美商藝電 (EA) 2006 Q3 法說會逐字稿

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

Today's call is being recorded.

For opening remarks and introductions I would like to turn the call over to Ms. Tricia Gugler, Director of Investor Relations.

Please go ahead.

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

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

Warren Jenson, Chief Financial and Administrative Officer; and Frank Gibeau, Executive Vice President and General Manager of North American Publishing.

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

Shortly after the call we'll 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 and affiliates, acquired in-process technology, and other acquisition-related charges, amortization of intangibles, employee stock-based compensation, and certain non-recurring litigation expenses and their related tax effects.

In addition, the Company's non-GAAP results exclude the impact of tax adjustments.

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

In addition of supplemental schedule, demonstrating how we calculate return on invested capital will be included on our website.

Online GAAP measures are provided as a compliment 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.

We have included our trailing 12-month platform shares and our 2006 estimated market outlook and a supplemental schedule that we will post on our website.

During this 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 10-K and 10-Q 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 February 2, 2006, 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.

The December quarter was one in which we essentially held our own competitively, but overall sales were disappointing and well-below our expectations.

With that said, on a relative basis many of our titles did well.

Five titles sold over 2 million copies, "Need for Speed Most Wanted," "FIFA 2006," "Harry Potter and the Goblet of Fire," "The Sims 2," and "Madden NFL 2006."

Need for Speed Most Wanted sold over 7 million copies with over 60% internationally.

It charted in the top five on the PS2, Xbox, Xbox 360 and PSP in both North America and Europe.

Harry Potter and the Goblet of Fire sold over 4 million copies.

The Sims franchise continues to thrive, over 7 million copies were sold in the quarter, up over 40% from last year.

FIFA 2006 and Madden 2006 continue to deliver.

YTD unit sales are up over 15% on FIFA and up 8% on Madden.

Our 360 revenue share was 30% in North America and we estimate approximately 24% in Europe.

In the quarter there were several meaningful long-term events.

We announced an agreement to acquire JAMDAT.

We expect the deal will close later this month.

We are well down the road with our integration planning and we look forward to having the JAMDAT team join us.

In Online, we successfully launched our PC digital distribution platform with "Battlefield Special Forces" and "Sims 2 Holiday Pack."

We also recorded our first micro transaction revenue.

Club Pogo offered "Badge Books" to our customers.

To date there have been 280,000 downloads, with each customer spending roughly $12.

We entered into a long-term exclusive agreement to bring "The Simpsons" to next-generation consoles, and we're pleased to announce we've extended our exclusive relationship with Tiger Woods for another six years.

For the calendar year, EA was the number one publisher on PS2, Xbox, PSP, and PC in North America and in Europe.

Specifically on the PSP, we ended the year with 31% revenue share in North America and we estimate 25% in Europe.

In 2005, we had four of the top 10 titles in North America, "Madden NFL 2006," "Need For Speed," "NCAA Football '06" and "NBA Live '06."

And six of the top 10 in Europe, "Need for Speed Most Wanted," "FIFA 2006," "The Sims," "Need For Speed Underground 2," "Harry Potter and the Goblet of Fire," and "FIFA Street."

In Sports, we had 70% category share on console in North America.

We had 15 of the top 20 sports titles on the PS2 and 14 on both the Xbox and PC.

In January we launched "NCAA 2006 MVP Baseball," which is off to a great start.

In the first two weeks since launch we sold through over 200,000 copies at retail.

Overall, across all platforms in North America our segment share grew roughly one point to 22%, and in Europe we estimate we lost roughly one point to 23%, net-net we held our own in a tough market.

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

First, I'll review our Q3 financials; second, I'll go over our outlook and financial guidance.

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

Q3 performance, net revenue was 1.27 billion, down 11% driven by lower current-gen in PC revenue partially offset by an increase in revenue from handhelds and the Xbox 360.

We released 49 SKUs in the quarter, compared to 40 SKUs a year ago. 13 of the SKUs this quarter related to the 360 and PSP.

Console revenue was 793 million down 21% year-over-year driven by a 29% decline in current-gen. 360 revenue was 76 million, essentially offsetting the decline in Xbox-related revenue.

PC revenue was 148 million, down 38% primarily due to last year's strength of the "Lord of the Rings," "Medal of Honor," and "The Sims 2."

Mobility.

Revenue more than tripled to 192 million driven by 120 million from the PSP and to a lesser extent the NDS.

During the quarter we had five of the top 10 PSP titles in North America and three of the top 10 in Europe.

