美商藝電 (EA) 0 Q0 法說會逐字稿

Please stand by.

Good day everyone and welcome to the Electronic Arts first quarter fiscal year 2005 earnings conference call.

Today's program is being recorded.

For opening remarks, I would like to turn the call over to Mrs. Karen Hancock, President of Investor Relations.

Please go ahead ma'am.

Good afternoon, and welcome to our first quarter fiscal 2005 earnings conference call.

Today on the call we have Larry Probst, Chairman and Chief Executive Officer;

Warren Jenson, Chief Financial and Administrative Officer.

Before we begin, I would like to remind you that you may find copies of our SEC filings, our earnings release, and a replay of the Web cast at Investor.EA.com.

Shortly after the call we will post a copy of Warren's remarks on our Website.

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

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

A supplemental schedule to our earnings release provides a reconciliation of non-GAAP to GAAP measures.

In addition, a supplemental schedule demonstrating how we calculate ROIC will be included with a copy of Warren's remarks we post on our Website.

All non-GAAP measures are provided as a complement to our GAAP 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 may make forward-looking statements regarding future events and the future financial performance of the Company.

We caution you that actual events and results may differ materially.

We refer you to our most recent 10-K for a discussion of risk factors that could cause our actual results to differ materially from those discussed today.

We make these statements as of July 22, 2004, and disclaim any duty to update them.

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

Good afternoon and thanks for joining us.

We would like to start off with a few highlights from the quarter.

First coming out of E3, our lineup looks great.

Collectively our teams walked way with five Best of E3 awards -- Def Jam Fight for New York, the best fighting game;

Burn Out 3, the best racing game;

The Sims 2, the best simulation game;

Madden NFL 2005, the best sports game;

The Lord of the Rings -- Battle for Middle Earth, the best strategy game.

Congratulations to our studio and global marketing teams.

We could not have started fiscal 2005 any stronger.

Second, our titles are selling better than ever.

Three of our Q1 releases went platinum.

And by the way, the first week sales of NCAA and preorders of Madden are well ahead of last year.

Third, we continue to deliver while investing for our future.

Even with 40% plus growth in R&D, our net income this quarter increased by 32%.

And finally, we're pleased to report another strong quarter.

Net revenue was 432 million, up 22% year-over-year.

Fight Night, EURO 2004, and Harry Potter and the Prisoner of Azkaban reached platinum status.

Harry Potter sold more than 2.5 million units.

Diluted earnings per share increased by 33% to 8 cents.

Trailing 12-month operating cash flow was 638 million.

Trailing 12-month return on invested capital was 84%.

Our balance sheet continues to be strong.

Inventory and reserves are at appropriate level.

In summary, one quarter into our new fiscal year, our titles look terrific.

Our financial performance is on track.

And from an investment perspective, we're exactly where we want to be as we head into a new generation of markets and technology.

For the next few minutes I'll focus my remarks in three areas.

First, I'll talk about our Q1 results in detail; second, our market outlook; and third, our financial guidance for the second quarter and fiscal year.

Following my comments, Larry and I will open the call to your questions.

Our first quarter result -- net revenue for the quarter was 432 million, up 22%.

We released 11 SKUs in the quarter compared to 10 a year ago.

Harry Potter and the Prisoner of Azkaban sold more than 2.5 million units globally, and 60% of those sales were international.

Fight Night was a great game and a solid success.

It sold close to 1.5 million units in the quarter and this title brought us solidly back into the fighting category.

Euro 2004 sold over a million units and approximately 90% of those sales were international.

Need for Speed Underground, MVP Baseball, and The Sims franchise showed continued strength, each selling over 500,000 additional units.

And by the way, unit sales of Underground have now passed 7 million.

Geographically our growth was driven by Europe, where the launches of Harry Potter and EURO 2004 were particularly strong.

In total, international revenue was to 221 million, up 43%.

Europe revenue was 190 million, up 49%.

Asia-Pacific revenue was 18 million, up 22%.

Growth rates were in excess of 80% on both the PS2 and XBox in Europe and Asia-Pacific.

North America revenue was 211 million, up 6% year-over-year.

XBox revenue was up almost 80% as a result of strong sales of Fight Night, Harry Potter, MVP Baseball, and Need for Speed.

