be the case and, you know, the winners and the losers start to fall in different directions.

I believe that's what's happening this year.

So yes there is a bigger gap.

It's driven by bigger marketing budget against bigger intellectual property reaching larger audiences.

The biggest titles are now household names where they were niche products five years ago.

They include things like Medal of Honor, Sims, Lord of the Rings, Harry Potter, and Bond.

You know that kind of a front-line didn't really exist for any company -- and anything five years ago.

So yet the big are getting bigger and the small are getting smaller.

I think the screams we hear in the background have also to do with the difficulty that we're having in a market place that's segregated as Larry mentioned before.

You know, very strongly towards the PlayStation 2.

So secondary titles on XBox and GameCube are having particular difficulty getting traction at retail.

So, and that's really a worldwide phenomenon.

So things are starting to separate as we anticipated into where the big are getting bigger.

We know who the big are and also there are a few other players up there doing really well, and these were the reasons I have outlined.

And then just how do you characterize the current state of affairs as far as GameCube and Xbox?

Install basis concern or in sale through and tie ratios and those kind of things.

Are you -- do you see right now that these two platforms have performed up to your expectations or within the range of expectations or you think there have been a, you know, disappointment or any comments?

I went through some pretty specific information with regard to sale through this year and our outlook for next year.

I would say that those two platforms are probably performing slightly below the expectations of Microsoft had for Xbox and Nintendo had for GameCube.

It's lining up fairly well with what our expectations were.

And going forward, it's going to be driven by the intellectual property that they will be exclusively available on those platforms.

So if Microsoft can start bringing first party products to the market, that sell hardware, their numbers will spike and the same thing applies to Nintendo.

So, it's going to be driven by exclusively available software products on those platforms and we will see who does a better job of executing against that objective.

One additional perspective on that is with the exception of Japan where GameCube has emerged as a legitimate number two and Xbox is in the third position, the rest of world largely splits where it's full of horserace between GameCube and XBox and that's one of the challenging things both the publishers and retailers had to figure out how to stock.

And so I think, its you know, somewhat what, you know, we're all hearing in the background is, the, we have a 1 and then a tie for second and that tied for second position is a challenging one to plan for.

And just as a reminder.

If you're saying that your question has been answered please press "#" to remove yourself from the queue.

And we will take the next question from Garry Cooper with Banc of America Securities.

Hi guys.

Couple of questions.

The NPD data are granted probably has its weaknesses, but it shows that Harry Potter sold roughly 3.4-3.5 million units and you guys have talked about shipping in or selling through 9.5 million worldwide.

Is this title really that big of a seller internationally and then how do you think it will sell relative, you know, on the three new councils relative to how the first the one sold.

And I've got a couple more.

Well, I'll take the how well did the sale outside of North America.

Sells extremely well outside of North America particularly well in Europe and also has done well in Japan.

And I'll take -- I cut the other part of you question and yes we have very high expectations for this years products.

The quality is extremely strong.

It's the first time it's available on the next generation platforms and we think that the products would do -- it would do very, very well on the PlayStation 2, GameCube, and XBox.

So, you know we are looking for a lot of success this year with Harry Potter as we achieved last year.

Just to build a little bit.

So the ratio is outright.

We did more business on Harry Potter outsides the US than we did in the US and in particular on the PC platform, which was just a stellar performer outside the US.

Our models for this year, in terms of the revenue we expect on Harry Potter, are based on actually, you know, as Larry said doing very well on the Next-Gen platforms, that are lower percent to install base penetration on X-box and PS 2 through the demographics on the platform.

The platforms in X-box and PS 2 platforms at this point in time is older than the typical demo for Harry Potter would be -- we sense to cut off in the 14-year age demographics.

But we've modeled on that and given the exposure to it much more platform issues.

We're sure we can grow that business.

Okay.

Can you remind us what happened in 1998 your world cup product sell-through versus the regular Holiday FIFA Soccer and how you expect that play out again this year?