Co-pub and distribution revenue was 99 million up 20 million year-over-year due to the strong launch of "Half Life 2" and "Black & White 2."

Internet, services, licensing and other revenue was 38 million, down 8 million primarily due to lower license revenue.

Geographically, North America revenue was 618 million, down 74 million or 11%.

Current-gen revenue declined 32% in the quarter, 360-related revenue more than offset the decline in Xbox revenue.

International revenue was 652 million, down 84 million or 11% year-over-year.

Changes in foreign exchange rates negatively impacted our topline by 21 million.

Europe revenue was 577 million, down 89 million or 13%.

Current-gen revenue was down 26% in the quarter.

Our European revenue was down in large part due to last year's launch of FIFA in Q3.

Asia revenue was up 7% year-over-year driven primarily by the introduction of the PSP.

In Australia we had 36% revenue share on the PSP with six of the top 10 titles.

Moving on to the rest of the income statement.

Gross profit in the quarter was 768 million, down 17%.

Gross margin was 60.5% versus 64.8% a year ago.

The decline was driven by higher price protection and sales returns, and unfavorable shift in product mix partially offset by lower effective manufacturing royalty rates.

Operating Expense.

Marketing and Sales.

Marketing and sales expense was 147 million, up 14 million over last year, as expected the increase relates to the support of our key titles around the world.

General and Administrative.

G&A was 58 million, down 20 million year-over-year.

The decrease was driven primarily by lower employee-related litigation costs and other personnel-related expense.

R&D.

R&D was 206 million, up 21 million or 11% driven by overall higher personnel and facilities-related costs partially offset by lower third-party development costs in the quarter.

R&D-related headcount was up 28% to roughly 5,000.

The consolidation of Digital Illusions and the addition of Hipnotix accounted for six points of the increase.

As you may know yesterday we moved to reduce headcount in some of our studio teams.

This was done to align our resources against our product plan for the coming year and strategic opportunities in next-gen platforms online in mobile.

This is an unfortunate but a natural part of transition.

Diluted EPS were $0.83 versus $1.18 a year ago.

Non-GAAP diluted EPS were $0.86 versus $1.23.

The $0.03 difference between GAAP and non-GAAP diluted EPS relates primarily to charges associated with our reorganization and establishment of International Publishing headquarters in Geneva.

Our effective tax rate was 29% versus 31% a year ago.

Our diluted share count was 311 million versus 317 million a year ago.

Had stock option expense been included in our results, GAAP diluted earnings would have been reduced by roughly $0.06 per share.

As you know, we will begin expensing options next fiscal year.

On to the balance sheet.

Cash, short-term investments, and marketable equity securities were 2.7 billion, up from 2.6 billion a year ago despite the completion of our 750 million share repurchase program.

Gross accounts receivable were 829 million versus 1.1 billion a year ago, a decrease of 24%, due to lower overall revenues and the timing of our release schedule.

Reserves against outstanding receivables totaled 262 million, up 27%.

Reserve levels were 13% as a percentage of trailing 6-month net revenue up three points from last year.

As a percentage of trailing 9-month net revenue reserves were 11% also up three points.

Inventory was 76 million, down 10% from last year.

Need for Speed Most Wanted, represented roughly $10 million of net exposure.

No other title represented more than $4 million of net exposure.

Our Outlook.

Before we get into the numbers, let me share our thoughts on the year ahead for the industry, and EA.

As we look ahead to calendar 2006, we anticipate the emergence of many long-term positives.

But to be balanced, we also see several near-term challenges.

First the positives: Xbox 360.

The 360 will continue to build momentum throughout the year.

We believe Microsoft will step-up production as the year progresses and as a result the financial significance of this platform will continue to build.

PS3 and Revolution.

The likely launches of the PlayStation 3 and Nintendo Revolution will add fuel to the excitement of owning a next-generation console and software.

As we enter late fall we expect that all pieces of the next-generation engine will be in place and ready to go.

At the same time, next-generation software will keep getting better, more plentiful and more exciting.

This should also naturally increase demand.

Online.

Online will continue to grow in importance and new revenue streams will likely emerge and expand, including dynamic in game advertising, microtransactions, and digital downloads.

These new revenue streams will be additive to our existing $80 million internet-based business.

Handheld revenue will continue to build.

YTD, our handheld revenue is over 300 million, up more than 210 million year-over-year.

Mobile phones.

As more game enabled handsets are sold, this category will continue to grow.

As a result of our pending combination with JAMDAT we could easily see revenue from mobile phones exceed $130 million in our next fiscal year.

