美商藝電 (EA) 2004 Q1 法說會逐字稿

Good day everyone and welcome to the Electronic Arts first quarter of fiscal 2004 earnings conference.

Today's call is being recorded.

For opening remarks and introductions, I would like to turn the call over to Miss Karen Sansot, Director of Investor Relations.

Please go ahead, ma'am.

Thank you.

Good afternoon and welcome to our first quarter fiscal 2004 earnings conference call.

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

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

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

This will serve as the official record of the call.

Throughout this conference call, we will present both gap and non-GAAP financial results.

Specifically, we will reference the following non-GAAP measures.

Non-GAAP operating income, non-GAAP net income, and non-GAAP EPS.

Non-GAAP results exclude charges associated with restructuring, accident impairment, other than temporary impairment of investments, acquired -- technology and amortization of intangibles and the related tax effects.

At a supplemental schedule to our earnings release, we have provided a tab reconciliation of non-GAAP measures to the corresponding GAAP measures.

All non-GAAP measures are provided to our results and we encourage investors to consider all measures before making an investment decision.

All comparisons made in the course of this conference call are against the same period for the prior year unless otherwise stated.

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

These statements are judgments made as of July 23rd, 2003 and we caution you that actual events and results may differ materially.

We refer you to our 10K for the period ended March 31st, 2003, and today's earnings release.

Our 10K and release provide a discussion of important factors that could cause our actual results to differ materially from those discussed today.

We make these statements as of July 23rd, 2003 and disclaim any duty to update them.

And now, I'd like to turn the call over to Warren.

Good afternoon and thanks for joining us.

We're pleased to report another solid quarter.

Net revenue was 353 million, up 6% over the prior year.

And a year ago quarter People & World Cup together sold more than 4 million units.

Needless to say, against such a tough compare, we're very pleased with this performance.

Gross margin was up 50 basis points to a record first-quarter margin of 57.6%.

Operating income, was up 247%, to 22 million.

Diluted earnings per share were up 141% to 12 cents per share.

Trailing 12 month operating cash flow was 673 million, or $4.55 cents a share.

Our balance sheet continues to be strong, our reserves and our inventory are at appropriate levels.

On a trailing 12-month basis a Return on Invested Capital was 44%.

Added all up, we continue to demonstrate the strength and advantage of our business.

Our trailing 12-month gross margin was 57%, up 300 basis points year-over-year.

Trailing 12-month non-GAAP operating margin was 22%, up 900 basis points.

Trailing 12-month operating cash flow was 673 million, up 349 million.

On a per share basis, that is a $2.32 cent improvement.

Our trailing 12-month OCF cash margin was 27%.

We continue to expand our lists of recurring franchises.

The MBA Street Franchise is here to stay.

In the quarter MBA Street Volume 2 sold over 1.4 million units.

And most importantly, this is a great gain.

We're very pleased with the performance of Death Champ Vandetta Jan Vandetta which has sold nearly a million units and while not a new franchise The Sims Superstar is another successful expansion pack having sold close to 1.5 million units in the quarter.

The renegotiation of our AOL agreement is also a real positive.

We have now gone from paying for access to being paid for integrated content.

Historically, we have paid AOL a carriage fee and made other financial payments in exchange for access, and exclusivity on AOL.

In our new partnership AOL will pay a programming fee for integrated content, including access to our Club Poego subscription gains, additional web content, and extended international and broad band service.

AOL will provide their customers with free access to our Club Poego gains.

The agreement is for two years, all remaining EA carriage fee obligations have been eliminated.

Again, this is a real positive and a great deal for both EA and AOL.

Technology in the consul manufactures continue to be great friends.

We're excited about Sony's E3 announcement of the PSP, given their track record for innovation.

We are also cautiously optimistic about its market potential, and the transition bridge it may provide.

In short, while we take nothing for granted, our performance this quarter has added to our momentum.

The tide continues to build.

For the next few minutes I'll focus my remarks in three areas: First, I'll talk about our Q1 results, second, our market outlook for the calendar year, and third, our financial guidance for the September quarter and fiscal 2004.

Following my comments, Larry, John, and I will open it up to your questions.

First, our Q1 result.

During the quarter, we released 10 skews, two one Champ Vandetta, three NBS Street Volume 2, four on Formula One, and Sims Superstar on the PC.

In the year-ago quarter we released 12 skews.

Net revenue for the quarter was 353 million, driven principally by the sales of MBA Street volume 2, Death Champ Vandetta and Sims Superstar.

Catalog sales of the Sims, Tiger Woods Golf and MPV Baseball also contributed to our results.

Revenue was up 6% versus the prior year quarter.

Geographically revenue in North America was up 15 per cent year-over-year, while internationally our revenue was down 2%.

This was a direct result of the impacted of World Cup in the prior year.

Absent a 21 million dollar foreign exchange benefit, our revenue would have been flat year-over-year.

