美商藝電 (EA) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to the Electronic Arts first quarter of fiscal year 2006 earnings conference call.

Today's call is being recorded and for opening remarks and introductions, I would like to turn the conference over to Ms. Tricia Gugler, Director of Investor Relations.

Please go ahead.

Good afternoon and welcome to our first quarter fiscal 2006 earnings call.

Today on the call, we have Larry Probst, Chairman and Chief Executive Officer; 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, our earnings release and a replay of the webcast on our website at investor.EA.com.

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

Throughout this 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 in affiliates, acquired in process technologies, amortization of intangibles, employee stock based compensation, and certain non-recurring litigation expenses and their 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 the copy of Warren's remarks.

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 call are against the same period for the prior year unless otherwise stated.

During the course of this 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 Form 10K for a discussion of our risk factors that could cause our actual results to differ materially from those discussed today.

We make these statements as of July 26, 2005, and disclaim any duty to update them.

We have included our trailing 12 month platform shares and our 2005 estimated market outlook by platform in a supplemental schedule that will be posted to our website.

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

Thanks, Tricia, and good afternoon, everyone, and thank you for joining us.

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

First, E3, well, we had a great E3, receiving 7 Best of E3 awards.

Spore received 4 awards - Best of Show, Best Original Game, Best PC Game and Best Simulation Game.

Madden NFL 2006, the Best Sports Game.

This is the second year in a row for Madden and Madden has taken this award 3 of the last 5 years.

Burnout, the Best Racing Game for the second year in a row and Battlefield 2 the Best Online Multiplayer Game.

This performance summarizes what we're all about, creativity, innovation and leadership.

Congratulations to our studio and marketing teams on these terrific accomplishments.

Second, we're pleased with the performance of our Q1 titles.

Battlefield 2, with a Metacritic of 90, is the number one PC title in both North America and in Europe.

In just 2 weeks we have doubled the size of the on-line audience for this franchise.

Medal Of Honor European Assault went platinum in the quarter.

In the UK, MOH was the number one PS2 title for 4 weeks post launch, and in North America it was the number one first person shooter for the month of June.

Third, our PSP revenue share is now 26% in North America.

For the month of June, we were the number one publisher on this platform.

And finally, we like our next generation trajectory.

We can't wait to get our titles in front of our customers.

For the next few minutes I'll focus my remarks in 3 areas.

First I'll review our Q1 financial results.

Second I will discuss our outlook.

Third I'll go over our financial guidance.

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

Q1 performance.

Net revenue was 365 million, driven by Medal of Honor European Assault, Battlefield 2, and to a lesser extent, Batman Begins.

The strength of these titles did not offset last year's strong performance of Harry Potter and the Prisoner of Azkaban, Fight Night, and UEFA EURO 2004.

We had 2 titles that went platinum in the quarter, Medal of Honor European Assault and Battlefield 2.

On the PSP, with 6 titles in the market, we were the one publisher for the month of June in North America.

Geographically, and North America revenue was 184 million, down 27 million or 13% year-over-year.

The decline was primarily the result of significantly lower overall PS2 and co-publishing related revenue, partially offset by sales on the PSP and PC.

Europe revenue was 144 million, down 46 million or 24%.

The decrease was driven principally by lower co-publishing and console-related revenue.

Last year's European results were driven by Harry Potter and UEFA EURO 2004.

Total international revenue was up 181 million -- was 181 million, down 18%.

Asia-Pac, which includes Japan, was up 21% year-over-year, driven primarily by PC and PSP related skills.

Changes in foreign currency rates improved our topline by roughly 10 million or 2% in the quarter.

Where do expect, however, this will be the last quarter in fiscal 2006 in which currency movements will favorably impact our topline.

PC revenue was 74 million, up 11% driven by the success of a Battlefield 2, offset by last year's launch of Harry Potter.

Mobility, which includes revenue associated with all mobile devices including handhelds and mobile phones, increased by 34 million in the quarter to 52 million, up 180%.

The increase was driven by the introduction of the PSP in North America and to a lesser extent the NDF [ph].

Need for Speed Underground Rivals continues to hold the number one spot in North America, and both Tiger Woods and PGA Tour 2005 and NFL Street were also top 10 titles.

As of today, we have the number one and number three was popular mobile phone games, as ranked by GameSpot.

Co-pub and distribution revenue was 30 million, down 56%.

Now that Digital Illusions is consolidated into our financials, Battlefield 2 revenue is classified as PC.

Internet services, licensing and other was 26 million down 7 million year-over-year.

The decrease was primarily the result of lower licensing revenue partially offset by an increase in Club POGO subscriptions.

If you have a chance, we'd ask you to go check out the POGO Minis, the new Avatars on Club POGO.

In the first 3 weeks post launch 2.1 million downloads have already taken place.

Moving on to the rest of the income statement, gross profit in the quarter was 214 million, down 16%.