Now, let me talk about the challenges.

Lower current-gen demand.

In the calendar 2006 we expect significant declines in the demand for current-gen software both in North America and in Europe.

And as a result we expect total software sales for the industry to be flat to down 5%, despite the new platforms and continued growth in the handheld segment.

Current-gen price.

While implicitly included in our estimates for the industry we want to again call out that prices will continue to climb for current-gen software.

Investments.

The investment phase of this transition is not over.

Talking about EA specifically there is several areas where we plan to invest for the long-term.

In every case these investments will negatively impact next year's P&L.

In the coming year we expect to do the following: First, spend on the PS3, well-ahead of revenue, and do everything we can to lead the way in the launch of this platform.

We will also continue to build out our 360 portfolio and prepare for the launch of Revolution.

Second, significantly expand our online business and content portfolio both domestically and internationally.

Third, increase our portfolio of new intellectual property.

Fourth, aggressively grow our mobile business globally.

And, finally, continue to evaluate acquisition and investment opportunities.

In summary, as we look ahead to 2006, we see the emergence of several positive trends that bode well for our customers and our long-term shareholders, our confidence in the potential for interactive entertainment remains intact.

That said, you should expect a tough 2006 where profits are again squeezed given the challenge of transition and our focused on investing for long-term growth.

I'll conclude my portion of today's call with our 2006 market outlook and our fourth quarter financial guidance.

Hardware.

In North America we expect the following hardware unit sales: Consoles between 12 and 14.5 million units, handhelds between 10.5 and 11 million units.

In Europe, we expect the following hardware unit sales: Consoles between 7 and 9.5 million units, handhelds between 8.5 and 9.5 million units.

We expect total North American and European software sales to be flat to down 5% with current-generation software sales down 35 to 45%, and total console sales down 10 to 15%.

Handheld software sales up 20 to 25% and PC software sales down 5 to 10.

On mobile phones we expect global publisher game revenue to be up 25 to 30%.

Now, on to our financial guidance.

The following forward-looking statements reflect our expectations as of February 2, 2006.

Actual results may be materially different and are affected by many factors, such as, consumer spending trends, the popular appeal of our products, development delays, current-gen and next-gen hardware availability, the seasonal and cyclical nature of our industry, the overall economy, competition, changes in foreign exchange rates, our effective tax rate, and other factors detailed in our earnings release and in our SEC filings.

For the fourth fiscal quarter we expect revenue to be between 550 and 600 million.

GAAP net loss per share to be between $0.15 and $0.23.

Non-GAAP diluted EPS to be between $0.06 and $0.14.

Please note that our expected GAAP results include approximately $0.17 of estimated acquisition-related charges associated with the likely closing of the JAMDAT transaction, $0.09 related to a possible decision to repatriate up to $500 million in foreign earnings under the Jobs Creation Act of 2004, $0.04 associated with the reorganization and establishment of an International Publishing headquarters in Geneva, and other restructuring activities.

Specifically in Q4 we expect to ship 32 SKUs.

Our expected lineup includes;

Arena Football on two platforms, two Battlefield Booster Packs on the PC, Black on two platforms, Command and Conquer the First Decade on the PC, FIFA Street 2 on five platforms, Fight Night Round 3 on four platforms, Godfather on three platforms, Godfather's Collector Edition on two platforms, James Bond from Russia with Love on the PSP, Lord of the Rings Battle for Middle Earth 2 on the PC, Lord of the Rings Battle For Middle Earth Collector's Edition on the PC, MVP NCAA Baseball on two platforms, Rugby '06 on three platforms, The Sims 2 Open For Business Expansion Pack on the PC.

On the Xbox 360 we plan to ship three titles, Battlefield Modern Combat, Burnout Revenge and Fight Night Round 3.

In addition, on mobile phones, we plan to launch four games, NASCAR, FIFA Street, Pogo Harvest and Pogo Word Whomp.

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

Thank you. [OPERATOR INSTRUCTIONS].

Our first question comes from Elizabeth Osur with Citigroup.

Thanks.

I guess I was just hoping you guys could give a little bit more detail on the headcount reduction if there is an estimated savings coming from that and how we can think about G&A on both for the coming quarter and for next year?

Liz this is Warren.

Let me go ahead and address that.

I wouldn't look at this as -- what we are really doing here is realigning our resources for our next-generation of growth opportunities.

So as we've mentioned I think going into this it is about 5% of our employee population, and it's an unfortunate thing that it is just a natural part of transition.

But the way I would think about it, as I would think about it as a realignment of our resources.