Microsoft’s price reduction to $149 clearly drove higher software sales in the quarter.

PS2 revenue increased modestly given the prior year strength of NBA Street, and Def Jam Vendetta.

PC revenue was down sharply year-over-year given the strength of Sims Superstar in the prior period.

Foreign currency movement impacted our top line by roughly 13 million or 4% in the quarter.

Next, our revenue by platform -- please keep in mind that our U.S. segment shares are based on NPD TRIST (ph) and NPD Tech World data.

U.S. console segment shares are through June 2004, while PC segment shares are through May.

In Europe, segment share information is based on EA estimates, as no services comparable to TRIST or NPD Tech World are in place.

First on the PlayStation 2, PS2 revenue was 38% of total revenue or 162 million, up 37% year-over-year.

The increase was driven by strong sales of Fight Night, Harry Potter and the Prisoner of Azkaban, EURO 2004, Need for Speed Underground and MVP Baseball.

In the U.S. we had two top 10 titles and 26% segment share.

In Europe we estimate EA had five top ten titles, and approximately 24% segment share, up 9 points from a year ago.

PC revenue was 15% of total revenue, or 67 million, down 17%.

Last year, our PC revenue was driven principally by Sims Superstar.

In the U.S., EA had one top 10 PC title and 19% segment share as of May, down 4 points from a year ago.

In Europe, we estimate EA had four top 10 PC titles and 21% segment share, down 1 point from a year ago.

On XBox, sales represented 13% of total revenue, or 57 million, up 81%, driven by strong sales of Fight Night, Harry Potter, EURO 2004, Need for Speed, and MVP Baseball.

Our leading U.S. segment share was 19%, up 3 points from the prior year, with two top 10 titles.

In Europe we estimate EA had three top 10 titles and 17% segment share, up 2 points from a year ago.

On GameCube, sales represented 6% of total revenue, or 26 million, up 25%, driven by strong sales of Harry Potter and MVP Baseball.

Our U.S. segment share was 17%, up 1 point from the prior year, with one top 10 title.

In Europe, we estimate EA had 17% segment share, up 5 points.

Co-pub and distribution -- revenue was 16% of total revenue, or 67 million, down 6%, reflecting last year's performance of Final Fantasy.

Subscription services -- revenue was 13 million, down 1 million year-over-year.

Revenue from persistent state world games declined while revenue from Pogo subscription services increased.

At the end of the quarter we had approximately 698,000 active players using our subscription services, versus 338,000 a year ago.

Subscriber growth was driven by Club Pogo, which ended the quarter with roughly 465,000 active players.

EA SPORTS and Games Nation -- our on-line console services continue to thrive with millions of registered accounts.

We now have 17 titles on PS2 on-line and expect to build a similar amount on XBox live this year.

Our first XBox live title, NCAA Football, is off to a great start.

Moving on to the rest of the income statement, gross profit in the quarter was 255 million, up 25%.

Gross margin was 59.1%, up 150 basis points year-over-year.

The increase was primarily driven by lower outside development costs, as we continued to shift to more internal development, and higher margin on our co-publishing related revenue.

Improvements were partially offset, however, by higher manufacturing related costs, and higher licensing royalties.

Operating expense -- marketing and sales expense was 63 million, up 7% year-over-year.

The increase was driven in large part by additional head count, most notably in Europe.

General and administrative -- G&A was 35 million, up 4 million year-over-year.

This increase was driven primarily by higher outside service costs, and higher salaries and wages.

As a percentage of revenue, G&A was 8% compared to 9% a year ago.

R&D.

Research and development increased by 43% year-over-year to 131 million.

The increase was driven by a significant increase in SKUs under development; expansion of our co-publishing business; development of next generation tools, technologies, and capabilities; and higher spending on selected current generation titles.

R&D related head count was up to 28% year-over-year to roughly 3100.

As a percentage of revenue, R&D was up 4 points to 30%.

On to the bottom line -- operating income was 25 million versus 22 million in the year-ago quarter.

Non-GAAP operating income was 26 versus 22 million.

Our op margin was 6% in the quarter and flat year-over-year.

Our non-GAAP operating margin was also 6%, also flat to the prior year.

Our effective tax rate was 29%, down 2 points.