The impact of foreign exchange was, however, factored into our guidance.

Next our revenue by platform.

Please keep in mind that our U.S. consul segment shares are based on MPD Tryst data while PC information is based on MPD tech world estimates.

In Europe, segment share information is based on EAestimates, as no service is comparable to Tryst or NPD Tech World are in place.

First, on the PlayStation 2.

PST revenue was 33% of total revenue, or 118 million, down 12% year-over-year.

The decline was a result of strong prior-year sales at People World Cup and Medal of Honor front line partially offset by strong sales of Street and Death Champ Vandetta Jam Vendetta.

In the U.S. or segment share was 22% with 25 top-title tight.

NBA Street, MVP baseball, Tiger woods Golf, and The Sims.

In Europe our segment share was approximately 15%, driven by The Sims.

On the PC, PC revenue was 23% of total revenue, or 80 million.

And up 6% year-over-year.

Sales were driven by The Sims superstar, Sims Delux and Command & Conquer general.

In the U.S., EA had four of the top-10 PC titles and a 22% segment share.

Titles occupying these top spots included Sims Superstar, Sims Delux, Command & Conquer Generals and Battlefield 1942.

In Europe, we estimate EA had three of the top 10 PC titles and 22% segment share.

Sims Superstar, Sims Unleashed and Sims Delux.

On Xbox, sales represented 9% of total revenue or 31 million dollars, up 57% year-over-year in the quarter we had 24 available titles versus 12 a year ago.

Our U.S. segment share was 16%, with four of the top 20 titles.

MBA Street Two, The Sims, MVP Baseball, and Tiger Woods Golf.

In Europe, we estimate our segment share to be approximately 15%.

On GameCube, sales represented 6% of total revenue or 21 million, up 41%.

In the quarter, we had 22 available titles versus 7 a year ago.

Our U.S. segment share was 16%, with two of the top-10 titles, MBA Street and Death Champ Vandetta Jam Vendetta.

In Europe we estimate our segment share to be approximately 12%.

Co-publishing and distribution.

Revenue was 20% of total revenue, or 72 million, up 52% year-over-year.

Driven by Double Make Cry Two in Europe, Battlefield 1942 and Final Fantasy Origin.

Subscription service revenue, which includes subfees and packaged good sales for on-line products were 14 million, up 60% year-over-year.

The increase was a result of the addition of the Sims On-line and Earth and Beyond during the year.

We ended the quarter with a total of 333,000 active players versus 250,000 a year ago.

Moving on to the rest of the income statement.

Gross profit in the quarter was 203 million, up 7%.

Gross margin was 57.6%, up 50 basis points year-over-year.

Margin improvement was driven by lower product costs and slightly lower licensing rates, offset by a shift in mix favoring co-publishing and distribution.

On to the bottom line.

Operating income was 22 million versus 6 million in the year-ago quarter, up 247%, driven by increased revenue and a higher gross margin.

Our op margin was 6% in the quarter compared to 2% a year ago.

Net income was 18 million, versus 7 million a year ago, up 148%.

Diluted earnings per share were 12 cents per share versus 5 cents.

Non-GAAP diluted earnings per share were 13 cents per share versus six in the year-ago quarter.

Our diluted share counts ended at 150 versus 145 million a year ago.

Now the balance sheet.

Cash, short-term investments and marketables ended at 1.6 million, up 34 million from the March quarter.

Gross accounts receivable were 166 million, versus 247 million in the prior year.

A decrease of 81 million year-over-year.

This was due to the timing of product releases as titles shipped earlier this quarter as compared with the prior year.

Ending net inventory was 17 million versus 25 million at March 31, and 24 million a year ago.

No one title represents more than $2 million of exposure.

Reserves against outstanding receivables totaled $129 million, essentially flat year-over-year.

Reserve levels were 16% as a percentage of trailing six-month net revenue versus 16% a year ago.

As a percentage of trailing 9-month net revenue, reserves were 6% versus 8% a year ago.

In short, our balance sheet is solid.

I'll conclude my portion of today's call with our market outlook and financial guidance.

Our estimates for calendar 2003 hardware and industry software sales remain unchanged since our last call.

Software prices: We expect a premium titles will continue to hold the $49 price point, but that lesser titles will move toward $39.

In North America, we expect growth in software sales as follows: For the PS2, up 25 to 30%, for the Xbox of 20 to 25%, for the GameCube, up 15% to 20% and the PC, up 0% to 5%.

In North America, we expect the following hardware unit sales: PS2 unit sales are between 9 and 10 million units.

Xbox unit sales are between 2.5 and 3 million units.

GameCube sales are between 2 and 2.5 million.

In Europe, we expect the following hardware unit sales: PS2, between 8 and 9 million units.

Xbox between two and 2.5 and GameCube between 1 and a half and two.

Our financial guidance.

Our guidance reflects our best thinking as of today.