Now what I would say relative to G&A expectations, this is a time of transition and you can expect throughout our Company that we were going to do everything possible to keep our costs in-line and appropriately focused on our growth opportunities.

Thanks.

Thank you.

And our next question comes from Brian Pitz with Morgan Stanley.

Hey, guys.

Just a little more detail on some of the costs for the quarter.

You guys came in a little bit better than my number.

I was wondering is there any headcount reduction at all across any of the buckets?

And more specifically in R&D, can you talk about development costs?

It looks like 360 may not have been as bad as you had expected.

Any more detail on development from what you've seen going through this quarter?

Thanks.

I'll go ahead and start and others may want to chime in on the development side.

I would say looking at our total headcount, no, there was not a decline in the quarter.

So headcount actually went up.

Looking at our cost across-the-board I think I detailed that the R&D, in fact, was up after some significant increases throughout the year, but up year-over-year.

G&A was down as I mentioned principally as a result of some personnel-related costs, but also employee-related litigation cost.

I would add with respect to the Xbox 360 we think we had a successful launch.

We ended up with about 30% market share for North America in the calendar year and a little less than 25, right around 24% in Europe.

We think we have got some terrific new titles that we're launching in Q4 including "Fight Night 3," "Burnout" and "Battlefield."

And so we expect to have a very successful year going forward on Xbox 360.

Can you maybe give us a sense, too, going out past the next quarter any thoughts on big name product releases, milestones, past the fiscal Q4?

If you look at our quarter, one, you're looking at a World Cup product, as well as a release of Superman in conjunction with our Warner Bros. partners, and then the full force of our lineup starts to hit on the next-gen starting September and in August with the sports lineups, MVP 2, Madden.

You'll also see a release of Medal of Honor in the Christmastime period on next-generation platforms called "Airborne."

So it's a pretty robust lineup and the portfolio really comes online on next-gen at that point.

Yes, specifically on Xbox 360 I think we have somewhere between 15 and 20 titles on that platform -- on Xbox 360 for our next fiscal year and we'll be refining that number as we conclude the planning process over the next month and a half.

Thank you. [OPERATOR INSTRUCTIONS].

Our next question comes from Heath Terry with Credit Suisse.

Great.

Thank you.

You talked about what you expect this year as far as software sales for the industry.

Can you talk a little bit about how given the strength in -- given the release schedule that you have got over the next 12 months or that you're planning over the next 12 months versus what you know about what the industry is going to look like, should we expect -- is this going to be a year where EA outperforms the industry?

Is this something we can know at this point?

Well, it is not something that we can know for certain at this point.

It is certainly our goal to outperform the industry.

That is our goal every year and we hope that we can put the titles in the marketplace over the next 12 to 15 months that will allow us to achieve that goal.

So, yes, that is obviously what we're striving to accomplish.

If you're looking at the release schedule that you've got over the upcoming 12 months versus the previous year, how would you rate this strength versus -- one versus the other?

I think we have got a very solid lineup.

We talked a little bit about Xbox 360.

We think that coming out of the year we'll have some solid catalog sales with products like Black and Godfather.

We think that we'll be in a strong position on the next-generation platforms from Sony and Nintendo.

We have got some pretty interesting new titles in the lineup for next year.

Frank mentioned things like Superman.

We've got a project that we're building in Montreal that we'll start to talk about at E3.

I think Frank also mentioned World Cup.

We've got NFL Head Coach shipping.

We've got a new version of Medal of Honor;

Medal of Honor Airborne.

And then later in the fiscal year products like Spore that we've talked about in the past.

So we think we have a strong lineup for next year across multiple platforms.

Thank you.

And our next question comes from Evan Wilson with Pacific Crest Securities.

Hi, thanks for taking the question.

You mentioned in fiscal 2007 you expect 130 million in mobile sales.

What do you expect the contribution to be in this fiscal Q4 from the JAMDAT business?

Roughly 15 million give or take.

It's going to depend, obviously, on when it closes.

But I would figure about 15 million and nothing on the bottom line.

Thank you.

Thank you.

And our next question comes from Jeetil Patel with Deutsche Bank.

Yes, thank you.

Can you just talk about as you look at the next cycle over the next several years is there any structural changes with the marketplace or market dynamic that would or would not allow you to kind of get to the peak operating margins, of let's say the high 20% range that you achieved in fiscal 2004.

What's the kind of single biggest variance that you look at that kind of gets you back to those margin levels that you had achieved a couple of years ago?

