美商藝電 (EA) 2007 Q3 法說會逐字稿

Good day, everyone and welcome to the Electronics Arts third quarter fiscal year 2007 earnings conference call. [OPERATOR INSTRUCTIONS] For opening remarks and introductions, I would like to turn the call over to Ms. Tricia Gugler, Director of Investor Relations.

Please go ahead, ma'am.

Welcome to our third quarter fiscal 2007 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 would like to remind you that 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 we will post a copy of Warren's remarks on our website.

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

Non-GAAP measures exclude charges and related income tax effects associated with acquired and processed technology, amortization of intangibles, certain litigation expenses, restructuring charges, and stock based compensation.

In addition, the company's non-GAAP results exclude the impact of certain one time income tax adjustments.

Our earnings release provides a reconciliation of our GAAP to non-GAAP measures.

Information regarding our use of non-GAAP measures along with the schedule demonstrating how we calculate return on invested capital will be included with a copy of Warren's remarks we post on our website.

These non-GAAP measures are not intended to be considered in isolation from, a substitute for, or superior 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 2007 estimated market outlook and a supplemental schedule on our website.

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 10-K and Form 10-Q for discussion of risk factors that could cause our actual results to differ materially from those discussed today.

We make these statements as of February 1,2007 and disclaim any duty to update them.

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

Good afternoon, everyone.

We would like to begin with a few highlights.

Our third quarter performance was solid with bottom line results exceeding our expectations and our top line right at the top of the range.

Revenue was $1.28 billion, up slightly year-over-year.

Gross margin was 63.3% versus 60.5% a year ago.

GAAP diluted earnings per share were $0.50 versus $0.83 a year ago and non-GAAP diluted earnings per share were $0.63 versus $0.86 a year ago.

In the quarter, several titles stood out.

Need for Speed: Carbon sold over $8 million copies and was a top 5 title in both North America and Europe.

FIFA '07 had a strong performance.

Since launch, our revenue was up more than 30%.

In the U.K., FIFO '07 was the top of the charts across all platforms for five consecutive weeks.

We estimate the overall FIFA franchise was number one in Europe in 2006.

The Sims 2 Pets sold over 5 million copies with more than 65% of our sales outside of North America.

It is now our fastest selling Sims 2 expansion pack.

It was also a hit on the NDS, selling over 1 million copies.

Madden NFL '07 sold over 3 million copies in the quarter.

Since launch, our revenue is up 25% year-over-year.

Madden NFL '07 was the number one title in North America in 2006.

In addition, we had 6 other titles that sold in excess of 1 million copies, Need for Speed: Most Wanted, Tiger PGA Tour '07, The Sims 2, Superman Returns, NBA Live '07 and Battlefield 2142.

We continued to see growth and payback in online.

On a trailing 12 month basis, our digital revenue reached a record $115 million.

During the quarter, our digital revenue was $37 million, up 50% year-over-year.

We sold three and a half million pieces of digital content, including microtransactions and digital downloads.

Pogo revenue for the quarter was $21 million, up 53%.

And total paying subscribers passed through 1.4 million.

In total, more than 1.7 million Pogo-based microtransactions were completed -- a sequential increase of 9x driven by successful launch of Pogo Gems.

In Korea, FIFA Online continues to expand, with December being the highest revenue grossing month since launch.

Today, we have completed 1.4 million microtransactions at an average retail price of approximately $1.60 per item.

In the month of December, the average revenue per user was over $10.

Up from roughly $6 in the month of September.

We are also pleased with our early performance on the PS3.

We ended with a strong 32% segment share.

All of our launch titles were in the top ten with an average rating of 80.

In summary, while we have work to do, we enter calendar 2007 from a position of strength.

Number one on the 360, PS3, PS2, Xbox, PC and the PSP -- number one with mobile phones and with a stream of digital revenue that's continuing to expand.

For the next few minutes, I will focus my remarks in two areas.

First, I will review our Q3 financial results.

Second, I will go over our outlook and financial guidance and then following my comments, Larry, Frank and I will open the call to your questions.

Q3 net revenue was $1.281 billion, up $11 million from last year.

Absent the impact of foreign exchange, revenue would have been down 2%.

Revenue was driven by Need for Speed: Carbon, FIFA '07, The Sims 2 Pets, and Madden NFL '07, all selling over 3 million copies in the quarter.

All four of these blockbuster franchises experienced both unit and revenue growth year-over-year.