There are plenty of unknowns and several things that could happen, which could cause our actual results to be materially different.

We ask you to carefully consider our risk factors when evaluating these estimates.

I'll cover our financial guidance in two parts.

First, I'll discuss the second quarter and then our outlook for the full year.

For the quarter ending September 30, we expect revenue to be between 470 and 510 million, up 4 to 12% and earnings per share to be between 35 and 42 cents, up three to 24 cents year-over-year.

In Q2, we expect to ship about 26 skews.

Madden on PS2, Xbox, GameCube, PlayStation, PC, and Game Boy Advance, NCA foot bauble on PST, Xbox and GameCube, NASCAR Thunder on PlayStation and PC, Tiger woods, PGA tour and PS2, Xbox GameCube and PC;

NHL on PST, Comps box GameCube and PC.

SimCity four, Rush Hour Expansion Pack on the PC.

Command & Conquer General, Zero Hour expansion pack on the PC.

And Battlefield 1942, Secret Weapons of War expansion pack on the PC.

A couple of things to note.

First, NCA football has already sold more than 400,000 units in its first week.

Obviously, a very strong performance.

Also, from all indications, this game also looks to be a hit on line.

Second, we are the distributor for Calibre 2 in Europe and Asia.

This is a title that will ship toward the end of our second quarter.

For the full year, we expect revenue to be between 2.8 and 2.9 billion, up 13 to 17%.

This guidance is unchanged.

Diluted earnings per share to be between 325 and 340, up 50 to 57%.

This is an increase from our previous full-year guidance of 310 to 325 per share.

What we saw as the high, we now see as the low.

Before opening it up to your questions, let me wrap up with a few thoughts.

This was another record quarter for EA.

We demonstrated in spades the power of our diverse lineup.

Medal of Honor and People World Cup are great franchises, but so, too, are MBA Street, Champ Vandetta and the Sims.

We further strengthened our mode this quarter.

We're exactly where we want to be heading into our second quarter and the fall.

Number one globally with big franchises in place and the know how to build even more.

And by the way, we think our coming titles look great as well.

That said we had 110% focused on execution and we take nothing for granted.

Speaking for my EA colleagues globally we are dedicated in creating the best of creative content with the power of technology at the highest rates of return in the entertainment industry.

We are a digital entertainment peer plain.

Our momentum continues to accelerate, we look forward to reporting our results in the quarters ahead.

Operator we'll now open it up for questions.

Thank you.

Sir.

The question-and-answer session will be conducted electronically.

If you wish to ask a question, please press star 1 on your telephone key pad.

We will only take one question per caller.

Once again hit star one to ask a question.

Our first question will come from Michael Wallace of UBS Warburg.

Hi.

Warren, I think last call you talked about gross margins being flat year-over-year and it looks like they're coming in better.

Um, you referenced, I think, lower product costs as well as licensing rates.

Could you talk about the licensing rates, are you getting cheaper -- cheaper goods from the hardware companies and do you still think gross margins are flat year-over-year, or are they expected to be up and, uh, timing on Medal of Honor for PC and console, if you could give us those quarters, thanks?

Sure.

Let me take the first part.

I guess we wish our licensing costs were getting cheaper Mike would be the best way to say it.

They were slightly down looking at rate, uh, in gross margin in the quarter, but only slightly.

On the product cost side that was really driven by lower overall manufacturing royalty costs and that's just purely a function of volume.

Looking ahead for the rest of the year, I think you could expect that our guidance will hold.

I would expect a gross margin will be flat to slightly up for the full year.

And, John, if you want to take the second part of the question.

Sure.

The Medal of Honor title you asked about, Console was * 3 and we're planning on the PC title in Q4.

Okay.

Thank you.

Great, thanks, Mike.

We'll go next to Edward Williams of Gerard Klauer Mattison & Company, Inc.

Good afternoon.

Just a couple questions for you.

What are your -- what do you have right now in development as far as looking over the next 12 to 18 months in terms of products and how are you breaking them down or platform specifically looking at PSP as well as the next generation of consoles?

Um, we've been talking pretty specifically about what's in the product plan for this quarter and the balance of fiscal year '04.

We haven't really talked about things that are in the product development pipeline beyond that point.

So if you have some specific questions about specific titles over the next nine months I'd be happy to answer those.

With regard to PST, um, we still need to, um, get exposure to the technical specifications of the business model before we decide how strong our commitment we make as a company.

And with regard to platform splits, I think that you will see a similar approach to what we talked about in fiscal year '04, where PS2 is our lead platform followed closely by Xbox and Nintendo GameCube and more of a presence on the handhelds than we've had historically.

All right.

Well, just looking at the next nine months, um, what do you have planned in your release schedule at this point on a -- on a console-to-console basis?

Just for your records, this is John, the 12-month basis our plan -- previously announced, is, um, '04 on the PS2, that will be a fiscal year total.