And second, just contribution from acquisitions on future growth, I mean is there some formula that you're looking out of, if you grow 20%, do you expect 10% coming out of growth through acquisition versus organic?

Jeetil, let me take the question in light of margin and others can jump in.

When we look at margin, where we will be focused in terms of building our operating margins, is really in the following areas: First of all, I think you have to look to how the consoles do in the years ahead.

And where we feel good is the technology that we're seeing in the marketplace today with the 360, its online capabilities, and the things you can do just from a game play standpoint I think are terrific and have been well received by the consumer.

We would expect nothing less than that from the PlayStation 3 coming out and I think when you first look at things like tie ratios and volume of consoles that will ultimately get into the marketplace, we would see that as a net-positive in terms of building operating leverage.

The second thing will be up to how the marketplace determines and that will be price.

Now I think the good news on the price side is over time, and Frank can jump in here, too, but I think you're going to see more of an ARPU model follow-on to the packaged goods sales, and that will be things like the in-game advertising, it will be things like microtransactions.

I think you'll also get steady increase in revenue from digital downloads as that will become much more prevalent over the coming years.

All those, hopefully, will be good things.

Third, we're focussed on new IP.

So the more we can own more intellectual property in our portfolio without royalty rates the higher our gross margins will be.

And then, finally, before I stop on the point, the other thing that we are focussed on doing and we're going to have to prove out that we can deliver is scaling our infrastructure.

We've made significant investments in RenderWare in our studio in order to drive capacity into the system over time.

Whether we're talking about our R&D, our marketing sales organization or our G&A we are looking as an organization for ways to scale that operating infrastructure that we have.

Those are a few of the factors that come into play in driving margin.

On the acquisition side, our screen, we've gone through before.

It's pretty stringent.

It's got to strategically make sense, it has to culturally fit, and also hit our financial hurdles.

And to the extent there are opportunities out there we will take advantage of those opportunities.

It's worked well in the past for the Company and we suspect that will be part of our business going forward just as it has been historically.

So on -- just on the industry component.

If you see an industry of 10 billion, just to throw out a figure over the next say three years, whatever it is.

But it's -- the ARPU model is something that we haven't been accustomed to, but can you just give us a sense as you look out over the next several years, what percentage of the industry revenue do you think comes in the form of ARPU versus the packet software products?

Jeetil, we don't know.

I mean at the end of the day we're going to have to start to see what emerges.

I know that on products that Microsoft has said publicly on Halo, for example, I think in follow-on transactions they've done at least 10 to $15 million of microtransactions.

We've started to experiment just at the edges here with Battlefield, with The Sims 2 Pack over the holidays, and with microtransactions on Pogo.

If you look at some of the Asian examples, you see a product like "Cart Rider" that is doing hundreds of millions of dollars in effectively microtransactions.

We're going to have to experiment and we're going to have to see how big it is.

Ultimately, we know what's good about them is they make the games more fun and give people what they want and that's added content in order to better the entertainment experience.

But you have to expect near-term.

You know what, these are small.

They are high margin, but they're small.

We fully expect they'll build over the long-term.

Thank you.

And our next question comes from Mike Wallace with UBS.

Warren, could you breakdown the hardware units a little more, I think you said 12 to 14.5 consoles in the U.S.

What are your expectations, PS3 units, Revolution, and 360 units?

And along those lines when do you think we will see the PS3 officially?

When do you think it's going to ship in certain territories?

And what kind of pricepoint are you assuming?

Well, specifically in North America on next-gen we would probably range Xbox to -- or Xbox 360 between 5 and 6 million units, PlayStation 3 between 0.5 million and 1.5 million.

And probably that same sort of range on Nintendo GameCube -- or on Nintendo Revolution, sorry.

And our expectation is that you're going to see PlayStation 3 and the Revolution platform sometime in the fourth quarter of the calendar year, and I suspect that it's probably sometime in the middle of the fourth quarter.

And any indication on pricepoints, Larry?

I know they wouldn't tell you if they did.

You wouldn't tell us.

But I mean do you think --?

You answered your own question, Mike.

[Laughter].

Yes.

I mean, you think that they're going to be reasonable in what a console should sale for?

Do you think they're going to try and minimize their losses?

Well, to be honest, we don't know.

We don't have any information.

They have not disclosed their pricing strategy to us.

I think we'll hear more about that at E3.

I would speculate that the Revolution platform is going to be less expensive than PlayStation 3, and that's about as much as we know at this point.

Thank you.

And we have a question from Edward Williams with Harris Nesbitt.

Good afternoon.