We released 41 SKUs in the quarter versus 49 a year ago.

Deferred revenue increased $21 million sequentially.

Were this deferral not required, our total revenue would have been $1.3 billion and EPS would have improved by approximately $0.04 and our operating margin by approximately 150 basis points.

Console revenue was $736 million, down 7% due to fewer releases, most notably Harry Potter.

The increase in next-gen revenue of $166 million did not offset the decline from current-gen platforms.

Mobility -- revenue was $229 million, up 19%.

On Mobile phones, revenue was an industry leading $35 million.

We have four of the top five games in both North America and in the U.K.

We estimate we had roughly 29% segment share in North America.

In Europe, we estimate our segment share was north of 15%, up more than 200% year-over-year.

On handhelds, revenue was $194 million, up 2%.

NDS revenue increased over 50% driven by The Sims 2 Pets slightly offsetting the decline in GBA.

PC revenue was $218 million, up 47% driven by The Sims 2 Pets and The Sims 2.

In North America, EA had nine of the top 20 PC titles with The Sims 2 franchise holding seven of them.

In Europe, The Sims 2 Pets was the number one PC title in the quarter.

Co-pub and distribution revenue was $49 million, down 51% due to significantly fewer releases and last year's strength of both Black & White and Half-Life 2.

Internet licensing, advertising, and other revenue was $49 million, up 29% driven by advertising and Club Pogo.

Total advertising revenue was $13 million, up 140% year-over-year.

Geographically, North America revenue was $637 million, up $19 million or 3%.

Console revenue was roughly flat, with next generation revenue offsetting the declines in current-gen platforms.

In addition, growth in PC and mobility offset the declines in co-pub and distribution.

We had two top five titles with Madden at number one and Need for Speed: Carbon at number five.

International revenue was $644 million, down $8 million or 1%.

Excluding a $33 million positive impact from foreign exchange, international revenue would have decreased 6%.

Europe revenue was $583 million, up $6 million.

Increases in Xbox 360, Wii, PC and mobility were partially offset by the declines in current-gen and co-pub and distribution.

We estimate that EA had three of the top five chart positions.

Need for Speed: Carbon, FIFA '07, and Sims 2 Pets.

Asia revenue was $61 million, down $14 million driven by last year's performance of Harry Potter, Burnout and Star Wars Battlefront.

Moving on to the rest of the income statement.

Gross profit in the quarter was $811 million, up 6%.

Gross margin was 63.3%, versus 60.5%.

Up 280 basis points driven by lower sales return charges and a lower mix of co-pub and distribution.

OpEx -- as you know, at the beginning of the fiscal year we adopted FAS 123(R).

In the third quarter this resulted in stock based compensation of $35 million.

Marketing and sales -- marketing and sales expense was $165 million, up $18 million primarily due to higher incentive and stock based comp.

And the impact of acquisitions, partially offset by lower ad spend in Europe.

Excluding the impact of stock based comp and acquisitions, marketing and sales would have increased to approximately 6%.

G&A and administrative -- G&A was $91 million, up $33 million, primarily due to higher incentive and stock based compensation, professional fees, and the impact of acquisitions.

Excluding the impact of stock based comp and acquisitions, G&A would have increased approximately 31% year-over-year.

R&D -- R&D was $330 million, up $124 million, primarily due to personnel related costs, acquisitions, higher contract services, and facility related expenses.

Excluding the impact of stock based comp and the impact of acquisitions, R&D would have increased 42 -- approximately 42%.

R&D head count was roughly 5,800, up 16% from a year ago.

Acquisitions including JAMDAT, Mythic, Phenomic and Head Gate accounted for 11 points of this increase.

Please remember that in contrast to last year, we anticipate a higher employee bonus payout, providing we meet our Q4 objectives.

This is materially impacting our expense comps year-over-year.

Our GAAP tax rate for the quarter was 35%, versus 29% a year ago.

As I have mentioned, you can expect our rate this year to be volatile and potentially fluctuate dramatically quarter to quarter.

Looking ahead, while things could change, we expect our GAAP tax rate for fiscal '07 to be around 50% and our non-GAAP rate to be around 30%.

GAAP diluted earnings per share were $0.50 versus $0.83 a year ago.

Non-GAAP diluted earnings per share were $0.63 versus $0.86.