And in the low 20 -- 20 to -- GameCube and Xbox.

Does that answer the question you're looking for?

Yes, it does.

Okay.

Then one other quick question is catalog in the quarter, what was the per cents of revenues from catalog titles.

The catalog in the quarter Ed was about 45%.

Last year it was around 42% for the full year, you know, we would expect that to be in the 15% to 20%, very consistent with last year, just up slightly.

And just to clarify the definition of catalog?

Uh, anything that's not frontline.

Not shifting quarter is what we've got.

So in -- in that definition.

Okay.

Thank you.

Anthony Gikas of U.S.

Bancorp Piper Jaffray, Inc. .

Hi guys good afternoon.

With the huge success of the NBA Street product, could you maybe characterize for us how big the NFL Street product could be?

Is this something that could do 20, 25% of the units that Madden does?

I would think that it has that kind of potential.

If you take a look at the number of units that Street 2 has done, uh, it certainly is at least 25% of what we would expect to do on NBA live.

So, um, yes, we have high hopes, we think it has great potential and we fully expect that to be a significant new franchise for us once it shifts.

Okay.

And then in terms of acquisitions in the market, would you characterize it as a target, you know, rich environment right now in terms of IP or companies, or are we running a little thin?

I don't think it has changed.

And our philosophy has always been to carefully monitor, um, all of the companies in this space and to be prepared to take advantage of opportunities as they present themselves.

And if one fits our acquisition criteria, whether test an a company or intellectual property we'll move forward.

Are you elephant hunting or are you looking at anything?

We have all kinds of weapons in our arsenal of hunting.

Moving now to Shawn Milne of Soundview Financial Group.

Thanks a lot.

Warren, I just wanted to ask on the guidance real quick.

Your earnings guidance was pretty strong, you raised the full number by 15 cents.

On the revenue range you kept it pretty much intact.

I guess, the bulk of the upside this quarter was currency.

But are you waiting to see something in the market, are you a little bit more cautious here, uh, does it relate to hardware price, cut expectations?

Um, just trying to get a feel, because it sounds like, uh, the current quarter's off to a good start with NCAA and you've moved a couple skews into the more important December quarter.

So it just seems like this I think is the first quarter we haven't raised guidance by a little bit.

Thanks.

I would say -- I mean, if I were -- we want to be appropriately conservative, Shawn, so -- and whether that's on the top line or bottom line, I think -- you know, we feel great about our lineup in Q2 and we feel very good about what we have ahead of us for Q3 and Q4.

Obviously we're watching performance as we go forward.

We feel equally as good about the operating leverage we're seeing in the business.

And as we look at our performance to date and what we see ahead, we just see more leverage taking place and that's reflected in our bottom-line guidance, taking it up to 320 to 340.

Okay.

Thanks, Warren.

Thank you.

Our next question will come from Jill Krutick of Salomon Smith Barney .

Thanks very much.

Good afternoon.

I was curious, in terms of the revenue declines in Europe, length of [INAUDIBLE] the would you characterize Europe as really weaker or is it really just more of a timing issue.

And, then, specifically on the hard ware target, um, what kind of growth rates are you seeing -- anticipating in the U.S. versus Europe?

Thank you.

This is John, our European business is not down year-over-year, it's kind of a starting point.

Um, and I'll get the exact specifics for you in a moment.

So that's just to kind of clarify the facts.

The issue with the cop is just on So we had a world cup title last year, we didn't have that this year.

And Warren's commentary is if we had the -- and successfully did lap the cup -- so does that kind of get to the question you're trying to understand.

Yes, that helps clarify it.

Thank you.

You know, in effect we're real pleased Europe was actually slightly up.

The impact at FIFA and world cup was felt certainly in Europe.

But also more significantly in Japan and Asia Pacific but even against that tough compare Europe was up a point.

We do World Cup on an every four-year cycle with the event.

We did about 2 million units last year, and so, um, that's a hole that we had to make up for.

I think a lot of people may have found it surprising we were able to do that.

And, Jill, just as a general reminder, the impact of currency was in our guidance.

And your next question will come from Heath Terry of Credit Suisse First Boston.

I was wondering if you could just talk a little bit -- you know, seeing margins go up again this quarter.

What do you think the -- particularly on the top line, what do you think the natural high watermark for that is going to be during this cycle?

And, then, Larry, I know you were down at the Merchants Association meeting and I have people down here talking to the retailers now.

Can you give us an idea of what their level of optimism is about the holiday season, um, how orders for -- or order indications for big products coming up are shaping up at that event?

Heath, I'll take the margin question and then turn it over to Larry.

I wouldn't sit here now and then try to predict where margins go to, exactly.

What I can tell you is philosophically, we want to keep fixed costs fixed and only deal with that which we need to add in terms of adding variable costs.

So I think as volumes continue to increase, uh, we will try to create additional operating leverage and, uh -- and build our operating margin from here.