Well, 1998, you're trying the lap world cup years, and so I believe that's what you're after, so I'll try and answer that.

You know, first of, in both instances at full price in Europe, we sold through over a million units -- that was actually the prior quarter.

The last time we put more inventory in the channel than we did this time and so in doing so, we left ourselves in a better position to deal with FIFA in the fall.

So last time we put about two or two and a quarter million units in the channel, I don't have number right in front of me, it was north of 2 and south of 2 and a quarter.

And we then had to price manage some of that at retail, because that was probably a third more than the channel was ready for, that was 98.

This time we put fewer channel -- fewer units in the channel and sold it through much better leaving very little on the shop.

Essentially, we learned from our first world cup experience and the revenues overall were up however due to a better management of that activity.

As we're leading into the fall, we've a different competitive set -- different competitive set-up than we had last time.

Last time we were bumping up really against ourselves.

There really wasn't strong competition out there to speak-up by comparison what we have [inaudible].

Kenami was out there.

But Kenami's product, really, wasn't a very sophisticated product back then.

This time we face competition from both Sony and Kenami.

Kenami makes an outstanding product.

Last year, they did better than we, actually hoped they might do, although we were able to meet our goals.

This time our shipping products that are rated near parity.

But, mind you, the Sega product and Madden products issue in North America were rated near parity.

They have very strong marketing campaign, a very strong product.

It's probably one of the most improved products in our portfolio and we have really high expectation for shipping in the clear channel, strong marketing, and a strong product.

That's the recipe EA Sports generates, you know, by and large very strong in up and down that if market positions with.

Okay and last question.

I believe you said on the last call that the Lord of the Rings product on the XBox and GameCube would be a fiscal year '03 product for you guys, and I see it's showing up with the December schedule to release on some websites.

Will those two games get into the Q3?

They will be in fiscal Q3, excuse me -- fiscal year '03.

Thank you.

And we will take our next question from Mike Wallace of UBS Warburg.

Hi guys, two questions.

First, Larry just following up on XBox and GameCube next year, outside the software, do you think there is anything that can do to kick-start sales?

Do you anticipate price cuts earlier rather than later in the year?

Do you see any first party software coming down the pipe from those guys that may help?

We don't have a lot of visibility on -- on first party software.

One title is out there that I think -- where I think Microsoft is going to have a little bit of an exclusive window is the matrix.

So we'll see how well that finishes.

But I think there is some, you know, there is anticipation out there with consumers.

I think they have got a window of opportunity.

I don't know how long that window of exclusivity lasts, but back that could drive hardware sales, I don't think either Nintendo or Microsoft would be price leaders with regard to price cut on hardware.

I think Sony will call that tune and you will see those -- the other two companies react to that and when Sony decides to take their next price cut, and how deeply they go, I think it's anybody's guess.

But I, you know, gun to my head, I would say the next price cut are probably going to be announced around these three.

Okay, and second question, as far as EA.com and the profitability, I think you said net income of around $50 million loss so it looks like Q4's loss is similar or slightly above the Q3, may be I think.

When do you see that getting the profits, are we looking at June, are we looking at September, what's the timetable?

I'd say Mike, your numbers are roughly right for EA.com.

You know, in the fourth quarter, I had put them, you know, pretty close to the third quarter numbers or so.

I think you can walk away with one thing, as one we are optimistic about this Sims online And so this has just now shifted back some, which has deferred our, you know, our growth in subscription revenue.

And two, we're equally as focussed on driving toward profitability.

We are not going to give guidance for '04 in this phone call, but what I can tell you is that we are all equally as committed as we have been in the past to getting this business to profitability quickly.

And we will take our next question from Shawn Milne with SoundView Technology Group.

Thank you and again congratulations on a good quarter.

Warren, if you look out into fiscal '04, I know you don't want to give specific guidance, Larry talked a little bit about market growth, but if you look at the cost structure of the business; can you talk a little bit about your expectations or just colour on gross margins perhaps going forward, and may be a little bit more colour on R&D?