Gross margin was 58.8% versus 59.1% a year ago.

The decline was primarily driven by higher sales return charges in Europe, offset by lower overall license royalty rates.

This quarter, our top titles were non licensed properties such as Battlefield 2 and Medal of Honor European Assault.

Marketing and sales.

Marketing and sales expense was 75 million up 12 million year-over-year.

The increase was primarily driven by higher employee related costs and increased advertising in North America associated with Madden draft day and overall increased ad spend related to our Q1 releases.

G&A.

G&A was 51 million, up 16 million year-over-year.

The increase was primarily driven by headcount costs, higher outside service costs and increased depreciation.

While this quarterly increase is significant, we expect G&A for the full year to be up in the mid single digit range.

Research and development.

R&D was 183 million, up 40% year-over-year.

The increase was driven principally by the development of next-generation tools, technologies and titles.

The increase was partially offset by lower third-party development advances as we continue to focus on increased internal development.

R&D related headcount was up approximately 40% year-over-year to roughly 4500.

Acquisitions accounted for 13 percentage points of this increase.

Please remember that we are investing ahead of next generation revenue.

We record the expense today but the revenue comes later.

Interest and other income.

Interest and other income was 17 million, up 85% year-over-year.

The increase was driven by higher interest income due to higher yields and higher cash balances.

Our loss -- diluted loss per share was $0.19 versus diluted earnings per share of $0.08 a year ago.

Non GAAP diluted loss per share was $0.18 versus non GAAP diluted earnings per share of $0.08.

Our trailing 12 month operating cash flow increased to 669 million, versus 638 million for the comparable period.

Through the end of the quarter, we had repurchased 7.1 million shares at a total cost of approximately 378 million.

We do intend to complete our 750 million share repurchase program by the end of Q2.

Our diluted share count was 308 million versus 316 million a year ago.

Because we had a net loss in the quarter, basic share count was used in the calculation of diluted loss per share.

On to the balance sheet.

Cash, short-term investments and marketables were 2.7 billion, up 378 million year-over-year and down 349 million from March.

The decrease from March relates primarily to the repurchase of our common stock.

Gross accounts receivable were 278 million versus 291 million a year ago, a decrease of 13 million.

Approximately 55% of our quarterly revenue occurred within the month of June versus 43% a year ago.

Reserves against outstanding receivables totalled 111 million, down 10 million from the prior year.

Reserve levels were 12% as a percentage of trailing 6 month net revenue, consistent with last year.

As a percentage of trailing 9 month net revenue, reserves were 5%, comparable to a year ago.

Ending net inventory was 66 million, up 4 million from March driven by the inventory build for the launch of NCAA Football 2006.

Other than NCAA Football, no one title represented more than $4 million of exposure.

Our balance sheet continues to be solid.

Our outlook.

Before we get into the numbers, let me just mention a few things.

First this is a great time for EA, it's transition.

And while difficult, we believe our ability to navigate the transition is a competitive advantage.

Second, while it's exciting to prepare for the launch of new platforms, this is also a hugely challenging time.

It's a time where the certainty of expense is more pronounced versus the promise of revenue.

If you're wondering whether something in the industry could go wrong, like hardware delays, production snags, or changes in demand, well, we think you should count on it.

There simply is too much change going on for us to expect otherwise.

That said, while these risks are real, we are in the middle of a powerful long-term secular growth trend fueled by improvements in interactive technology, expanding demographics, globalization and new avenues for distribution.

In short, this is a great time for interactive and a great time for EA.

I'll conclude my portion of today's call with our market outlook and financial guidance. 2005 market outlook.

We have essentially maintained our total software estimates for North America and Europe, but have slightly lowered our total hardware estimates for the year.

As Tricia mentioned, you can find a detailed summary of our market outlook on our website after the call.

Now on to our financial guidance. the following forward-looking statements reflect our expectations as of July 26, 2005.

Actual results may be materially different and are affected by many factors such as development delays, hardware availability, competition, the popular appeal of our products, changes in foreign exchange rates, our effective tax rate, and other factors detailed in our earnings release and in our SEC filings.

Now the numbers.

For the quarter ending September 30 we expect revenue to be between 600 and 630 million.

And GAAP and non GAAP diluted earnings per share to be between flat and $0.05.

These expected results also include the projected impact of our share repurchase program.

In Q2, we expect to ship 32 SKUs.

As you know, we have already shipped NCAA Football 2006.

This 90-rated title is off to a strong start, tracking ahead of last year's sell through in North America.

Preorders for Madden are already at record levels and the early reviews look great.

Our expected line up for the second quarter includes Burnout 4 on 3 platforms, Madden NFL 2006 on 7, Marvel Nemesis Rise of the Imperfects on 3, NASCAR 2006 Chase for the Cup on 2 platforms, NBA Live 2006 on 5 platforms, NCAA Football on 2 platforms, NHL 2006 on 4 platforms, Sims 2 Nightlife Expansion Pack on the PC, Tiger Woods PGA Tour on 5 platforms.