I think this quarter and our performance over the last 12 months with operating margin on a trailing 12-month basis, being 22%, really exemplify that fact.

And I think when you look at our full-year margins they will be higher this year than they were last.

That's directly as a result of getting leverage on our cost base and, uh -- and improvements that we're able to make in gross margin.

I think those trends should continue.

We will have some pricing pressure which will abate some of that, most certainly.

But overall we're looking to create leverage every place we can while continuing to invest in this business.

With regard to the sentiment of retailers at the IEMA conference.

I would characterize the ones I met with as very optimistic and thinking very positively about the holiday season.

Specifically with regard to titles, I think Warren mentioned in his remarks that NCAA is also a very sad start relative to what we achieved last year.

And in terms of preorders on big titles, the one example I could mention is Madden, preorders exceed 100,000 units at this stage of the game and that's a record level for Electronic Arts on any new release.

So we're looking forward to great things from Madden.

Great.

Thanks.

Moving now to Arvind Bhatia with SWS Securities.

Good afternoon, guys, congratulations.

I wanted to focus a little bit on market growth for next year.

Um, as you look into 2004, can you talk about what sort of level of growth do you forecast, that you can see now.

And then you talked in the past about, uh, the next generation consoles coming out either in 2005 or '06.

At this point, would you lean towards '05 or '06 if you were a betting man?

I think it's really too early to definitively call whether it's going to be '05 or '06.

I think we'll learn more about that in the months to come because we typically begin to receive technical specifications and first-generation development systems about two years in advance of a hardware launch.

So I think over the next four to six months we'll be able to more clearly define what the landscape looks like in terms of next-generation launch dates.

You want to talk about ....

Well, we haven't put out any sort of industry guidance for 2004 yet.

I would tell you if it is mapping against the last cycle, some folks would be tracking the '98 year and some would be tracking against '99.

The respective numbers for industry growth globally as we track it were 23 and 5% for '98 and '99.

So between those two numbers when we get around to putting -- you know, coming out more definitively.

Okay.

And as you look at the NCAA product and how successful it already looks like it is.

Uh, and the historical trends or ratio of NCAA versus Madden, um, you know, can you provide some more color on what sort of sales level increases there should be looking out at this point on Madden versus last year?

Too early to call and one of the reasons that NCAA is off to such a rapid start on such a good basis is that we did more television advertising upfront this year than last.

So the awareness level was higher, then as a result a much faster start.

But it's too early to predict how sustainable that is versus last year's results versus Madden because we haven't launched it yet.

Again one final question.

How many skews do you have in your plan for this fiscal year?

We will be somewhere between -- I would say, 90 to 95.

Got it.

Thanks guys.

Thank you.

Our next question will come from Bill J. Lennan, Jr. of WR Hambrecht & Company

Bill Lennan, Jr.: Good afternoon, thanks.

For the North America, can you -- can we go back to earlier in the year you talked a little bit about Europe being faster.

I wonder if you could kind of give some sort of percentage Delta?

For example, you say PlayStation 2, 25 to 30% in the U.S.

Should we be thinking of one per cent delta in Europe or 5% or something in between.

And secondly, could you remind us again what your thinking is on console prices?

What price points hit the market at what time in the calendar to get you to those growth assumptions?

Thanks.

With regard to Europe, what we have said previously to comparison to North America we talked about PS2 software up 25 to 30%, Xbox up 25 to -- GameCube 15 to 20%.

We talked about Europe growth rates being slightly higher than that on each specific platform since they're later in the lifecycle of those platforms.

Okay.

Price timing for console?

So you'd asked about that timing for some pricing adjustments.

Um, it -- you know, most typically what we'd expect to see is adjustments as we head into the holiday season, we see the season pick up with kind of a vengeance, beginning October, and that's September, October usually is when they're going to start to look at things.

And they've got a lot -- remember, they have a variety of tools.

They may be bundling software in with the hardware, you get a lower perceived price, uh, currently they're bundling the mode many with the hardware and that may come undone.

Those are the options available and so far they have not given us a clear indication of which way that's going to work.

Bill Lennan, Jr.: Thank you.

Moving now to John Taylor of Arcadia Investment Corporation.

Hi.

Let's see.

Could you talk a little bit more about the AOL, the implications of the AOL new agreement?

I guess the -- was the carriage fee and was the reversal of charges; in other words, the payment for content, was any of that booked in June and when does that kick in and kind of give us maybe an annual -- a guess or a range at the analyzed implication of that.

And sort of a follow on to that is was that in your previous guidance of 310 to 325, or is that a decent part of the difference?

I think Warren and I will end up splitting this question.

Me on the substance on it and Warren on the financial implications.

But, you know, essentially the shift is a very good one for EA.

Although we think it's also going to work well for AOL.

The shift as it was described in the release in an earnings -- in Warren's earlier commentary -- um, essentially our deal previously had us, you know, paying for carriage, and in the replacement of that they are currently playing us for content.