And I just have one follow up.

I'll give that, you know, answer to this, Shawn and then probably John can add, you know, further depth in terms of my answer.

I think this quarter that we just had, demonstrates several things.

I think the first thing is you see tremendous operating leverage.

So despite really a world-class campaign for NCAA and for Madden in terms of advertising and marketing, our operating expenses increased about 5% on a 108% increase in gross profit.

Yeah

I think that validates the strategy.

But you know that I had nothing to do with.

But the people around this table have executed very well relative to big titles doing, you know, big things in a great market.

So, you know, if I look ahead today from, you know, my relatively new advantage point, I think that, you know, our approach will be to continue to invest in our titles, continue to make the quality better, take advantage of the franchise strengths that we have.

But at the same time, be able to leverage our expense base just as we did in 2003.

You might see some movement in gross profit, but I'd look it for to be you know, roughly in the same sort of league as it was -- as it is today.

Yeah.

I would just add to that that that's going to be mix-driven and we need go through the line item forecasting process before we can get specific about that.

With regard to R&D, I suspect we will set a plan where our revenue growth exceeds the growth in the R&D area.

But we'll continue to be aggressive in terms of building our studio capability and new intellectual properties.

Having went through this drill before, we will see a bit of pricing pressure on the next-gen in counsels, which will be, you know, depressing marginally.

Remember, it doesn't actually come down a whole lot because there is a mix of catalogue sales, frontline, you know, that must be taken down from the year before.

So it's not as big a jump as you might imagine.

And Larry is pretty insistent on all of us in the operating side of the business to make sure that the expenses match were coming in under what we can do with our gross margin.

And there would be some volume, discounts and royalties, wouldn't there be gross margin?

There always are.

But, you know, as Larry mentioned earlier you needn't - before you can get any more definitive in this kind of general smoke were thrown up here and in terms of you know general information.

We really need to get in to line item details to make those forecast, because we start with titles, we break them by platform and then we make those calculations and realistically we haven't made those yet.

Okay, that's fair and just my last question is -- just want to circle back -- not to harp too much on that EA.com business, if the Sims product is -- looks like it's couple weeks late, given that it's a subscription product in the March quarter, I am still not sure why that pushes the whole sense of profitability back a full quarter?

Can you help me out with that, Warren?

Thanks.

Yeah, let me just give you a couple of the things.

First of all, you know, we consciously made the decision, as John said, to extend the date because we thought that was important.

That said, we will miss the thanksgiving weekend.

And while we don't think that impacts lifetime units; it will impact unit sales in both the third and the fourth quarter.

The second thing is we made the determination during the quarter, appropriately so, that the packaged goods revenue and margin, and also the margin associated with the subscription is really amortized over the subscription period.

So in other words, in the month of sale, we don't record a 100% of the packaged good.

We record roughly one-sixth of that and one-sixth of the margin.

That determination also causes both revenue and margins to be directly impacted.

Those things together with a soft advertising environment caused us to reach the conclusion we did relative to our guidance.

And we will take our next question from Edward Williams with Gerard Klauer.

Good afternoon, couple of quick questions.

Larry, could you provide some European hardware numbers, as to what you are thinking the installed base is at the end of this year?

Yes, we think that PlayStation-2 is probably 12-13 million at the end of the calendar year.

XBox is probably 1.5-1.8 million and in terms of GameCube 2.0 to 2.2.

Any preliminary stab at next year?

Haven't taken a cut at that yet.

But I would say that, you know, you can take the North American numbers and probably apply a factor of about 75%.

Okay and then in the quarter, Warren, I think you mentioned that the catalogue was down from the prior quarter, but could you just give us an idea as to what the percentage of revenues was from the catalogue games?

I can give you a percentage from the affiliated label.

Is that what your after?

No, I'm referring to the games that were launched in quarter prior to the September quarter.