Just a quick question for you on your studios.

Larry, what is your expectation at this point for your headcount growth rate in the studios throughout the year?

And if you can give us an idea as to the focus that they're putting on the next-gen consoles versus the current-gen?

I don't know that we have specific headcount numbers for you at this point.

We're going to have to complete the planning process to get there to give you a sense of where we're going to be at the end of next fiscal year on studio headcount.

As Warren said, we're trying to align those resources with our longer-term strategic initiatives and we're in the process of doing that.

That process will continue.

Should we assume that part of this is focusing more on internally on the next-generation of hardware and less so on -- are you going to move to outsource the current-generation?

Well, we're absolutely focussed on getting in position for these next-generation platforms.

We talked a little bit about the second wave of products on the Xbox 360.

We think we've done a really good job on those.

We expect to have high quality products available at launch on PlayStation 3 and Revolution, and we're going to -- I mean, that is job one around this Company and we're going to be very focussed on that across all of our different studios.

Thank you.

And we have a question with Chris Kwak from SIG.

Great.

Actually two questions.

It would be safe to say given the lineup that you guys have coming out with Superman, Medal of Honor, and Lord of the Rings on 360, and Godfather that fiscal '07 looks to be a better year, year-over-year versus fiscal '06.

But relative to what you guys have guided to for the March quarter, obviously numbers are coming down a little bit relative to expectations.

Should we expect the numbers to be coming down a little bit for fiscal '07?

Can you comment at all on fiscal '07 given the lineup that you have relative to fiscal '06?

I think we've addressed our lineup in fiscal '07 in some of the early responses.

We're not going to give financial guidance on this call for our fiscal '07.

The only thing that I would add to what Larry and Frank have said on the title lineup is what I said in the more prepared remarks and, that is, just be cautious recognizing that we have real investment priorities that we think are mandatory for the long-term growth of EA.

Thank you.

And we have our next question with Justin Post from Merrill Lynch.

Hi, this [Dawn Farman] for Justin Post.

I was just wondering if you could comment -- on your previous earnings call you had said that you expected to increase R&D in fiscal year '07 by 10 to 15%.

Can you update that number or let us know when you think the peak year in terms of percentage of revenue R&D will be?

I would put -- at least in -- recognize that we are very, very still in the preliminary stages of our formal planning process, but I would still put those numbers in the roughly 10 to 15% range.

The only difference, I would say, is I would also include the R&D portion of JAMDAT in those numbers, as well.

Okay.

Thank you.

Thank you. [OPERATOR INSTRUCTIONS].

Our next question comes from Gary Cooper with Bank of America.

Hey, sorry.

Couple of questions.

I wanted to know how you think your retail inventory is right now and whether you think you've got enough reserves?

Similar to that, any change since the fall and how the retailers are managing their business and how it impacts you?

And then finally, does the Godfather go out at $49 and if it does, can any other of your current-gen titles go out at $49, thereafter?

Thanks.

I'll take those questions.

The inventory levels feel pretty good right now.

If you look at what's going on in North America in January, people are cautiously optimistic about how the months are rolling up.

We've had a good start on MVP Baseball, as you heard earlier in the call, and as well, our catalog is responding strongly.

The specific platforms that are doing well are the DS, the PSP and also the 360.

There is a little bit of softness on the current-gen products where a lot of that inventory might be, but I believe that we're in a good position to move through that inventory.

In terms of the reserves, we've handled that appropriately in Q3 and also going forward into Q4.

And your final question about Godfather is that we will be releasing the game at $49.

In addition to that we will have a collector's edition at $59.

As you know, current-gen software is having some pricing pressure and we believe that that $39 pricepoint is going to start to take effect on most launches, but I believe, and so do most of us at EA, that there are a few select titles, some premium tiles that can bear the $49 pricepoint going forward.

Okay.

And how about the retailers, are they timing up even more so than, let's call it last August or September?

I don't think so.

I think that the feedback that we've received from our retailers over the last couple of weeks is that they are cautiously optimistic about things going forward.

Their inventory levels were managed very tightly in the holiday season.

Obviously, it was a tough quarter.

But things seem to be moving nicely right now at retail and they are replenishing.

Obviously they held it tight, so there are opportunities to replenish against new business.

Thank you, sir.

And we have a question from John Taylor with Arcadia.

I have got a question about this talk about sequelitis.

I wonder if you guys are thinking that the consumer resistance to some of the sequels that were put out this year is more of a reflection of kind of the end of the last generation cycle and people looking forward or whether there is -- how you're thinking about it.