Net income was 24 million, up 18 million, up 32%.

Diluted earnings per share were 8 versus 6 cents.

Non-GAAP net income was 25 million versus 19 million, and our non-GAAP EPS was 8 cents versus 6 cents.

Our diluted share count was 316 million versus 300 million a year ago.

Our option share overhang was 17%, flat to a year ago.

On a trailing 12-month basis, options issued represented approximately 3% of weighted average basic shares outstanding.

Now the balance sheet -- cash, short term investments and marketable equity securities were 2.4 billion, up 748 million year-over-year.

Gross accounts receivable were 291 million versus 166 million, an increase of 125 million.

The increase was driven by our release schedule.

This year, over 40% of our Q1 revenue was realized in the month of June compared to 28% a year ago.

Reserves against outstanding receivables totaled 121 million versus 129 million in the prior year.

Reserve levels were 12% as a percentage of trailing six-month net revenue versus 16% a year ago.

As a percentage of trailing nine-month net revenue, reserves were 5% versus 6% a year ago.

Ending inventory was 53 million, down 2 million from March, and up 27 million year-over-year.

No one title currently represents more than $4 million of exposure.

And one final housekeeping matter -- in the quarter, we made the decision to recognize certain long-term royalty related commitments on the balance sheet.

This increased total assets and liabilities by 57 million at June 30, and 63 million as of March 31, 2004.

This did not and will not impact our income statement, cash flows, or net equity.

In short, our balance sheet continues to be solid.

Before jumping into the guidance, I would like to reinforce a few things that we've talked about over the last several conference calls.

First, we are committed to making the necessary investment in tools, technology, libraries, and people in order to extend our leadership into the next generation of market.

We fully intend to support next generation consoles and the PSP, and will expand our focus on both mobile gaming and Asia.

As we have stated, these investments will pressure margins in both this year and into next.

We also expect pricing pressure over the next couple of years as console prices trend lower.

Second, despite these investments, it is our clear objective to grow both our top and bottom lines straight through the end of the current console cycle.

Our performance this quarter is indicative of what we will work to accomplish.

Third, we think this cycle will likely be very different than the last.

And we think that EA is very different, too.

So, when will the transition hit, and what does that mean?

Well, as to the first question, we think it's already here.

And in fact, we are right the middle of it.

Fiscal 2005 for EA will likely be the year we experience our highest growth rates in R&D spending.

The good news here is that pricing on top tier titles remains globally strong and likely will through at least the remainder of this year.

This transition, however, is not just about consoles.

In fact, it's much bigger.

It's about markets.

Here is how we see the breadth of this market transition.

First, content and the relative value of what we create.

The entertainment world is beginning to understand the value of interactive content.

We think this will only accelerate.

Our industry advantage is demographic and technology-based.

We also possess proprietary tools and development know-how that is not easily replicated.

Every year our audience is expanding.

And technology is making our products better.

Second, the entertainment value proposition.

The entertainment value proposition for our products will continue to challenge that of linear film and television.

In the markets of the next generation, our products will benefit from the convergence of motion picture-quality cinematography, cutting edge music and sound, and the emotion that only interactive technology can provide.

As this element of transition takes place, our market should very naturally expand.

Next generation console transition -- this is clearly a big part of what we are investing in today.

The cross benefit is that our investments will generate returns in every other aspect of this market transition.

If you think about it globally, the console transition really applies to North America, Europe, and Japan.

Next, mobile -- historically we have called this the handheld segment.

What's going on here is truly a market transition.

The market is expanding from kids' handhelds to a market of fully connected, interactive mobile gaming.

Mobile will include three sub segments -- traditional handheld aimed at kids; the cell phone, where the demographics start roughly at 12 years old and go up from there; and finally the 18 to 34 year olds, served by the PSP, Nintendo Dual Screen, and the Nokia N-Gage.

On-line -- on-line in some ways is hard to separate as a point of transition.

But we felt we needed to, as it will impact every form of future game play.

It will be a part of next generation consoles, mobile phones, and globalization.

It will also enable microtransactions and real time exchanges.

We also see the value of our content becoming increasingly important to MSOs, RBOCs, and their global equivalent.

Globalization -- technology is clearly making all kinds of things possible.