The specific number on that, um, is 70 is subject to nondisclosure in the agreement but it is a positive swing for EA.

The -- it -- I guess -- in general we're very pleased with it.

I think our content's great, it attracts a large audience, it generates a lot of interest with the consumer and we're now generating an income that exceeds our cost to build it.

So let me follow up on that if I can.

If I recall, you were paying about 4.5, 18 million a year kind of thing for carriage, so essentially that goes to zero and then you get paid on top of that?

Is that fair for us to assume?

Um, you're kind of carrying us right through the middle of a non-disclosure.

I think that a fair description of the shift that's taken place in our relationship.

I think it is -- I'm sorry, John?

So the number actually is 80 million carriage over a five-year period, so, you know, I can do the math in my head you're roughly right.

So, um, you know, you've got a pretty good grip on it.

Okay.

And then was that -- what about the inclusion of that in previous guidance?

It was in our previous guidance.

Obviously we've been working on this for some time.

This is an important partnership to us.

Um, and I think -- you know, looking back at what we have disclosed in the past, we have talked about the carriage fee being roughly $4 million a quarter and obviously based on what we said that's not there anymore.

Okay.

Okay.

Great.

Okay.

Then, um, John, this is probably another one for you.

Can you guys talk at all about the -- what you're seeing in terms of play patterns, consumer behavior, usage, whatever, some of the metrics you're using to measure usage of the PS2 on line and NCAA, whatever people are playing of your -- you know, give us a sense of the scale of that again -- these days?

So, yeah, we've actually seen a surprising uptake of NCAA.

I was on a couple days ago and I think a qualitative is more impressive than the quantitative.

If you just look to what's happening on the message boards or you listen to people so you can engage in the conversation yourself using the voice chat.

It's a very, very, very enthusiastic audience.

So far we've had a little over 30,000 people register to use it.

That was as of the day before yesterday.

Peak simultaneous usage on Monday night was 2800.

That's a very crowded lobby for something that's just shift.

So I think it's a good early indication.

You know, those numbers are close to revealing what happened in terms of peak users, last year Madden peaked out at about 3400 so that, again, this early in its cycle it's popped that high, um, suggests we're on to something.

Probably a more interesting and telling discussion will take place six to nine months from here, as we start implementing the play to play tournaments and other things we've talked about in different times and how those get taken by the consumer in terms of acceptance to pay for these -- for some of these new on-line features.

Okay.

Great.

And then final question.

On the -- what do you see in terms of advertising trends as it relates to the cost of buying media going into the holidays and so on.

You know, to some extent maybe it's a negative if they're going up on the other hand as people shift money to on-line advertising, maybe that's a benefit.

So can we talk about those issues a little bit?

In general we saw the upfront buyer just a little while ago was up.

I don't have the exact number.

It would have been double digits, though.

For us that's not such a big deal, though.

A lot of our advertising is purchased in larger packages where we're trading out media buy for inclusion of cyber strait or promotional benefits, etc.

So we feel really good about our media buy this fall and what it's going to deliver for us and the cost efficiency of it.

Essentially what I gave you is what happened to list prices but, you know, EA as a package general lip doesn't pay retail.

Okay.

And are you seeing much in the way of people's budgets moving away from other older forms of media to on-line internet advertising in a way that's going to benefit that side of things?

You know, frankly we're not a big seller of television media so I'm not getting a good audit of that.

What I read in the paper is yes there's actually some modest shift to go on-line and I know that our pogo site had an up quarter in advertising to a record level for us.

So more people are coming to us.

But the only exposure I've got with media buyers in general is people coming to pogo so that's a pretty limited direct okay.

Thank you very much.

Moving now to Jeff Vilensky of Bear Stearns.

Hi, thanks.

With regard to your cash, what are your thoughts on declaring a regular or special dividends?

Jeff, I would tell you right now we are really focused on continuing to generate cash in our business.

Secondly, as Larry indicated earlier, you know, this going to be we think an interesting environment over the next couple of years and, as we've said before, this is really an important time that we want to be very cash -- in a great cash position and be very strong as there may be opportunities.

Philosophically, I think this is a company that has demonstrated -- it is very shareholder focused and we are going to do things to drive return on our invested capital and to drive shareholder value.

And, you know, for now we think the best solution is to stay where we are.

Do we philosophically object to the notion of a dividend or the notion of a share repurchase or the like?

No.

Again, we're focused on driving long-term value.

Okay.

Moving to the on-line business with John just alluded to or not alluded to but with respect to the pay for play and the sports on-line business that you guys have been talking about.

Could you elaborate on what your plans are going into the fall football season and what kind of things you're looking six months down the road in -- in testing out and then on-line format?

If I can use the expression fast, because that's what this year's already about, it's So the on-line connected console is a brand-new concept.