We plan to have 4 titles available for the launch of the PSP in Europe, NBA Street, Need For Speed Underground Rivals, NFL Street and Burnout Legends.

On mobile phones, we plan to launch 6 games in North America, Need for Speed Underground, Madden 2006, Tiger Woods 2006, POGO Poppit!, POGO Turbo, and POGO Tri-Peaks Solitaire.

For the full year.

For the full year, we have reduced our previous range by 100 million on the topline and by $0.10 per share on the bottom line.

This reflects our decision to delay Godfather.

It also reflects to a lesser extent the impact of changing exchange rates, most notably on the top line.

Make no mistake, we were disappointed by the delay in launching Godfather.

Nonetheless, it was the right -- it was the right thing for the long-term strength of this key franchise.

For the full year, we now expect revenue to be between 3.3 and 3.4 billion.

GAAP and non GAAP diluted earnings per share to be between $1.45 and $1.60.

These expected results include the projected impact of our share repurchase program.

Looking ahead, while we do attempt to hedge a portion of our foreign currency exposures, any material movement, most notably in the Euro and the British pound will impact our results.

Further we now expect our revenues to fall in roughly the following percentages for the back half of the year. 45 to 50% in Q3 and 20 to 25% of the total in Q4.

I'll now conclude with a few closing thoughts.

First, we feel very fortunate today to be in the middle of the -- one of the most interesting global growth trends in business today.

Second, while there is plenty of risk and we certainly can and will make mistakes, there is no company in a better position to take advantage of this long-term opportunity than Electronic Arts.

And third, rest assured as a team and as a Company of game makers, we are intent on winning.

We look forward to reporting our progress in the coming quarters.

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

Operator?

[OPERATOR INSTRUCTIONS].

Edward Williams, Harris Nesbitt.

Good afternoon.

A couple of questions for you guys.

As the -- as the year began what have you seen is the biggest change in your expectations for developing for next gen of hardware?

Where -- where you were 6 months ago versus where you are today.

I would say one of the -- one of the challenges is probably getting as many development systems as we would like as quickly as we would like.

Having said that, we've got hundreds of development systems -- beta development systems for the Xbox 360 and probably 45 or 50 next generation systems for the PlayStation 3.

But we'd certainly like to have more and have them sooner.

Is it taking any longer to create the games or to get them to a level that you were hoping to have them at this point?

I don't think so.

I think they're tracking to our expectations, but again, if we had more deb [ph] systems -- more next-generation deb systems sooner, that would be helpful, but in terms of the development timeframe and tracking to the initial launch dates I think we're in good shape.

And I would add to that, Ed, I think one of the main takeaways is we got back from E3 and all huddled to look at our various conclusions, I don't think there was an individual that wasn't impressed with the quality of what we were seeing and what is going to be made possible by next gen.

So clearly challenges like in any other major change, but at the same time we're really enthused about what this product can turn out to be.

Okay, and then also looking at the retail channel, you had mentioned there are -- inevitably with any transition there are difficulties.

Looking at the retail channel both in North America and Europe at this point, are you seeing any excess inventory that is creating any issues?

I think we're in good shape with regard to retail inventories and I think we're appropriately reserved.

Thank you.

Mike Wallace, UBS.

Hi.

Couple questions.

First, could you talk about your '06 expectations?

Not earnings, I'm talking from your market standpoint?

Sounds like things do get trickier, as we all know, but particularly in '06 are you looking for a flattish-type market, up a little bit?

And along those lines, how would you classify the PSP?

Is it tracking to expectations?

Do you think you see a price cut and improvement next year, and you think the PS3's going to be on time?

Second question, Godfather, when in Q4 is that going to ship?

Is it going to be early or later in the the March quarter?

And the third question is, pricing for the 360, it looks like your games are going out at 60.

How long do you think those price points are going to hold?

So with regard to our outlook on industry sales for calendar '05 --

'06.

I don't think that we have put out any information with regard to our expectations for '06.

I think that's something that will come at a later point in time.

I can review '05 with you if you'd like.

Okay, sure.

Essentially we haven't changed.

If you take a look at consoles, handhelds and PC combined in North America, we're estimating either -- somewhere between flat to up 5% in total.

Similar outlook for Europe and when you combined North America and Europe, again, we get to that flat to up 5% in total.

And with regard to -- I think you had a question in there about handhelds, specifically.

Yes, is PSP -- is it -- do you think it's hitting your expeditions at this point?

Is it a disappointment?

Better than expected?

And how do you think it rolls out through next year?

I think that it's meeting our expectations.

We still believe that in North America, the range for the year is probably between 4.5 and 5.5.

And in Europe, if the product actually launches in that September timeframe, we're thinking 2 to 3 million units that will be sold.