The $0.13 difference between GAAP and non-GAAP EPS is principally due to stock based compensation of roughly $0.09, amortization of intangibles roughly $0.03, and restructuring charges of $0.01.

Our trailing 12 month operating cash flow was $520 million versus $733 for the comparable period.

Our return on invested capital on a 12 month basis was 10% versus 27% a year ago.

Now on to the balance sheet.

Cash short term investments in marketables were $2.6 billion, up $270 million sequentially primarily due to cash generated from operations.

Gross accounts receivable were $779 million versus $829 million a year ago.

Reserves against outstanding receivables totalled $228 million, down $34 million from last year.

Reserve levels were 11% as a percentage of trailing 6 month net revenue down 2 points from last year.

As a percentage of trailing nine month net revenue, reserves were 9%, also down two points.

The channel is in great shape heading into calendar 2007.

Inventory was $72 million, down $4 million from a year ago.

Other than Need for Speed: Carbon, no one title represented $4 million of net exposure.

Now our outlook.

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

Calendar 2007 and our upcoming fiscal year are all about three things.

Growth, reward, and changing business models.

Let me talk about each for a moment.

Growth -- in the traditional console handheld and PC segments, we see a healthy year ahead.

We expect growth in North America and Europe's software sales to be between 13 to 18%, driven by an expanding install base and healthy TIE ratios.

When we exit calendar year 2007, we expect an install base of 80 million next-generation systems in North America and Europe, an increase of roughly 100% year-over-year.

For EA, our growth will be fueled by our strong lineup.

We expect to launch more than 10 wholly-owned titles.

Just to name a few -- Army of Two, Burnout 5, Medal of Honor: Airborne, Escape, My Sims, SimCity, Need for Speed, and Spore.

In entertainment, Harry Potter, Warhammer and the Simpsons.

Through EA partners we will co-publish both Crisis and Hellgate: London.

We have reached an agreement with Pandemic Studios for global distribution of Mercenaries 2: World in Flames.

In sports, our full lineup will be back.

Net, while we expect very competitive year we have our own slate of blockbusters on the way.

By platform, fiscal 2008 you can expect us to ship between 20 and 25 SKUs on both the 360 and PS3.

On the Wii and the NDS, we are all over both.

We have more than 15 SKUs in development for both the Wii and NDS, including several originals.

We have shifted and acquired resources and are attacking these successful platforms.

First, the Sims.

You can expect a new title, My Sims, on both platforms.

In addition, we are developing SimCity for the NDS.

Second, Spore.

Not only focusing on the PC and online, we are launching this innovative experience on the NDS.

And finally EA Sports.

We think our brand coupled with the right sports content can win on both platforms.

In short, we are on it.

In mobile, we expect global industry growth of 20 to 25%, fueled by new handset sales, increased consumer adoption of mobile entertainment and more great gains.

For EA, we expect to continue to expand internationally most notably in Europe.

In the coming fiscal year, mobile revenue will likely pass through $175 million.

Online -- For fiscal 2008, we think our online revenue before deferrals could pass through $200 million, up close to 60% year-over-year.

Driven by digital downloads, dynamic and game advertising, microtransactions, Warhammer in the MMO space, Pogo, and in Asia we will aggressively ramp our mid-session game offerings.

We anticipate that FIFA Online will go live in both China and in Japan.

We also plan to roll out NBA street.

Reward -- the last few years have clearly been about investment.

In the coming years, including fiscal '08.

Looking ahead to fiscal 2008, we expect significant improvement in our non-GAAP operating margin.

This should be driven by a strong top line, growth and gross profit, and comparatively slower growth in our expense space.

We expect R&D to grow in the single digits in fiscal 2008.

If you strip out the growth from mobile and online, our core studio R&D should increase by no more than 5%.

Changing business models -- as we have mentioned, given the expansion of online game play in too many of our titles, you should expect to see more deferred revenue.

The challenge we have been wrestling with is how to optimize the customer experience and expand our online service offering, but at the same time navigate the complexities of SOP 972, which deals with software revenue recognition where services are included as part of the software sale.

From the customer perspective, we have now made one simple call.

That is, beginning in fiscal 2008, we will continue to expand our online offering and we will not charge for online hosting as it relates to our packaged goods title.

Further, we now know that Sony will not charge for its online service.

So what does all this mean?

Beginning in fiscal 2008, for online enabled games on the PS3, PS2, PSP, and PC, all packaged goods revenue will be amortized over the length of the online service period which we currently estimate to be six months.