In the case of on-line, it's now opening up huge new markets like China and others where price and piracy have been big obstacles.

Mobile gaming is a big factor here as well.

And finally process-based advantage -- it is increasingly clear for us that global process-based efficiency and productivity will be a way of life, and is a major part of this transition.

In summary, our strategy over the coming years is to position ourselves for continued leadership in the reconstituted global interactive world.

We are in the middle of this broad market transition as we speak.

The stakes are huge, and the potential opportunity may be in multiples larger than the market segments we presently address.

This transition is not only about next generation consoles in North America and in Europe.

It's also about the value and quality of our entertainment, mobile and on-line gaming, globallization, and process-based efficiency.

In short, it's about markets.

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

Our industry estimates for calendar 2004 hardware and software sales remain unchanged.

Console pricing, XBox and PlayStation 2, are currently at $149 in the U.S.

We don't necessarily expect another round of price reductions, but one is possible.

In Europe it's possible and fairly likely that a price reduction could happen prior to the holidays.

During the year, we expect premium titles to continue to hold the $49 price point, but that lesser titles will move toward $39.

Pricing on top tier titles remains strong.

In North America, we expect the following hardware unit sales -- PS2, between 6.5 to 7.5 million units;

Xbox, between 3 to 3.5 million units;

GameCube, between 2.5 and 3 million units.

In Europe, we expect the following hardware unit sales -- PS2, between 7 and 8;

Xbox, between 1.5 and 2 million units;

GameCube, between 1 and 1.5.

In North America we expect growth in software sales as follows -- for the PS2, up 8 to 12%; for the XBox, up 15 to 20; for the GameCube, up 10 to 15’ and for the PC, roughly flat.

Overall we expect software growth rates in Europe to slightly outpace the comparable growth rates in North America.

Now on to our financial guidance -- the following forward-looking statements reflect expectations as of July 22, 2004.

Results may be materially different and are affected by many factors, such as -- changes in foreign exchange rates, development delays, the overall global economy, the popular appeal of our products, our ability to secure key licenses, and other risk factors detailed in our earnings release and in our annual and quarterly SEC filings.

I'll cover our financial guidance in two parts.

First I'll discuss the second quarter of 2005 and then our outlook for the full year.

For the quarter ending September 30, we expect revenue to be between 680 and 715 million, up 28 to 35% compared to the prior year; earnings per share to be between 28 and 34 cents, up 12 to 36% year-over-year.

In Q2, we expect to ship a strong 35 SKUs.

As you know, we have already shipped NCAA Football 2005.

This title is off to a strong start, selling at a pace of more than 50% ahead of last year.

It went platinum in just a week.

Madden ships on August 9, and preorders are double last year.

And by the way, the game looks great.

We expect to ship the following SKUs in the second quarter -- NCAA 2005 on three platforms, Madden NFL 2005 on 6;

Madden NFL 2005 Collectors Edition on the PS2;

NASCAR 2005 Chase for the Cup on three platforms, NHL 2005 on four;

Tiger Woods PGA Tour 2005 on four platforms.

Catwoman is out on five platforms, Burnout 3 on two, Def Jam Fight for New York on three platforms, The Sims 2 on the PC, The Sims 2 Special Edition on the PC, Medal of Honor Pacific Assault on the PC, Medal of Honor Pacific Assault Director's Edition the PC.

Our full year guidance -- for the full year we expect revenue to be between 3.3 and 3.4 billion, up 12 to 15% year-over-year; earnings per share to be between $2 and $2.10 as compared with $1.87 for the prior year.

CapEx -- in the quarter, we made the decision to significantly expand our Vancouver studio.

As a result of this decision, we expect our total capital expenditures for the year to now be between 120 and 135 million.

As we look at our lineup for the quarters ahead, we expect strong year-over-year comparisons for our fiscal 2nd and 4th quarters.

For our fiscal third quarter we expect our top line to be roughly flat to last year.

Our bottom line trend should be similar.

I'll now conclude with a few closing thoughts.

First, we are playing from a position of global strength, with big, recurring, lasting franchises in place.

Second, we're fortunate to be in a position where we can build for the future by investing in people, processes, and technology, and in new, exciting global markets.

At the same time, we are intent on delivering bottom line results.