So we think it's tracking well and in line with our expectations.

And the Xbox weaker than you thought at this point?

Do you see continued weakness, or is that also about what you thought in terms of hardware?

I think the issue with Xbox is how Microsoft manages inventory as they transition to the 360 platform.

And so it's slightly below expectations so far this year, but how that plays out over the next few quarters I think is dependent upon how much inventory they have and how they manage the transition to the next generation platform.

Okay.

And The Godfather, is that early or late in the March quarter?

No announcement, Mike.

Okay.

And the last question, the pricing at 60 bucks for the 360.

Do you think that's something that holds for a year or a couple years?

I think ultimately this is going to boil down to quality.

I think pricing has been incredibly robust for great titles.

If you look at top 20, it continues to be very strong in the marketplace, which is all a direct correlation to how good the entertainment experience is.

So I'd like to think that if we can deliver great next generation games for both the 360, for the PS3, pricing will take care of itself.

Okay, thanks.

Shawn Milne, Friedman Billings Ramsey.

Thank you.

Warren, hopefully you can hear me on a cell phone.

Can you hear me?

We got you.

Okay, great.

Just two questions.

The first, can you break out the change in guidance and the impact from The Godfather versus FX and secondly, could you talk about what you expect your headcount to be the -- R&D headcount to be at the end of year?

Thank you.

Sure, I'll take the first one.

Larry can talk about the headcount at the -- at the end.

Broadly speaking, as all of you know, there's a lot of ins and outs.

We come back from E3 and at the end of the quarter regardless we're always looking to just sort of fine-tune our forward projections.

So all of that netted down to down 100.

If you had to pick specific driver in that 100, it would be Godfather.

So that is the single biggest of everything.

The big picture for us is the decision was pretty straightforward.

It boiled down to shipping a title that we didn't quite think would be ready and make guidance, or two, invest in this franchise for the long term.

And our decision was really pretty straightforward in an easy one at that point is we believe in the franchise for the long term.

We believe in the team.

And we felt it was important to make that call and that's the call we made.

Looking at FX, I would say that FX today reduced our topline growth rate for the year given the movements and the strengthening of the dollar, most notably as I said between the Euro and sterling.

I'm -- roughly 50 to 100 basis points on the topline.

Less of an impact on the bottom line for a couple of reasons.

One, we have a lot of natural hedges in place.

We do enter into financial hedges throughout the plan year in order to help mitigate --

And headcount?

Head -- total R&D headcount at the end of Q1 was a little over 4,500.

Now I'm including headcount in our studio, in our online group, and also regional development.

We expect it'll be about 5100 at the end of the fiscal year so about 600 from here until the end of the fiscal year.

Then would headcount grow going forward more in line with the sales growth in the out years or is there more of a step function up?

Well, I think at all times we're very careful about adding headcount in all parts of the Company.

Obviously, we have to make sure that the teams in our development organization are properly staffed, and we'll learn more about what those requirements are as we get closer to the launch of Xbox 360 and Playstation 3.

Thank you very much.

Thank you.

Jeetil Patel, Deutsche Bank.

Yes, hey, guys.

Maybe a couple of questions.

First of all what I think Sean alluded to 100 million incremental change in kind of your guidance going forward relative to your previous expeditions.

It seems like given the outperformance in Q1 -- it was more like 150 million.

Should we read that as basically mainly Godfather as you pointed out on that 150 million change on the guidance, especially with the bead [ph] out there?

Or is it more a balance between FX and Godfather?

Second question, I guess if you look at fiscal '06 -- calendar '05 and calendar '06 from an industry standpoint, obviously a lot of moving parts from an industry standpoint.

What do you think is the single biggest variable, positive or negative, as you look at this year -- o the balance of this year and calendar '06 from a market development standpoint?

And that's about it.

Jeetil, I'll take the first one, and then both Larry and I can maybe chime in to the second one.

I think when we look at it, we sit as we go into guidance and go through our quarterly process and we forecast out the year, and on that basis, we make our call on where it should -- where we think revenue is going to come in.

And when we added it all up including our Q1 performance, that came into the range of between 3.3 and 3.4 billion.

So that is just where it came out, regardless of how you may view our Q1 performance.

We think that's an appropriately conservative range and one that we feel is the right one.

I won't get into a ton of specifics relative to the overall -- to every driver of the change.

We'll tell you there are both positives and negatives.

By far and away the single biggest driver, however, was the decision to delay Godfather, again, which we felt we needed to make a smart long-term call.

So with regard to key drivers that we're watching in calendar '05 and calendar '06, obviously one would be an ample supply of PlayStation 2 and Xbox hardware units.

A second would be continued strong sales of the PSP in North America and a strong launch in Europe.

And I guess the third thing that I would mention is supply to meet demand on the next generation platforms, both Xbox 360 and PlayStation 3.