I will have to get back to you on that.

Okay and then just going into the fourth fiscal quarter.

Could you just mention what some of the key games are?

And whether or not any of those are going to be late in that quarter?

I didn't hear the entirety of the question, so what some of the games in what?

Q4.

And in the quarter?

So here are some of the key titles.

Def jam wrestling, let's say NBA Street, Triple Play.

We talked earlier about moving the Sims console and SimCity 4 to Q4, Command and Conquer Generals on the PC, and I think those were the -- key titles for that series.

Okay and then Triple Play, I take it as a late March launch.

Triple Play will be towards the end of the quarter as will be NBA Street.

Okay, great.

Thank you very much.

And we'll take our next question from David Farina with William Blair & Company.

Thank you.

Warren, can you just tell me a little about your kind of policy with return reserves, I mean, we keep creeping up here as a percentage.

The absolute dollars look really conservative.

I just want to understand, you know, why it is so large going into a holiday season where everyone expects things to get, you know, pretty much sell out, seems like a big number to me.

Well I think there are, you know, there are really two questions.

One, the accounts receivable reserves that we talked about, really had to do with existing receivables on the book.

And we go through as EA has always done, a very detailed process of estimating, you know, what the appropriate level of reserves should be.

And I would tell you I have been through that process in detail with the team here.

And I would just tell you that based on what we see and trying to take an appropriately conservative view of the AR reserves that I've outlined, we think are -- are appropriate and keep us in the appropriate conservative position.

With respect to sales returns, we do exactly the same thing.

So we sit down with the sales team and the account managers and review an account on a title by title basis, what we think the appropriate level of reserve is, dealing with sales returns and then -- and do so.

We also go back and look at history as well as current level and our performance expectation.

So, best answer I can give you is -- is we look at it very carefully, we want to be appropriately conservative, that has been continued in this quarter.

Okay fair enough.

And one more balance sheet question, you guys are throwing off so much cash and you are already hitting the billion dollar mark, I mean, I know, it's great to have a billion dollars in cash, but it does, in a kind of low return on assets these days, and any thought that what you are going to do with that money?

Well, I'll jump in on the first part, and then I am sure Larry would want to -- would jump on the top of this, but I would tell you, I think that, you know, it's our view and we're in a great position and we are just going to continue to do everything we can to generate more cash.

We are in the business with lot of big competitors and we want to be the strongest amongst everybody we can think of.

So for now, we are going to continue to do everything we can to strengthen our position.

And our next question comes from Chris Debiasi with Goldman Sachs.

Thanks, Larry you mentioned some industry assumptions earlier.

I wonder if you can give us a sense of where some of those numbers come from and how fresh the date is whether that takes into account some of the recent unit tender on XBox cuts?

Well, the numbers that are reported here today come from Tryst, so those -- those are actual numbers.

The forecast for the balance of the year and for the following year, it's a bunch of people around here getting together and taking a look at historical patterns, and trying to -- we look at what's happening in the market place currently.

It's based on the discussions with the hardware companies and the retailers.

And it's our best thinking at this point in time and as we go through the planning process, we will continue to refine that.

But it's a process that we go through literally on a quarterly basis and -- and we're constantly upgrading that information and pulling as much data from as many sources as we can.

We have lot of people around here who are very experienced in -- in projecting the market going forward and we are pretty confident about our outlook.

Okay so that would -- the forecast would take into account some of the recent consumer spending issues the sales date in September...

Yeah.

At a broader retail level.

Yeah.

Okay.

And we will take our next question from Jeff Vilensky with Bear Sterns.

Mr. Vilensky your line is open.

Oh sorry thanks.

I have a follow-up question on the Sims and a few others.

Upon launch, what kind of shipping numbers are you looking for to get to -- and what kind of subscriber number you are looking to get by fiscal year-end?

The shipping number -- to be honest we are still modeling that, it's likely to be between 200,000-400,000 on initial ship and it kind of depends on the exact marketing plan, we decide to.