We are 110% focused on execution.

And we take nothing for granted.

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

We are a digital entertainment (speaking Latin).

With that, Larry and I will open it up to your questions.

Operator.

Thank you at this time if you do have a question, please press star, 1 on your touch-tone telephone.

If you are use speakerphone, please release your mute function and pick up your handset so that your signal can reach our equipment.

We will take only one question per caller today.

Again, that is star, one for any questions.

We'll take our first question from Heath Terry of CS First Boston.

Hi, guys, a couple of questions.

First, Larry, assuming you have, and I know you've had people out there, are just back from the IMA event.

Can you give us your feel on kind of retail attitude towards the rest of this year, and maybe how that's changed recently?

And particularly what their outlook is relative to the level of competition this Christmas?

How are they dealing with the number of big titles that are competing for the same amount of shelf space this year?

And then, Warren, you mentioned that this was going to be the year where growth in R&D peaked.

Is that also fair to say that this is going to be the year where R&Ds as a percentage of sales peaks?

Or is that going be to next year?

So, Heath.

This is Larry.

I would characterize retailers' attitudes as being very well bullish.

Most of them had strong months -- in the month of June.

July is off to a good start with titles like NCAA Football.

And as you correctly point out, there are some tremendously strong titles in the pipeline, and there's lots of anticipation on the retailers' parts towards them in the back half of the year.

So obviously FTA has a great lineup.

And there are titles like Gran Turismo on the horizon, and Grand Theft Auto San Andreas, and Metal Gear Solid 3, and Halo 2.

So I would say that retailers are very excited about the back half of the year.

It remains to be seen whether all of those titles will be delivered on time.

But I would characterize this year's lineup of titles as stronger than last.

And then Heath as to your second question, obviously the answer to that depends upon our relative revenue growth rate.

And while I won't comment on that specifically for FY '06, but what I will say about FY '06 is, you know, the good news is pricing has been holding very strongly recently on top tier titles.

And we'll see how that works into FY '06.

But there is a clear trend today, and then the second thing is that we have a very strong lineup of titles in our SKU mix.

The third thing is we'll all see, but we remain very optimistic relative to the success of the portable PlayStation.

And we will continue be to working to build and expand our business globally.

Some of that will also help out in terms of our FY '06 revenue growth rate.

Great thanks.

We'll move next to Tony Gikas with Piper Jaffray.

Hi, good afternoon guys, couple of quick questions for you.

Could you give us a little more color on European market update to date?

Do you think that they are still running roughly a year behind the U.S.?

Or have they caught up to some degree?

And when do you think we might get price cuts on hardware in Europe?

And then the second question, as it relates to the PlayStation portable, how much do you think that can grow the overall handheld market through the next cycle?

Does that boost the overall handheld market by 50% or more?

Well, with regard to Europe, business is very good in Europe.

Warren made some comments in his opening remarks about the success we had with our soccer title in the June quarter.

And we've given guidance previously about hardware sales and software sales in Europe relative to North America.

We're actually projecting more units of PlayStation 2 being sold this year in Europe than in North America.

And the way things are tracking so far, that looks to be on-track.

So I would say business in Europe is good, and people are optimistic about the back half of the year.

With regard to PSP, I don't know if we can quantify what it's going to do to the handheld market.

But I think it introduces a whole new demographic of 18 to 35 year olds who typically have a lot of disposable income and buy a lot of software.

So I think it's going to have a significantly positive impact on the overall handheld business.

It remains to be seen what percentage that is, but I think it's going to be meaningful.

Do your hardware sales assumptions in Europe assume a price cut?

They do not, but it would not surprise us to see a price cut prior to the holiday season.

Okay.

Thanks, guys.

Thank you.

Next we'll hear from Harris Nesbitt's Edward Williams.

Hi, good afternoon, a couple of questions.

First of all, Larry if could you could kind of take the Tony’s question on the PSPs further out a little bit, and expand on what you're looking for mobile.

How significant could it be in the next generation of the platform cycle?

And do you anticipate it cannibalizing consoles to any degree?

Are you asking a question about PSP in particular, or --

No, I'm looking at PSP, Mobile, cell phones, Nintendo DS, just as you referred it to as the mobile market.

We think that that's a pretty interesting longer term opportunity.