Given the significance of the holiday season, this means that likely more than $400 million in revenue that would have otherwise been reported in fiscal 2008 will be deferred and recognized in fiscal 2009.

We do not intend to defer any product costs.

Now it's important to keep in mind that this change first will not impact any of your estimates for fiscal 2007.

Second, does not in anyway impact the economic fundamentals of our business.

Third, will not adversely impact our cash flows.

And finally you will hear in a moment that through our non-GAAP reporting you will have comparability year-over-year so you will, on an apples to apples basis, easily be able to judge our performance.

In short, a big change in our GAAP results for fiscal 2008, but no change in the economics of our business, our cash flows or your ability to judge our performance.

Now let me talk about our reporting and comparability -- how you will be able to judge our performance year-over-year given this change.

If you look at our financial presentation this quarter, you will see we made a few changes.

Most significantly, we added a line to our non-GAAP reconciliation where we plan to add or subtract the change in deferred revenue in order to determine our non-GAAP EPS.

We have modified our non-GAAP measures in this manner for several very important reasons.

First, the simple addition of this one line item will provide you with year-over-year comparability.

Again, we do not intend to defer any of the product cost.

Therefore, this one added line will normalize our year-over-year costs.

Second, modifying our non-GAAP measures this way is more reflective of the cash characteristics of the business.

Remember that the deferral of revenue does not adversely impact cash flow.

The business has not changed.

Third, it is how we will manage our business, assess our operating performance, and measure management.

We want our team focused on the customer, improving cash generation and increasing our ROI.

In addition, if you go to our website you will see an expanded set of schedules and reconciliations, including an FAQ that should also assist you in understanding the impact of this change and our other non-GAAP adjustments.

A few things to note.

Packaged goods revenue associated with the 360, and Xbox will not be impacted in large part because Microsoft charges for its online service.

As a result, we expect no change from current practice.

As it relates to the Nintendo platforms, our revenue recognition will be dependent upon the ultimate service offering.

For our MMO offerings, we will continue to recognize revenue as we do today -- the packaged goods portion of the product is recognized over the service period.

Microtransaction revenue will continue to be recognized as we do today.

For downloadables, revenue is recognized immediately.

Where the microcontent is only playable while connected to EA servers, it is viewed as a service and recognized over the service period.

To summarize on this point, while our GAAP results for fiscal 2008 will be impacted significantly, this change is all about putting the customer first and letting the accounting follow.

The economics and cash characteristics of our business are not changing.

No adjustment to your GAAP or non-GAAP estimates for fiscal 2007 is required, as this is a prospective change we will make in fiscal 2008.

And finally you will have comparability through our non-GAAP measure.

You will be able to evaluate our 2008 performance in all material respects the same way you do today.

I will now conclude my portion of today's call with our market outlook and financial guidance. 2007 market outlook -- for calendar 2007, we expect overall North America and Europe console handheld and PC software sales to increase 13 to 18%, and mobile software sales to increase 20 to 25%.

You can find a summary of our console, handheld, and PC estimates on our website.

Now the numbers.

For the quarter ending March 31, we expect revenue to be between $550 and $600 million.

GAAP diluted loss per share to be between $0.17 and $0.12.

Non-GAAP diluted earnings per share to be between roughly break even and $0.03.

Overall, we expect our non-GAAP EPS to be roughly $0.15 better than our GAAP results.

The estimated break down of these adjustments is as follows.

Stock based comp approximately $0.08, amortization of intangible assets roughly $0.03, restructuring charges approximately $0.02, and acquisition charges of roughly $0.02 associated with our acquisition of Mythic.

On share count, for positive earnings, the appropriate share count would be roughly 320.

For a net loss the appropriate share count would be approximately 315 million.

In Q4, we expect to ship 27 SKUs compared to 29 a year ago.

We expect to have 16 next-gen SKUs including five for the 360, four for the Wii, three for the PS3, and two on both the NDS and PSP.

In addition, for the launch of the PS3 in Europe, we will have at least five titles.

In January, we released NCAA March Madness '07 on the 360 and PS2.

This title is already off to a great start.