The questions are whether we would launch with a big TV campaign or choose the old [inaudible] and we are planning to examine very carefully our data information, the results speaking back to the consumer to make those final determinations of product finals.

So, just a little bit of range for looking go end to the December launch.

In terms of 10-year subscribers, the current projection is a little a north of 250,000, that's our internal modeling and of course that subject to review as we complete all of the planning that we do when we get through this data information.

The reason I keep relying on the data information is that -- it's in fact very useful.

We learn a great deal about what the consumer likes and doesn't like in the product and our interpretation is that, that influences purchase intentions and subscription intentions and we try to optimize that, we are trying to learn as we go, [inaudible] we give as wide as we know how.

Okay thanks.

Can you give me your US market share year-to-date on the counsel and also on the PC?

The market share to-date?

Right.

We had a couple of sources for that.

Okay so on the GameCube year-to-date it is 14%, on PlayStation 2 it's 25%, on XBox it's 17%, and the PC it's 22, North American year-to-date though September.

Thank you, and one more question.

Warren, what are your thoughts on how the company currently treats software development costs, are you comfortable with that methodology?

Any plans on reviewing it or changing it?

Well, I am very comfortable because I think it's about it's conservative issue can be.

So on any internally developed product, we expense it currently.

So, I think, you know, the company is not building balance sheet obligations with respect to our internally developed product, and that which we do on the outside, anything that is capitalized is cross-collateralized against multiple products, you know, if you are very comfortable with any exposures that are reviewed really monthly and quarterly in detail.

So, I feel very, very good having really been through our practices relative to how the we expense things and be going though our balance sheet position and how we state those assets.

Ok, great, and Larry one quick question on the Xbox and GameCube next year, directionally will you be doing more or less SKU's on those two platforms?

I think, we would probably sort of plan together and have a similar number on each, and we'll adjust as we go through the year.

Ok, thank you very much.

Great, thank you Jeff.

And operator, we have time for one more call.

And we'll take our last question from Heath Terry with Credit Suisse First Boston.

Thanks, good morning there.

Wondering if Lawrence if you could just kind of talk just a little bit -- just a kind of clarify some of the revenue recognition, how that's going to be done on the -- the Sims online package product.

Right.

And then -- if you could give us just an idea of what the first few days of NBA Live have been like.

And if you got it, kind of how it paired up against Sega's version of the NBA game?

I'll take the second part of the question first.

We are outselling Sega's product.

We've got about two weeks where to sell-through data, we are outselling Sega's product by about 2.5-1 on PlayStation 2, which is the key platform.

In the first week on XBox, their product outsold ours, in the second week we reversed that and lifetime-to date, we're ahead on XBox and we're ahead -- significantly ahead on GameCube though the numbers are pretty inconsequential there.

So we feel really good about where we are overall with NBA Live.

We are going to continue to pour on the heat in terms of marketing and promotional support, we think we are going to win that battle.

Great.

Heath, on revenue recognition, let me start with the expense side of the development.

All expenses currently in development are expensed in the current period, so any development that we are presently doing for the Sims online is going through the income statement today.

As we begin to sell the product and signs up subscribers, you treat that effectively as a bundle and because you treat it as a bundle, you basically amortize that revenue associated within any just pure CD manufacturing cost, which is obviously smaller.

You take whatever that net gross margin is and you amortize it over the average life of this subscriber, which you know, we'll learn more about that, you know, we are estimating at 6 months.

So, you can assume you take packaged goods plus the subscription revenue, amortize it over a 6-month period, but then at the same time we are currently and presently expensing all the development costs that we're currently incurring.

And that does conclude the question and answer session today.

Okay.

Thank you.

Thank you everyone for joining us on the call.

If you have any further questions please give us a call.

Great.

Thanks everyone.

That does conclude today's conference.

Thank you for your participation and you may now disconnect.