We do not want to stack a long-term precedent that it's a free benefit, but we don't think we can get paid for the simple act of matching two consumers to play against one another.

So what we've been doing is looking at alternatives.

Starting with NBA live this year we're going to be offering pay to enter tournaments where there will be prizes and some head to head competitions where they pay for certain benefits.

There will also be looking with the -- in some of our EA Games on-line console titles to have downloadable content if they pay to take a new game.

This is -- you know, from a financial perspective it rounds to zero this year.

The issue is what we learn in terms of what the consumer's willing to pay for as this business scales for the balance of the cycle and then into the next.

It's a learning exercise.

Okay.

And just two more quick questions.

Any titles on the cusp of your second quarter?

I would say of the titles that we -- we've discussed, no.

I mean, we feel very, very good about those -- you know, there could be titles that could move either way, but we're not counting on those in terms of our guidance.

One challenge is calibre and the reason we highlight that is because we have, you know, a lack of belief in We don't directly control their studios, they are very successful organization but that was on the cusp.

And that's Asia only?

Sorry?

Is that Asia only?

No.

It's Europe and -- so it's not selected telemarkets in Asia.

And when's the expected shipment of NFL StreeT?

NFL STREET.

It's Q4.

Q4.

Okay.

Thank you very much.

Great, thank you.

Our next question will come from Dean of JP Morgan.

Just a few questions.

First, can you tell us if the carriage fee was eliminated in the first quarter and you received the income?

Secondly, can you tell us how much the last was narrowed to EA.come in the quarter and then with that business are you comfortable with the size of the business, or could we see, um, more slimming in the future?

And then, just on -- could you give us the FX effect to the bottom line in the quarter and, secondly, in your revenue guidance for the second quarter, is FX included in that guidance?

Thank you?

I'll see if I can go through that list and all the issues.

Let me start with the FX.

It was 21 million dollars on the top line and virtually zero on the bottom line.

And the reason for that is that we have effective natural hedges in place so the bottom-line impact was effectively zero.

As we look ahead to the next quarter, the FX impact is included in our guidance.

So yes, it is.

And we factored that in to our performance.

On the carriage fee, as I mentioned earlier, we did receive $4 million of benefit in the first quarter.

And if you look at the marketing in sales lines, you'll see that that's slightly down and one of the reasons for that is the reduction in carriage fee.

Beyond that, you know, the terms -- I won't go into the agreement.

As it relates to ea.com, fundamentally that's an entity that does not exist any longer.

We have integrated the business back into EA.

So I really have no basis on which to answer your question.

Our objective is to continue to build the game service that we alluded to today, to build the business associated with our console products on line.

And then the third part is to build our business around PSWs.

So you're not even tracking the EA.COM anymore?

No.

No, we are not.

Okay.

Thanks.

Thank you.

Moving next to Gary Cooper of Banc of America Securities.

I just wanted to ask about your PC estimates, zero to 5%.

It seems like it's a bit aggressive given the -- not in the year and hear rumblings that half life two may not be in this calendar year so can you talk about what the key drivers are in that estimate?

And then also talked about maybe what in your lineup benefits from this point going forward since June 3's not there and maybe it's half life two's not there.

Thanks?

Well, first off, the -- I'd like to point out that in fact in Europe the PC business has had a really strong year so far.

So we've got a bit of a split in market performance.

When North America's underperformed on PC so far and Europe has performed better.

And I think you're very wise to -- something like half life as being a category mover.

You know, my sense of the PC business at this point in time is that it's very title driven.

It's our feeling we could make our forecast almost independently of how the category turns out because the business for Battlefield, the business for Sims, the business for Sims City tend to exist in the absolute independent of the underlying trend.

That won't go forever, but at the present time, you know, that's pretty much what we're experiencing.

Net, the zero to five, um, on a global basis is probably still reasonable.

But we're going to need to see a pretty strong seasonal pickup in the fall.

Okay.

Thanks.

Our next question will come from Tom Marsical of Marsical Capital?

High.

Trying to understand the -- the incremental operating leverage that there is in the business, which would seem to me to be fairly substantial.

Can you tell me the number of employees that you had at the end of the June quarter of '03 versus the end of the June quarter of '02?

We'll grab the '02 number.

The June quarter of '03 we had 3500, Tom.

And, uh, we'll grab the 2002 here in a minute.

Sorry --.

Actually, um, if you take a look at a year ago, the end of Q1, fiscal '0 p, the number is 3500 ( '03) and it's just over 4,000 at the end of Q1 '04.

Were you looking for '0e 2 the prior fiscal?

Yeah.

I thought Warren just gave me 3500?

The end of Q1.

Q1 fiscal '04.

Q1 of fiscal '03?

3500.

That's June of '02?

That's correct.

Okay.

And June of '02 -- or June of '03 is a little over 4,000.

And where are you adding most of those people --? -- I see that your R&D is up?

In product development.