During the quarter, we expect to release Def Jam: Icon on the 360 and PS3 which will include dynamic ads, Medal of Honor: Vanguard on the PS2 and Wii, Burnout Dominator on the PS2 and PSP, NBA Street Home Court on the 360 and PS3, Command & Conquer 3: Tiberium Wars on the PC, Champions League on four platforms, Godfather the Game on the PS3 and Wii, MVP '07 NCAA baseball on the PS2, Arena Football: Road to Glory on the PS2, SSX Blur on the Wii, Tiger Woods PGA Tour on the Wii, Theme Park on the NDS, Pogo Island on the NDS, The Sims Life Stories on the PC, The Sims 2 Seasons expansion pack on the PC, and Battlefield 2142: Northern Strike booster pack on the PC.

On mobile phones we plan to launch six games.

EA Sports NASCAR '07, MVP Baseball '07, Pool multiplayer, Tetris multiplayer, Pictionary, and the next iteration of Bejeweled.

Full year guidance -- for the full year we expect revenue to be between $3.025 and $3.075 billion.

GAAP diluted earnings per share to be between $0.15 and $0.20.

Non-GAAP diluted earnings per share to be between $0.70 and $0.74.

Overall, we expect our non-GAAP EPS to be roughly $0.55, better than our GAAP results.

The estimated break down of these adjustments is as follows.

Stock based comp, roughly $0.34.

Amortization of intangible assets, approximately $0.13.

Restructuring charges of roughly $0.05.

Acquisition charges, approximately $0.03 related to our acquisition of Mythic.

One final housekeeping item, as you begin building out your models for fiscal 2008, please remember that we face the challenging comp in Q1 given the strength of last year's World Cup.

That said, we do expect that Harry Potter will be a June release.

Before we open the call to your questions, I will conclude with a couple of closing thoughts.

First, it's a great time -- it's great to have all the next-generation platforms in the marketplace.

These platforms and online are beginning to open up a new digital age for interactive entertainment.

We believe that we are uniquely positioned to take advantage of these opportunities given the investments we have made in next-gen, online, and in mobility.

And second, our long term priorities are clear.

Next-gen leadership including the Nintendo platforms, winning in online, Asia, and mobility.

Expanding our wholly owned IP portfolio while at the same time delivering long-term value to our share holders.

Of course, these priorities are not without complexity and we will make mistakes along the way.

All that said, EA has the best team in the business to lead us through this changing, challenging, and exciting time.

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

[OPERATOR INSTRUCTIONS] We will take our first question from Mike Hickey.

Thanks, guys.

Great job on the quarter.

Thanks.

Could you please provide us with your initial observation about the PS3 launch and install base growth as well as maybe the 360 install base growth?

Sure.

The PS -- this is Frank.

The PS3 release in Q3 met expectations as per our earlier guidance on hardware quantities.

The rollout was definitely successful from a demand generation standpoint.

The one area that we saw little bit of disappointment was in the TIE ratio.

It was lower than expected.

On the 360, we were very pleased with the TIE ratio that came in above expectations.

And while the hardware total didn't quite meet guidance, it was very strong and when you combine that with the TIE ratio being higher, we were largely right there.

Okay.

And can you remind us the strategic importance of the Asian gaming market.

It looks like over the last several quarters you're experiencing negative year-over-year growth.

Is it still as important as it used to be and what steps are you taking to accelerate growth in that region?

This is Warren.

I think you have to look at it in two respects.

One, you have to look at it in terms of the packaged goods business which was down year-over-year.

And as I mentioned in my prepared remarks, that was really as a result of the SKU plan.

As we look at the online market going forward, we think it's very important and as you know, we so far have had -- we think really a strong launch and strong kickoff with FIFA Online in Korea and as I mentioned in my prepared remarks, this coming year we plan to roll FIFA Online out hopefully in both China and Japan and also it's our intention that we begin the rollout of NBA Street into the Asian markets.

Longer term, we think it's very valuable.

We think the learnings that we are getting from the microtransaction marketplace in Korea and other parts of Asia will also be invaluable to us in the western markets in the years ahead.

And the one comment I would add to that is that we think there is significant opportunity on the mobile platform in Asia and we are just getting started in that respect as well.

Great.

Thanks, guys.

Moving on, we will take our next question from Todd Greenwald with Nollenberger.

Hi, thanks.

Just want to -- going back to the PS3, wondering if you're expecting a price cut this year?

Just wondering how concerned you are about that ramp of the install base and also any of your thoughts on the recent Xbox 360 forecast reduction?

With regards to the price change, that's a question that we would refer to Sony.

Looking at the early January result, the trends on the PS3 are good.