Obviously, the things that are on the immediate horizon are PSP and Nintendo Dual Screen.

And we're ramping up pretty aggressively for both of those platforms.

In terms of short term opportunity, and now I'm talking specifically about cell phones, I don't think that's huge.

But longer term it's something that we're going to be focused on.

And we think it's going to grow over time.

Previously in the cell phone business, we've take a licensing strategy.

We're going to get more directly involved on the development side.

I think we've got three EA titles in development, and three Pogo titles in development.

We'll be partnering with a distribution partner, so we're going to be moving up the food chain very quickly and taking a bigger piece of the pie from a financial standpoint.

So we're going to get more involved.

And we think it's a pretty interesting longer term opportunity.

Shorter term, obviously PSP, Nintendo Dual Screen, and we're going to be strongly supporting both of those platforms.

You know, Ed, I would just add to that that I think you're going to have to analyze it based on region of the world, because different regions will have different trends relative to how important one -- console relative to mobile, and just based on demographic trends, and how people live.

So I think it is going be to slightly dependent upon which region of the world.

Okay.

Any anticipation that there may be any cannibalization of the console market in any of the regions, or is that something that you're not anticipating at this point?

We don't see that at this point.

Okay, and then secondly looking at your head count, what do you currently have in the development studios?

How many teams do you have?

And what's the percent of the SKUs that you're going to launch this year that will come from those internal studios?

Well, in term of teams, I don't know that specific number.

I will tell you that our total head count in the studio is about 3100 currently, and that's out of 4800 total employees.

And in terms of internal SKUs versus external --

We're going to do -- roughly 85% of our revenue will be done -- will come from internal development this year.

And in terms of our gross margin for example, we clearly benefit in our gross margin this quarter as a result of -- as a result of that shift.

We think also, you know, the side benefit here is we know we get quality enhancements, revenue enhancements by doing it.

So it's really a margin game, and not just a cost game.

Okay.

And then just to follow up on that for a moment.

The -- how many of these 3100 -- percentage basis if you can look at it that way, are working on new technology, be it the PSP, the PlayStation 3, or whatever it might be?

I wouldn't -- you know, I won't go into -- it's honestly kind of a hard question to answer, because all of our teams are developing with an eye toward next generation development.

We do have people specifically dedicated to things like our fusion project, which is all around building an efficient process-based way to support existing platforms, building efficient ways to build the PSP titles, as well as building next generation technology.

I will tell you our investment is in the tens of millions of dollars, currently, for next generation.

And we're going to continue to invest at that, if not even slightly higher levels here over the next several quarters.

Okay.

Great.

Thank you.

Thank you.

Moving on to Mike Wallace of UBS.

Hi.

A question about the product flow.

You talked about the December quarter being flat.

It looks like that would imply the fourth quarter is up 20% or so.

Could you talk about what the release schedule looks like Q3 and Q4?

And has anything shifted around?

Not really any significant shifts.

In terms of number of SKUs we're going to release, it looks like about 35 in the September quarter.

About -- I'll give you a range for December.

It's probably in the range of 35 to 40, and a similar number in Q4.

Okay.

But as far as the major products, though, nothing's moved out of Q3, or Q4, or vice versa?

No

Okay.

Regarding the football game, I -- it's only been out for two days, but the ESPN game looks like it's doing pretty well.

Do you think, at $20, it's going to have any impact?

It seems to be selling well, and it also to be helping out preorders for Madden.

So what's your thought on Take 2 and Sega going out at $20?

Well, as Warren stated in his remarks, NCAA Football sell through is up about 55% year-over-year.

So we're very happy with that.

Preorders on Madden are up 100% versus last year.

We're very happy with that.

As you rightfully point out, Sega has had a good two days initially.

We think that more people this year will buy two football games than they did last year, and we think that once Madden is in the marketplace, it's going to be tremendously successful.

The quality is extremely high, we're very happy with the marketing that we're about to launch.

And we think that we're, again, that we're going to have by far the largest market share in the professional football category.

So everything is on-track as far as we're concerned, and we'll see whether or not that $19.99 price point moves the needle for Sega.

But we're very happy with NCAA, and we're very bullish about what Madden is going to do once it launches in a couple of weeks.

Thanks.