Also, when PlayStation 3 actually launches in Japan, North America, and Europe and what the price points are on Xbox 360 and on PlayStation 3.

I think those are -- that's a pretty comprehensive list of things that we're going to pay close attention to.

Do you think that if you look at next gen, it's more than -- strong enough, at least, given still the variables -- enough to offset obviously, a kind of industry cycle that is going to start to kind of come to a decline as you look at calendar '06?

Do you think we'll still be coming up as an industry?

Well, I -- we've talked about our outlook on overall software sales this year.

We think the business is slightly up in large part driven by the success of the new handheld systems.

And again, if Xbox 360 launches effectively and the same occurs in conjunction with the PlayStation 3, then I think the outlook for next year is more positive.

That's still up for calendar '06?

Without going into a lot of detail at this point in time, my instinct is that calendar '06 is a more positive comparison.

Thank you.

Arvind Bhatia, Southwest Securities.

Good afternoon, guys.

Hey, Arvind.

Hey.

Just a couple of quick questions.

First wondered -- could you talk about the catalog sales this quarter, how big those were?

And then Godfather, is there a way for you to give us a general idea of how large your thought this title to be?

Maybe you can compare it to another one of your titles, again just to get a general idea?

And then I don't know if you have any data on how penetrated the U.S. market is from a -- console penetration of U.S. households standpoint, and where you think that might go to over the next cycle, just to see how much room there is for the industry to grow over a long period of time?

Okay, so as we define it, in Q1, front line titles were 68% of the total and catalog was 32%.

So that's anything -- front line is anything that came out this quarter?

Front line includes anything that came out this quarter and catalog is anything that's 9 months old.

Nine months old, okay.

Okay.

And then the second one is The Godfather question, just a general idea.

I would -- I won't go into specifics, Arvind, beyond what I've said.

I can tell you that, again, we felt this is an important long-term franchise for EA, and we believe in it, and that's why we made the investment we did.

Okay.

And then the question on the penetration of U.S. market?

I'll start off, and Larry can probably jump in here.

I think what you read is sort of 40-ish kind of penetration on the consoles in North America.

I think is there room for it to go up?

I think there's certainly room for it to go up.

I think we have really one of the most interesting battles for the living room that will take place is -- it does ultimately involve who will own that connection to the Internet in going into the living room.

I think that's a pretty interesting -- pretty interesting battle to have take place.

I also feel and we do, that most importantly, the great thing about these consoles is just how darn good the entertainment is.

It's really an opportunity for the business to take another step function forward in terms of the entertainment experience and delivering value to the customers, bringing the benefits of connectivity and online into the living room.

I think that all bodes well for penetration of the consoles.

Warren, does that -- sorry.

Does that take into account the cross platform ownership that we might have?

Give or take.

They're -- I don't know that I can exactly specify the percentage change but give or take, it's not going to be too far off.

The other thing that I would just encourage everybody to really consider is also where are we in Europe?

So Europe today is probably on average, I would say no more than 25% penetrated.

It actually ranges in some of the European markets anywhere from the low teens to the high 20s.

So just building on Warren's point, there's tremendous opportunity for increased penetration in the European markets, and I also believe that the number can go higher in North America as well.

Just two really quick ones, shares outstanding expected following the buyback for the September quarter and for the year?

I would -- I would stay in the neighborhood of 316 to 318, some were in that neighborhood.

Got it.

Last question, industry conditions today, are we seeing anything that suggests there is some weakness in demand, that the -- transition is coming up.

You talked a lot about the expense side of the equation, but is there any real impact on demand right now?

Actually, if you take a look at the MPD numbers through the month of June, total software sales -- and again, this is consoles, PCs and handhelds, year-to-date the business is up about 9%.

So I actually think it's tracking ahead of what industry expectations were.

Certainly it's a bit above what our expectations were.

Now having said that, there was a tremendously strong lineup of titles in the holiday period last year.

It remains to be seen how this year's lineup will measure up, but first 6 months of the year I think the overall business is tracking ahead of most people's expectations by a slight bit.

Great, thanks guys.

Evan Wilson, Pacific Crest.

Hi, first a couple of housekeeping questions.

What were the number of Club POGO members at the end of the quarter, and what do you expect for CapEx for the year?

The number of Club POGO members at the end of the quarter is approximately 900,000.

And I would expect our CapEx to be somewhere in the neighborhood of 125-ish.

All right.

And you talked about a number of the influencers on the reduction in guidance.

Could you fit the new Valve publishing and distribution deal into that picture and try to give us an idea of how much of The Godfather was offset by Half Life 2 on Xbox this October?

We had been in discussions with Valve for quite some time and you should assume that by and large, Valve was included in our planning process.

And I really won't go into the relative size of the offsets any more than I've said.

All right, thanks very much.

Thank you.

Tony Gikas, Piper Jaffray.

Hi.

Good afternoon, guys.

A couple quick questions.