It's selling through at a comfortable clip.

Again, you have to recall that this is a price point that is much higher than the PS2.

When you're setting expectations looking at a PS2, for example, you would expect that the PS3 would be a bit slower in terms of its ramp.

But we are confident that the full year number will be good.

With regards to the cut in the 360 forecast, we see the strong lineup of software on the 360 this year will drive strong demand for that platform and we don't anticipate that there will be any big problems there.

Great.

Thank you.

Next we will hear from Colin Sebastian with Lazard Capital Markets.

Good afternoon.

Thanks for taking my questions.

I have a couple.

The first -- the significant increase in the support of Nintendo platforms that you referred to, is that coming at the expense of any other platforms?

That's the first question.

And then secondly, excluding the impact of the accounting change, there is anything on the competitive landscape you see that would make you think it might be difficult to maintain market share in 2007?

With regard to the first question, the support for the Wii and NDS platform is not at the expense of the other platforms that we deem strategic.

So you will continue to see us be very prolific on the PlayStation 3 and Xbox 360 platforms as well as the PC.

We are -- one of the things we have done is acquired the Headgate studio in Salt Lake City.

Up to this point, they have been exclusively developing titles for the Wii platform and that will give us additional development capacity on the Wii.

And we are redirecting some other resources toward Wii and NDS.

By the end of this fiscal year, we will have six titles in the market -- which, other than Ubisoft, we will be the most prolific publisher on the Wii platform through March.

And you can expect to see a ship a number in the low to mid teens next year in fiscal '08 on both the Wii platform and on NDS.

So we have very aggressive market share goals on both those platforms as well as PS3, Xbox 360 and the PC.

Your final question on competition next year, it certainly will increase.

However, if you look at the lineup that we have planned for calendar year, it's pretty impressive in terms of the lineup of blockbusters.

We're very confident in the lineup that we have -- if you listen to the list that was read off earlier in the script, things ranging from Medal of Honor: Airborne to Army of Two, Skate, Burnout 5, Spore, SimCity, The Simpsons, Harry Potter, Warhammer, Hellgate, Crisis, Mercenaries II.

It's quite an impressive list in the nonsports categories and obviously next year we will be back with a strong lineup in EA Sports.

Let me clarify one thing.

The online deferral will not impact how segment shares are measured as that is being done on a sell through basis.

So this is purely a GAAP measurement.

No one should walk away with any level of confusion that segment shares would be negatively impacted as a result of 972.

Okay.

And that is helpful.

Following up on the slate quickly.

The Lord of the Rings title, I think, that was originally planned for next year.

I'm just curious if you can provide any color on what happened to that title and what was behind the decision to cancel it?

Thank you.

The Lord of the Rings product is back in development in terms of being on hold and we're looking at the creative positioning and feature set on the Lord of the Rings franchise.

We did not decide to move forward with releasing it this year for those reasons.

Okay.

Thank you very much.

Next we will hear from Chris Kwak with SIG.

Great.

Just a couple of questions.

On the first one -- when you look at the online business, you projected it to be around $200 million.

And including ads and digital downloads and microtransactions and MMOs -- what's your expectation for gross margins?

It's hard to understand from a blended basis.

But what do you think the general idea of the gross margin should be?

Should it be higher than the corporate average today?

By and large I would say yes, higher than the corporate average.

You have to take a look at a couple things.

For example, on microtransaction,n you have to look at are you starting after the platform splits with say a Microsoft, for example.

So on a microtransaction, if you start it with absolute gross, you might be lower than our averages, but if you look at the net proceeds coming to us, then you could very easily be higher.

Overall, when I take a look at the whole mix as between in-game advertising subscription, what's going on in microtransaction and the like, I would expect higher gross margin.

How would you as of this moment, how would you be leaning toward the gross or net revenue recognition -- for things like microtransactions?

Microtransaction is a little bit easier.

We will play it as we go, but pretty much net.

Okay.

And then just looking at the gross margins, obviously very strong this quarter.

It looks like it was largely a revenue mix issue with PC being higher and the co-pub and distribution being lower.

But overall the console gross margins, did that change markedly this quarter?

The only thing that I would correct there is I mentioned the principal driver of our higher gross margins was lower sales returns charges.

So as opposed to just console mix which had a factor in lower royalty rates which was a factor, roughly two points to the increase came as a result of lower sales return charges.