Is there some bigger problem about innovation or something like that?

Maybe talk about that issue a little bit.

Thanks.

Yes, I can take that one.

If you -- one of the things that we like to look at is cycle performance.

How did a franchise start the hardware cycle and how did it end?

So if you look at '00 to '05 and use MPD data, Madden Football was the number one selling franchise over that period of time.

If you also then look at how the rest of our franchises did, we had the most titles in the top 10 selling franchises over the last cycle; more than any other publisher.

We had Madden, Sims, and Need For Speed.

Of the top 20 we had more than any publisher and that was eight.

And a lot of these franchisers are based on annual updates or every other year updates.

And I think the important thing that really comes through for us on the analysis when we look at this cycle performance is, 13 of our top 20 franchises ranked higher at the end of the cycle than they did at the beginning.

So in 2005, 13 of our top 20 franchises, which accounts for the majority of our revenue are ranking higher on the charts than they did at the start.

And, in fact, six of those 13 ended calendar year '05 at all-time highs.

So that seems to indicate to us, coupled with consumer feedback and talks with our reviewers and critical people out there, that we are on an uptick with a lot of these franchises.

We continue to innovate inside of these franchises.

If you look at Madden, for example, or [NC2A] or a Need For Speed, within each of these franchises there are any number of feature innovations that really keep them fresh and keep them moving and growing market share.

So the declines that we saw on a couple of the properties or some of the properties, particularly on the entertainment side, I think, do you -- I mean, is that causing you to rethink whether those properties may be ought to be put away for a while, or have they affected your SKU planning for next year or the following year at all?

Well, we are managing a portfolio and there is a pipeline into the portfolio of new IPs and new products that keeps it fresh.

And when we do experience sales below expectations or a critical claim that's less than expected, we do look at that franchise and actively try and replan its reintroduction and address the learning that we got from that.

So as part of a platform or portfolio play we have a number of franchises that perform very well in any given year, the ones that don't we look at.

But we are constantly feeding new franchises into that pipeline.

Larry cited some of the new ones that are going to come out in the upcoming year that we believe will continue to keep the health and effectiveness of that platform high.

Thank you.

And our next question comes from JP McNealy with American Technology.

Yes, good afternoon.

You have now had a couple of quarters of challenges here with the results.

And as you go back and look and kind of do your forensic accounting in looking at the December quarter, what would you classify as the biggest two challenges for the quarter that missed against your planning assumptions?

I think there is one, and that was we did not properly assess demand and/or properly estimate the potential fall-off that -- or anticipate the fall-off that happened in the quarter relative to the transition.

And I think it's as simple as that.

Yes, just to expand upon that a little bit.

Our expectation was that more units of Xbox 360 hardware would have been delivered to the market in that time frame both in North America and Europe.

And I think we really underestimated the impact of consumers sitting on the side lines and not spending dollars in anticipation of getting their hands on a next-generation console, specifically the Xbox 360.

So I think that had a lot to do with some of the softness in the marketplace.

There are other factors as well, but if you're looking for just one I think that was probably one of the most significant.

Thank you.

And our next question comes from Lowell Singer with SG Cowen.

Thanks.

Good afternoon.

Warren, can you sort of talk about some of the reasons that both sort of interim reasons and long-term reasons that this console transition appears to be so much more difficult than the last one and why the forecasts?

If you look at multiple year period it has obviously been much more dramatic.

I can give you my perspective.

Larry probably has a lot to add to this just given the experience base.

But I think it has to do with the time over which the consoles are launching, having Xbox 360 come one year, and that has a whole set of development challenges, obviously associated with it.

Second thing is, you have a very different architecture of the PlayStation 3, which is also adding development challenges.

And you've got overall technology that people are clearly saving up for as they're not necessarily inexpensive.

They're great pieces of hardware that can do some great things from an entertainment perspective, but they also require a significant investment and I think all of that together really is just extending the time of transition.

Yes, I would say -- I would add to that there are more moving parts.

We've got more platforms in the marketplace than we have had in the past.

When you think about three new console platforms, plus the PSP, plus the Nintendo dual screen, there is the online functionality that we have to take into account these days.

We're trying to aggressively grow our business in new markets like China and the rest of Asia.

So there are just a lot more investment areas that we are confronting these days then we may have five or six years ago as we went through the last transition.

Thank you.

And our next question comes from Robert Haley with Gabelli & Company.

Hi.

Thanks for the question.

I wanted to ask about the online advertising opportunity and maybe just zoom in on that.