How long into calendar 2006 or fiscal '07 do you expect the R&D spend to be higher?

Where's that break point where that number as a percent of sales starts to come in?

Number 2, marketing expense was a little higher in the quarter than we anticipated.

Is that a trend we should expect to continue through the fiscal year, and I guess I'll be the one to ask the question on the ratings of games in the market.

Do you anticipate that the Ratings Board is going to get a little bit tougher on rating products looking forward?

Whether it's your product or industry product and could that impact any of your product sales looking forward?

I'll answer the marketing question.

For the year, we are expecting our marketing expenses to be in line with revenue growth.

And then I think Warren has consistently said G&A, expect that to be a single digit growth number for the calendar year.

So I wouldn't get particularly hung up on any one particular quarter.

We're trying to manage the business across the entire fiscal year.

With regard to ratings, I think the ESRB system is a good one.

It has received praise multiple times in the past.

I think the people that run that rating service do a terrific job.

And we're not expecting the rating system to change.

I think it's well done, it's well executed, they've been consistent over multiple years and it's a highly respected rating system.

And then the question on R&D?

On the R&D side, I think it's just too early to make the call.

We'll know a lot more as we move through the completion of the 360 titles and into PS 3.

I think the good news on this front is that our studio management team I think has really taken a smart long term perspective very early on in trying to create standard tools and libraries and get those implemented.

And that's all about scalability and all about building incremental capacity in order to free us up to do more.

The good news is that those investments were started early.

We are in the middle, still, of making them, and hopefully that will allow us to get to the point when it comes, sooner rather than later.

And last one, tax rate, 28 or 29% going forward?

I thank we had said -- the guidance holds from the last call, Tony.

I think as a long term sort of rate, I'd kind of use 28% and on a non GAAP basis I'd pretty much figure 29 for the year.

If you factor in the potential for one-time sort of tax resolutions, the GAAP rate could be down for the year in the 27% range.

Okay, thank you, guys.

Thank you.

Brian Pitz, Morgan Stanley.

Hi guys, a couple of questions here.

How should we think about your mobile strategy going forward?

And when should we expect to see an impact on your numbers from some of the deals that you have recently signed?

Can you talk about really what the margin impact will be as well?

Yes, I mean, the mobile strategy is actually pretty straightforward.

In the past we have had essentially a licensing strategy, and now we're going to directly manage that business where at least for the time being, we will use external developers but we will be the publisher, we will be the distributor going forward and you will see us announce distribution agreements with multiple carriers, both in the United States and Europe and in places like Japan and Asia.

And I think we've -- we've said that we're contemplating shipping something like 15 to 20 titles this year, and the revenue expectation is sort of in the 20 to $25 million range this fiscal year.

We think we can grow that pretty aggressively over the next couple of years.

So that's not really incremental to your guidance for the back half of the year?

That's not offsetting any of what we've discussed previously with Godfather and the foreign exchange?

No, that was included in our guidance.

Okay.

And then I just have a question regarding your IP licensing.

You recently, obviously, extended Lord of the Rings.

Can you talk about where you stand with other licenses such as Harry Potter, which I believe is pretty close to up for renewal?

I'll jump in and just start on the licensing overall and then we can address Harry Potter and some of the things a little more specifically.

Overall on the sport side, without going into any specifics, I think we're in -- we're in great shape and basically things have been pretty well taken care of.

A lot of that is effectively behind us.

Larry, if you'd like to add --

Yes.

Specifically on Potter, the current license runs until September of 2007 and we're in discussions to extend that license further.

Okay, great.

Thank you.

Mike Hickey, Janco Partners.

Hi guys, hopefully you can hear me okay.

I was wondering if you could update us on your efforts to penetrate -- or how the Chinese market is working out for you and what you're doing in that area?

In addition, I'm not sure if you've mentioned this or if you can, thinking about R&D and the amount that you spent on next gen, can you break that out per console?

For instance, how much of your next gen spend so far -- I'm thinking about an open time period here -- is accountable to the PlayStation 3 as a percentage of 360 and revolution.

And then last question, if you would, on Godfather, have you made the adjustments to the development team?

Have you added more team members there?

Have you changed the structure?

Is the game play going to be maybe a little bit different than you anticipated and then the end product.

Did you think that with the extended time period you have for development that will have a better end product in the end?

Any thoughts on that would be appreciated.

With regard to R&D spending on next gen as a percentage of the total development spending this year, it's sort of in the 25 to 30% range.

With regard to The Godfather team, we're actually focusing the team probably slightly reducing the number of people working on the project, adding to the management team at a senior level and making sure that the very most senior in our studio are focused on that.

So just more focus and attention, and as Warren said earlier, we could probably ship a product in Q3 with a 60 Metacritic rating, but that's not what we have in mind for this title.

We want to make sure that it's very high quality and that's what drove the decision to move it to Q4 and we have a high level of confidence that it will ship and be successful at that point in time.