That said, again, let me clarify as I mentioned in my prepared remarks -- we think channel is in great shape and in great shape both in North America and in Europe.

Just a final question.

You mentioned on the online business.

Given that PS3, PS2, PSP, and the PC being deferred, it sounds like all of it's going to be on the balance sheet as short term deferred revenue.

But you also gave us a $400 million number -- if I am not mistaken -- if I recall.

Is that the ending balance number for the fiscal year or is that sort of the volume of deferred revenue you expect to generate?

That would be the ending balance.

But again, let me remind everybody that with online deferral this is tricky.

So depending on the month of shipment that could impact what that ending number would be.

This number could easily go down and it could easily go up.

So that gets a little bit vague.

What we were talking about is the $400 million being an ending balance.

I'm sorry?

And that's on top of the $75 you currently have as of today.

That is correct.

Great.

Thank you very much.

Yes.

Moving on we will take John Taylor with Arcadia Investment Company.

Hi, I got a couple of questions too.

First, could you give us what catalog was in the December quarter and what you expect it to be in March?

Second question, is Larry, wonder if you could talk a little bit about maybe market share goals on the Nintendo platforms.

You know, given that Nintendo tends to kind of have the primary share on their own.

So maybe give us a sense of kind of how you are thinking about that?

And then on this deferred revenue issue, Warren, maybe talk a little bit about -- okay, I understand the development costs and support costs and all that.

Hosting costs are going to be absorbed.

Realtime, what are you going to do with advertising and allocating that over the six months and G&A load and the other pieces of operating on that?

Thanks.

With regard to the split between front line and catalog in Q3, it was 51% front line and 38% catalog.

With regard to market share goals, it's always our goal to have a leading market share on the platforms that we believe are strategic -- are clear that we have number one market share goals on all of the platforms where we are currently number one and that would include PS2, PS3, PSP, Xbox 360 and the PC platform.

On the Nintendo platforms we think we can be a very strong number two.

Clearly Nintendo going to always be number one on the Wii platform, on the NDS platform.

We believe that we can be number two, and our market share goals will be in the 15 to 20% range on those platforms.

And then, J.T., on revenue deferral, what will be deferred is in essence net revenue.

For example, if we had a sale of -- call it $40 million worth of inventory and we had an SRA reserve for, say, $4 million, we would then -- over the period -- we would put $36 million on the balance sheet and amortize that into revenue over the following six months.

What I mean by the following six months is if that sale were to occur in December, we will begin amortizing that revenue into -- or that deferred revenue into revenue beginning in January.

Relative to all other costs, product costs, as well as G&A, R&D, everything else, that will all be expensed currently as really title will have passed on the sale of the packaged goods.

Therefore we feel the obligation is out there and it's more appropriate for us just to go ahead and recognize the expense.

The silver lining of all of that, as I mentioned is that now in our non-GAAP measures is a result of adding that one line in terms of change in deferred revenue.

It completely normalizes our results.

So while this can have a dramatic impact on our GAAP results.

What it won't have is -- it will not change our non-GAAP results to where you should have complete comparability in all material respects year-over-year.

Okay, so let me try this one.

On the $400 additional, what do you think -- what should we -- how should we think about the cost side of that which is going to be recognized in fiscal '08 of which the revenue pieces is going to get pushed out?

In other words, should we assume that costs are going to take up say 80% of that or 70% of that revenue amount because that will be reported in your -- captured in your fiscal '08, right?

I think you have to -- first I would tell you to focus on cash, and the pattern for expense recognition and/or cash receipt will be exactly what it is today.

So the economics of this business have not changed in any way.

Now on the GAAP results, the cost for all of those products consistent with your sort of non-GAAP margin forecast would be recognized currently without the revenues.

So that would increase the expense on -- would increase the expense relative to the revenue in a quarter where there is the deferral.

So GAAP results you will see expensed without the revenue,and then as the revenue is amortized in, that will tend to offset each other.

But net -- let me come back to the macro point.

Through our non-GAAP measures you will have complete comparability, the economics of the business have not changed.

So the cash flows incoming to EA will be no different and the outflows will be no different.

But given the dynamics of 972, the revenue will have to be amortized over the length of our service obligation.

So I think it's great that you guys are doing this simply so that we can just add the revenue back and see what that delta is.

I guess maybe to ask it one final way.

So on the 400, what do you think the EPS difference is going to be between the reported GAAP in '08, and between GAAP and non-GAAP?