Moves next to our Arvind Bhatia with Southwest Securities.

Good afternoon guys.

A couple of questions.

First one is -- Warren can you comment on operating margin potential as you go through the next cycle?

Obviously you had an increase every year during this cycle.

What sort of increases do you think we can see as we move forward and you start to leverage a bigger and bigger revenue base?

And then I have a follow-up.

I would say looking out -- I mean time will ultimately tell, quite obviously.

But if you think about what could change the margin structure, I've sort of outlined a few things.

First of all we will continue to focus on the development of more wholly owned intellectual property.

That stands to move margins up and obviously gross margins up.

The second thing depending upon the development of the on-line business and a mobile business, some of that could be very high margin business.

And then the third thing, again which is a multi-year transition if you will, will be our relative success in building standard processes, if you will.

We call it in development, standard tools and libraries.

But really it's applicable to everything we do a on a global basis.

And if we can do that with all our processes, we think we've got a great shot at building some real process-based productivity into our future.

Those will be the drivers of margin looking ahead to the next generation.

Is it a target that you have in mind, you know, 30%, anything like that that you would like to target?

No, I don't -- we're not prepared right now to put out a target for the next gen.

I'll tell you, our principal target is to continue to do what we did this quarter through the back part of this console cycle, and that's we want to grow our top and grow our bottom line.

And again we're very pleased that we're able to do both this quarter, despite the strong spending.

And I know you didn't want to give any guidance for next year necessarily, but you did say you expected revenues to continue growing.

Would that same thought process hold as far as margins are concerned as well, into next year?

No.

Again, let me just clarify.

What I tried to do was lay out the factors that we see ahead for us in FY '06.

We know that there's strong pricing trends today.

We like our lineup in terms of our SKU plan.

We know the PSP is on the horizon, and you know we are investing to build our presence globally.

Those are all things that could help drive our top line.

The flip side to that is we will expect and do expect some pricing pressure as we move to the latter part of the current console cycle.

That will play out as we get closer to FY '06.

On the bottom line, it's going to be more of the same.

We're going to look to continue our investment strategy, at the same time look for ways that we can build productivity into everything that we do.

Okay.

And then just a quick follow up on NCAA, and maybe even Madden preorders.

How much of that has to do with the XBox Live feature of those products?

In other words, how much strength are you seeing in XBox versus the PS2 version?

I think it has something to do with the strength of the sell-through and the preorders on Madden.

Obviously there's a lot of pent-up demand for our sports titles with people that are on the XBox Live system.

So obviously we think that's going to help the sales of our XBox sports products.

We think it's going to drive market share for us on the XBox platform, we think it's going to help Microsoft sell more hardware.

Got it.

One more if I could on Catwoman, you know the ratings that you've received so far seem pretty low, by your standards anyway.

What happened there?

Can you make any comments on it?

I'm sorry, the ratings on Catwoman?

Yeah, on the game that just came out.

I think you talked about it just launched a few days ago, and the movie comes out, I believe July 23.

I wonder if you could maybe comment on what the sell-through trends have been and, you know, the ratings that -- that we've seen so far seem to be in the 50% range.

Wondering if you could comment on kind of what happened there?

You know, I can't specifically comment on the ratings to date.

What I can tell you is that we think we've got, you know, a great star in Halle Berry in the middle of the game.

We've got a great plan at retail.

We don't think this is going to be Need for Speed Underground 2, but we expect a strong sell-through of the product.

Okay.

Thanks, guys.

Moving next to Merrill Lynch's Karen Rusillo.

Hi, I was just wondering if you've noticed any shift in major retailers.

Specifically, I guess Wal-Mart, and if you had any comment on -- and it looks like Wal-Mart is starting off a lot of the Triple A titles at $45, rather than the $49.99.

We have not seen any sort of significant shift in term of a percentage of our business or percentage of market share with the major retailers.

And interestingly, there was a price survey done not too long ago, which actually showed Wal-Mart be to the highest priced retailer.

So I don't know if that's go going to continue to be the case as we go through this year, but they have not been particularly aggressive in terms of pricing.

Regardless, they're obviously everybody's number one customer, but they have tended not to be a price leader.

Okay.

And then if I could just get one more follow-up on some of the earlier wireless questions.