Our -- and I'll speak to China, our strategy for China this year, which is on our internal set of metrics and goals, is that we want to have a studio up and running and China in this year.

Eric Hachenberg, as many of you know, is on the ground, started those efforts and we want to do is build our development capacity.

Right now, we're in the process of localizing POGO for that market, for example.

The second objective is to prudent continue to evaluate different opportunities for partnerships.

And what we're going to do is just that is really try to make sure if we make that sort of move, that it's the right one, that it makes sense and that it's the right long-term arrangement, but primarily for the market it's get POGO localized, number 2 is get a studio up and running.

Okay.

And just to clarify on the R&D, that -- the next gen, the 25 to 30%, can you break that out between the 3 different consoles?

No.

All right.

Thanks, guys.

Thank you.

Gary Cooper, Banc of America Securities.

A couple of questions.

First, on Godfather.

EA typically comes back with a sequel 12 months or so after the origination of new IP, so I'm wondering if Godfather 2 is in your holiday of '06 plans?

We haven't publicly talked about our SKU plan for the next fiscal year.

It would be premature to do that.

What we're focused on right now is building the very best product we can on current generation platforms and getting prepared to exploit that property on next generation platforms.

Okay.

Couple of questions on the holiday quarter.

Your two biggest games in that quarter, Need For Speed and Harry Potter, so Harry Potter was 10 to 11% of your revenue for a couple years running a few years back.

Last year, no holiday title.

Can you get us in the ballpark of what your expectations are?

I honestly don't think it will be as large as it was a few years ago, but, do you think it will be the second largest title in that quarter?

And then secondly, on Need For Speed, 8.2 million units is the comp.

Lots of driving titles out in the last 12 months.

Do you think Need for Speed this year is as large as the one was last year?

Thanks.

Gary, I won't get into the comps.

I'll tell you that you have highlighted titles that we do expect will do very well in the quarter and they're certainly going to be in the top 5 to 7 titles.

I would also point out that in that same quarter, the lineup is going to include things like FIFA, Battlefield Modern Combat, a new title Bond From Russia With Love, which by the way, looks great.

FFX 4, Expansion packs, Tiger Woods, Lord of the Rings Third Age, Burnout 4 so -- Burnout 4 actually this quarter.

But my point is that, yes, we have high expectations for the games.

We have high expectations, one, because they've got a great history but, two, and most importantly, the games looks great, and then secondly, there's also a pretty strong portfolio of some great performers.

Just to add -- just to add a little color to that, with regard to the Harry Potter title this year, we're going to be delivering that on 7 platforms.

Last year we were on 5 platforms and this year we have a movie to work with.

So you would expect that we have higher expectations this year for the Harry Potter product than we did last year.

Similar story on Need For Speed.

Not a movie, obviously, but we're going to be delivering that product on 8 platforms, last year it was 5.

So again, pretty simple math to imagine we have high expectations for Need For Speed for this year.

Okay.

Last question, save for some of the sports games that are facing competition, all these big titles that you mentioned, are you planning them all at $49.99?

Thanks.

On of the price side, you -- we'll -- just you'll have to wait and see.

I mean, at the end of the day, we think these are great titles.

They'll come out where they need to be, so far looking at the market data, I would tell you great titles, great entertainment, top 20 titles continue to hold premium price point.

We'll see where the market is, we'll be competitive, but these we expect to be premium titles.

And they'll get their just due.

Heath Terry, Credit Suisse First Boston.

Thank you.

I was wondering if you'd talk just a little bit more -- I know you're probably tired of answering Godfather questions, but the ratio kind of between the topline change and the bottom line change is the little tough to understand, particularly given the upside this quarter and what seems like higher guidance for the bottom line next quarter.

The implication seems to be that Godfather's going to be -- is expected to be an extremely profitable product, somewhere around almost 60% operating margins by the back of the envelope math that we're kind of doing.

Can you tell me what we're missing there?

Is there something else in those numbers that's having a disproportionate impact on the bottom line?

And then, Larry, I guess, if you could, following the IEMA event last week where you were able to get all of your retailers together, can you talk about what kind of general themes were coming out of the retail partners and what kind of tone they have when talking to them about the second half of the year and particularly the holiday season?

Heath, on the first question I'm really not going to go into any more detail.

I would tell you that, again, as I mentioned, we go through on a title-by-title basis, particularly after E3 and always at the end of the quarter as we redo our forecast to try to best estimate where we think revenue's going to come in, where we think margin's going to come in and then roll it up accordingly.

And I think we've given you guidance that is a appropriate and appropriately conservative.

And this is how the numbers -- the numbers fell out.

As to margins, I won't go in on the title-by-title basis.

Again, I would tell you there is -- there are many, many ups and downs, some positives, some negative.

Godfather was a negative for Q3.