And do you have a target for where that's likely to be at the end of the year?

We don't have a particular target.

I will tell you that we will continue -- you know, one of the strategic, uh, imperatives that we have around here is to build our internal development organization and we will be focused on doing that.

So you should expect to see us continue to add to the roster of employees in developing part of the business.

Perspective on that by the way underpinning that strategy has been a strong shift towards internal production and away from external development.

So it's our judgment for the most part with successful titles, we get a better quality product than are produced by our internal studios and we do so cost efficiently because these guys are paid salary and bonuses and they're not paid royalties like most of our other developer deals are.

So then I should see an improvement in the margins in the, uh -- where in the marketing in sales line as well as the cost of goods sold line?

You know, right now Tom, I mean --

I'm just trying to understand the internal development fees?

So that's coming out and that's going to gross margin.

I would say just -- the way we talked -- or the way we think about it, Tom, is we're going to continue to invest in the business in two ways: One, we want to continue to invest in R&D and continue to invest in our products.

And I would assume that the R&D line is going to stay relatively constant as a percentage of sales.

And I think secondly, when you think about marketing in sales, investing in our products and brands in terms of marketing in sales, we will also continue to invest.

Now, I would expect that over time we will get some leverage more directly on that line and leverage in general.

You know, a couple of the things that we've done that John could also comment on here over the past couple of years is where we haven't had a direct sales force we've built it out.

Now, that adds the head count in the short-term outside of product development but in the long term it's adding to the top line in generating return.

And philosophically on a head count basis, our objective is to stay focused on, you know, adding people that drive our codes and build our games.

Right.

Just following up on the direct model.

The channels that you're selling to, it would seem to me are present and not growing at a substantial amount.

So that you should get a fairly high leverage on each salesman as far as the dollars sold per salesman.

Given that you have greater content going into whatever distribution channel you have.

So you should get --?

I -- the only thing offsetting that a little bit is where the profits are taking Italy direct, some of the eastern European markets, a year and a half ago we took Portugal, Iraq opened up, Brazil -- um,.

So the in U.S.?

China.

And those are actually sales generators for us.

But we are absolutely getting more leverage for sales.

And certainly in North America.

Uh-huh.

So the North American model, is that fairly well built out now?

Yes.

And it has been for several years, I think.

Uh-huh?

We've had a very limited amount of head-count growth.

The head-count growth has occurred in marketing as our marketing budget has gone up in a very substantial way to drive volume.

Uh-huh.

And then just a question and -- I think either -- I wasn't paying attention or someone was talking over.

You mentioned that the benefit of development inside was on the COGS line?

The development inside is on the R&D line, not on the COGS line.

Okay.

So your R&D goes up, does the COGS line go down because you aren't paying a license fee?

The COGS line would go down, yes.

That's obviously going to be dependent upon overall volumes but it's a matter of principle.

On a percentage of sales basis?

Yes.

Okay.

Thanks very much?

Built on one point here.

I don't know if you've noticed, but the analyst published the data on the average game quality medic critic average. 77, 81 in the past 12 months for EA and I've seen a bundle of others that use different time frames.

But the general positive trend in our game quality.

Um, that's the biggest place we get a return from interim development.

We have the world's finest studios and when we put our best internal people on you've got it.

You know, in fact you'll see a little bit of that in Q2, Tom, because we will be doing much more internal development this year than we did last.

So you might see a higher relative expense, uh, higher relative expense on the R&D line, most notably in Q2.

And our final question will be a follow-up from Mike Wallace of UBS.

Hi.

A couple quick ones.

First, the Medal of Honor for the consoles, will that have on-line play for PS2.

Second, could you give us the major titles for the March quarter, and then, third, with the on-line costs coming down, what sort of thing are you doing to drive revenue?

I know The Sims on-line is still kind of moving sideways, but are there other subscription games that you're working on that you can talk about?

So the Medal of Honor to have on-line play.

I think Larry's going to get the second piece.

And in terms of the other on-line question, the couple of things are happening positive.

One is we are going to be launching a 3D-version of UL in Q-4 of this year which will help reinvigorate the ultimate franchise.

And beyond that we are going to be relaunching TSO around some new features in the fall.

The key titles, Mike, that are in the pipeline for Q4 at this point would include The Sims, busting out, which is on four plat forms, that's a console based game.

Sims 2.0 on the PC, Medal of Honor, Pacific assault on the PC, Death Champ Vandetta 2 on four platforms, again, a console orientation there.

NFL STREET, as we mentioned earlier on three platforms.

Our next generation NPV baseball product and another Sims City expansion pack.

Okay.

Any update on the on-line Microsoft issue?

Uh, no change in the status of those discussions.

Okay.

Thanks.

Great.

Well, thank you everyone for joining us today and if you have any further questions please feel free to give us a call?

Thanks a million, everyone.

And that does conclude today's conference call.

Thank you everyone for your participation and you may now disconnect.