If you could size the market potential that you see, is it a two-year or a five-year opportunity and what are the steps that need to be taken in order to get there?

Thanks.

Well, the biggest step, and Frank can jump in here, too.

On dynamic in-game advertising is really getting more gamers online.

So once more and more next-generation consoles are in the marketplace that's going to expand the opportunity and then it is building the technology and the games to allow for the dynamic serving of the advertising inventory.

We've said in the past that we don't see this necessarily in the hundreds for us.

But could it be in the tens?

I think that's certainly a possibility.

Thank you.

And our next question comes from Mike Hickey with Janco Partners.

Hi, guys.

You talked about a soft spot at retail.

Obviously, we saw that pre-360 launch.

Are you anticipating a similar magnitude of soft spot pre-PlayStation 3/Revolution launch?

And if so, what adjustments are you guys going to make to your operating model?

Well, we're actively planning our '07 right now and that is something that we will be looking at.

The difference is that there will be a next-generation system in the market, obviously with the 360 with a lot of software library titles coming in.

But we will account for that in our '07 planning.

Thank you. [OPERATOR INSTRUCTIONS].

Our next call -- or our next question comes from Mark Schumacher with Hallum Capital.

Thanks for taking my call.

I just was wondering if you guys would elaborate on the reserves for your accounts receivable that you took?

It seems like they grew relatively quickly this quarter and nothing off the top of my head really struck me as a good reason why.

I would tell you our process really resembled the same one we do every quarter and, that is, we go through and summarize what's in the channel, look at our weeks of supply on hand, evaluate how it's selling through, and then set our reserves accordingly.

And, as Frank said, I think, we're just as we always try to be straight down the middle of the fairway.

Thank you.

And we have a question from Brendan McCabe with CIBC World Markets.

Hi, guys.

I was wondering if you had a breakdown between the retail version of Battlefield 2 Special Forces and the downloaded version?

What we found actually with the release of the Expansion Pack/Special Forces is we had a higher tie ratio on this expansion pack than we ever had before.

We had roughly a two-third to one-third look at online versus retail sales on the product, and it was a larger number than we anticipated in total.

So it actually ended up expanding the market overall.

And somehow I paid $30 for a Grappling Hook but I still play every night.

I have the same problem.

And anything -- would you guys move Black to next-gen?

We believe that Black will be an important IP for our Company and it obviously has potential in the next-gen systems.

Thank you.

And we have a follow-up question from Elizabeth Osur with Citigroup.

Hi, my question has been answered.

Thank you.

We do have a question from Tony Gikas with Piper Jaffray.

Hi, good afternoon, guys.

If we look back over the last five or six years at the past cycle now, it looks like its fallen short of most people's expectations.

Looking to the next five or six years with hardware pricepoints going up about 30% and software pricepoints potentially moving 20% higher, do you think that there's an opportunity to grow hardware units over the course of the next cycle?

My answer would be a resounding, yes.

I think these are very, very powerful machines.

I think the types of products that we will be able to build on these platforms will appeal to a broader demographic, both in terms of age and gender.

So I absolutely believe the installed base on next-generation will be larger in all of the major markets.

And then you've got the online component that I think will help drive incremental business as well in the future.

I think, Tony, that this is, in my mind, will the quality of the entertainment experience get better in next-gen?

And if it is meaningfully better, that would argue you should have more consoles in the marketplace.

Operator, we'll take one more question.

Excellent.

And our next question comes from John Taylor with Arcadia.

And, sir, if you would please press star, zero -- star, one, I'm sorry.

Operator, is there one last question?

Are you there?

Yes.

Okay, sorry.

So I know you're staying away from financial guidance for next year.

But can you give us a rough sense by platform of what your SKU plan might look like?

Well, as we said earlier, I would expect that we're going to have something like 15 to 20 titles on the Xbox 360.

I'm thinking we will have something like eight to 12 on PlayStation 3.

Sort of in the four to six range on Nintendo Revolution.

Frank, help me out.

No, that is about right.

Our current-gen lineup will be pretty good on the PS2.

The Xbox will obviously be scaled back.

Our handheld business on the PSP and the NDS are growth opportunities we believe for us.

So we'll be very aggressive there.

Okay.

So total SKUs roughly in-line with what you're going to do this year?

Total SKUs next year are roughly 130 and that's not too dissimilar from what we've done this year.

Right.

And that does not include the mobile phone stuff?

Correct.

Okay.

Thank you.

Thanks everyone for joining us.

Thank you.

And this does conclude today's conference.

We would like to thank everyone for your participation and have a wonderful day.