I don't have the answer to this.

I didn't quite get it.

In terms of the handheld mobile market for, you know, on the cell phones, is it -- your strategy going to be to continue to partner with some other developers that have the infrastructure already in place in terms of the billing with relationships with the carriers?

Or is there something that you are investing in now to try and build that out?

What I talked about was -- previously we have taken a licensing strategy where we were not involved in the development of any of those products.

We're now going to get more actively involved in the development.

We're going to partner with some people to do the ports, if you will, to all of the different handhelds and different carriers.

And we're going to move up the food chain in terms of the revenue splits, and what kind of revenue we can generate for EA.

Longer term, you know, we'll figure out what our strategy is as we want to get further involved.

Okay.

Great.

Thank you very much.

Moving next to Bill Lennan with W. R. Hambrecht.

Thank you.

A couple of data points for first question.

Could you tell us catalog as a percentage in the quarter, foreign exchange?

And Warren could you give us an estimate of what percentage of revenue you expect from international in the fiscal year?

That's part one.

Part two, Activision spoke yesterday of -- they're expanding their European presence, and the implication was there was an opportunity there that they have not yet fully exploited and they want to get more people on the ground.

Did you feel that you, too, could expand your market with a greater European presence, or that you have adequate bodies on the ground right now?

That's it thanks.

As to the first question on catalog we are at just slightly under 30% catalog in the quarter, and in the year ago quarter we were at 31%.

So it's down, you know, roughly 200 basis points year-over-year.

And then I may have missed the second part of that question.

Well the second part of the question had to do with Europe, and the answer is that we've got a tremendously developed -- or tremendously developed business in Europe already.

I think you asked the question what percentage do you think international will represent this year, the percentage of the total.

It's probably a number in the neighborhood of 45% of our total business, 45 to 47%.

Our business in Europe is huge.

It was more than $1 billion last year.

It's already bigger than the worldwide business of any one of our competitors, and we think there is tremendous opportunity for growth from here forward.

So I guess what Activision talked about is something we've already achieved and we're going to continue to push forward aggressively.

And again, that is star, 1 for any questioners or comments that you may have at this time.

And we'll move next to Liz Osner with Citigroup Smith Barney.

Hi guys, how are you?

Just a couple of real quick ones with regard to on-line revenues and on-line initiatives.

I know you are spending a lot to kind of develop infrastructure.

Do you have any sense of when that becomes really material to profits, you know, obviously with the new XBox Live initiative kind of ramping up, when that kind of ramps up?

And then, also, you know, when advertising becomes sort of a bigger piece, whether that means, you know, more integration of on-line advertising, or product placement within the games --?

I would -- I'll take a stab, and Larry may want to jump in on this.

I think, you know, first of all, I'd recognize one of the real success stories of this year has been what Club Pogo has been doing.

We're over 450,000 active players.

About 90% -- 90% plus of people that sign up for the free trial period are converting to pay.

And we continue to grow that base to a very comfortable -- be well in excess of half a million paying subscribers on Pogo.

I think as you look on-line, the next step will be taking that service to other platforms and other geographies for example.

So it may be that, you know, Pogo shows up here within the next year, it could be 18 months or so in a market like China.

You'll also see us as we move into the on-line markets like a China for example, an Asia, that we'll begin to then development our on-line business.

So I think in a meaningful way, it's not, you know three months, it's not five years, but we're clearly investing today.

We'll clearly be ramping up.

There's going to be some learning, and you're going to see it really take place, I believe, you know, principally in the foreign market.

So with regard to end-product advertising, product placement, sponsorships, that's a business that's growing.

It's probably something that's in the neighborhood of 20 to $30 million in this fiscal year.

We think it's going to get bigger over time.

Is it going to get 10 or 20 times bigger than that overnight?

No.

We have to be careful about not overwhelming the consumer with too many advertising messages.

And what's more important is the integrity of the entertainment experience.

So we will grow that business, but we will be careful about how we include advertisers’ products or any kind of sponsorship in our products so that we don't disturb the entertainment experience.

Okay.

Great.

Thanks guys.

Thank you.

And there appear to be no further questions.

That does conclude today's Electronic Arts conference call.

You may now disconnect, and have a great day.

Great.

Thanks everybody.