FX was a negative for Q3, for example, but FX didn't impact the bottom line so much.

So there's a lot of ins and outs.

Godfather clearly the single driver -- single biggest driver, and we think we gave you what we think is appropriate guidance for each of these quarters as we fine-tuned our estimates.

So, Heath, I didn't personally attend by IEMA, but the feedback I heard was that retailers are cautiously optimistic about the second half of the year.

As I mentioned earlier, I think it's a bit of a surprise how well the industry has done for the first 6 months.

Last year obviously there were some mega titles in the market with Halo 2 and San Andreas.

It's not clear that there are any titles that are on the horizon that might drive software sales as those did.

But to offset that, obviously people believe there will be more PlayStation 2 inventory in the marketplace.

They've got the PSP to work with, and they will have the Xbox 360 to work with so those all very positive factors for this year.

Net/net, I think people feel pretty optimistic about the second half of the year and the holiday season.

Great, thanks.

Thanks, Heath.

Colin Sebastian, Thomas Weisel Partners.

Thanks a lot.

Just a -- two quick market questions.

Number one, do you have any assumptions on initial hardware unit shipments for the Xbox 360?

And secondly, disregarding the European market and the state of the market, it doesn't sound like you're making changes to your software forecasts but are there any issues in that market specifically that we should think about heading into the back half of the year?

Thanks.

We don't really have anything to add.

We'll leave it to Microsoft to make announcements on 360 volume.

Relative to Europe, we continue to perform -- perform well across the market.

We think our shares are strong, we think we've got a great line up going into the back -- the back half of the year.

As best we can estimate, we don't quite have the same obviously as MPD data, but pricing continues to hold strongly in those markets as well.

Yes.

I would just add to that, if you take a look at the first 5 months of the year where we do have data for Europe, we've got the leading market share on the PlayStation 2, we're a strong number two on GameCube and we're the leading market share on Xbox and we think we have a strong line up of products for the second half of the year and we think we can drive those numbers higher.

Any further questions, Mr. Sebastian?

Yes, just following up on the marketing question from earlier, any changes for the holiday period regarding marketing and promotional plans?

I know you commented on I guess a percent of sales basis, but anything different in the mix?

Thank you.

Well, obviously with Godfather moving to Q4, that will change -- that will have an impact on the total marketing spending in that quarter but in general, we're going to be aggressive.

We clearly understand what our -- what the key titles are that will drive our business and they're going to be strongly supported with advertising, marketing and promotion across the board in all markets.

I think as a percentage of sales you'll see it roughly in line with historical averages for the third quarter.

Great.

Thank you very much.

Operator, we will make one more question.

Yue-Shun Ho, Wells Fargo Securities.

Hi, good afternoon, I got into the call kind of late so I apologize if this has already been covered.

Let me ask you regarding the Madden game, I understand that you paid a lot more in terms of [inaudible] et cetera.

What kind -- how do you suggest or what kind of assumptions should we make in terms of modeling this game in terms of margins, or [inaudible]?

What I would say to you is I think what we've said in the past that historical is that you have to understand that this is a very valuable long-term franchise for us and you can see another great game, by the way, this fall.

I think you clearly will.

So we're excited to watch the launch.

The margins are going to go down.

The reality is that we invested in this product.

We have higher license fees.

Our objective is to continue to build our segment share given our exclusive relationship.

It's to deliver a great quality game, which all indications are we have the share and we'll continue to be able to do.

And to look for ways that we can increase our revenues by expanding our relationship with the NFL.

So margins under pressure, factored in.

At the same time, hugely a valuable franchise, we're going to look for ways to expand our volume.

While we won't have the same margin percentage, we'll look for ways to try to offset that with increased profit dollars.

And I would say in addition to Madden, you're going to see us build other football products, so the purpose of that obviously is to increase the size of our overall football business.

So you have to think about it as a portfolio of products, not just Madden.

Great, thank you.

And in terms of wireless, can you talk about anything then in terms of overseas market?

I think, as Larry said, the only thing I would mention is in due time, we will expand our wireless business into both Europe and into Asia.

I just returned, for example, from a trip to Hong Kong and I know our publishing salesforce is busy striking arrangements, working with our wireless team here in North America to take our games to various markets in Asia.

And now they expect several million dollars of revenue coming out of Asia for related this year, so -- and the same thing's going on in Europe for that matter, so we do expect to -- this to be a global business just like our other businesses, with expansion from North America to Japan to Asia and also into Europe.

And how much proportion of revenue coming from North America [inaudible] wireless gain in this fiscal year?

It's just to early to tell.

I would say that this year, I'd figure roughly 50% is North America and 50% is going to be outside of the U.S., and that's just a ballpark.

Okay, thank you.

Great.

Thank you all for joining us.

We look forward to talking to you in post follow ups, and thanks for joining us.

That concludes today's conference call.

We do appreciate your participation You may disconnect at this time.