It would be 400.

No, no, no.

The revenue would be 400.

But the EPS, the delta between GAAP EPS and non-GAAP based on that 400 would be roughly what?

We will give specific guidance at year end, J.T.

But in the hypothetical, what you can assume is that if $400 million of revenue is deferred and given the fact that we currently expense everything, in effect if you were to -- that will fall directly to operating margin.

Do you follow me?

So in other words, if $400 million of revenue leaves fiscal '08, that will directly impact our operating margin.

Yes, when it's added back on an non-GAAP basis.

Okay.

All right.

We can go over this later on.

Thanks.

Next we will hear from Jeetil Patel with Deutsche Bank.

Great.

Thank you.

Going back to the $400 million question, can you give us a sense I guess what percentage of the Sony and PC titles will have that online component versus just a pure packaged software play?

And I have a quick follow-up.

We will give you that guidance as we get into our call next quarter as we talk more specifically about FY '08.

You can sort of figure today give or take roughly 50%.

So it will depend upon our exact plans which we'll go through when we get to our call here in three months.

But today it's roughly 50%.

Okay.

And as it relates to the R&D spending, you talked about I think 5% core and then when you add in online, you get to the mid to high single digits.

Is that kind of what you said about fiscal -- kind of going forward into the upcoming year?

Yes.

Okay.

And it won't be amortization of R&D expense.

It will all hit the P&L in the upcoming year.

That is correct.

Excellent.

Thanks.

Lowell Singer with Cowen and Company will have our next question.

Thanks.

It's Lowell Singer.

I have a couple questions.

First, in your 13 to 18% category growth assumption, Warren, for calendar '07, can you talk about your assumptions for pricing on both PS2 and next-gen titles?

What's embedded in that forecast?

And second, there has been a lot of discussion on the Wii, whether their success this early on is sort of faddish or whether they have a platform that's going to challenge for a much bigger share throughout this cycle than they had last cycle on the hardware side.

I'm wondering how you think the sort of three to five year forecast on console sales is shaping up -- whether you think that Microsoft and Nintendo are going to be much more competitive with Sony and potentially pass Sony this time around compared to the last generation.

Thanks.

With regards to the price in question, we are looking at the current trends in front line pricing of both next-gen and current-gen and moving those assumptions forward.

There doesn't appear to be a lot of resistance for the $59 price point for frontline next-gen titles.

On the current-gen, it's becoming more of a $39 market but there still is room for premier titles to command the $49 price point.

So in our forecast assumptions we have a mix based on those assumptions.

With regard to the Wii platform, at least initially it seems like it's expanding the overall market.

And expanding the demographic of users and people that purchase software.

So we think that's a good thing and we will have to see whether that's sustainable over time.

But certainly they have gotten off to a very encouraging start.

And over the next cycle, whether it's three to five years or longer, it appears as though both Microsoft and Nintendo are positioned to gain some share.

But we think that Sony will continue to do extremely well.

They are very strong, in particular in Europe and so we think that there are three viable hardware platforms out there and we will be very proactively supporting all of them.

Okay.

Thank you.

Moving on, we will hear from Heath Terry with Credit Suisse.

Great, thank you.

Warren, I was just hoping that -- or Larry, that you could maybe look out a little bit and when you think about what you are seeing right now in terms of the attached rate for the incremental revenues from both advertising and from the digital downloads that you are doing on a per-title basis, is there a number that you feel like is appropriate for us to be thinking about in terms of the incremental revenue from those two opportunities?

Heath, this is Warren.

I think it's just too early to tell.

I think some of the more interesting things that we are clearly seeing is -- take people online in Korea, these models really work and people like playing mid-session online games like FIFA online.

I think the numbers that we have seen just this quarter in Pogo by introducing the Gems as sort of a payment model are fascinating.

Need for Speed, in the quarter, our in-game advertising was roughly $5 million.

So we will see.

But I think there is a lot of very positive things that we are seeing.

And most importantly, they're things that are making the games better.

And if we can continue to come up with ways to make the games better, these revenue streams will just continue to grow in importance.

So you said that Need for Speed did $5 million in the quarter and incremental advertising revenue, or?

In in-game advertising, both static and dynamic.

So when you mentioned the other titles that you've got that are going to have in-game advertising in this March quarter, should we be thinking that those are able to do similar-type numbers, of course, adjusted for the size of the install base on the game?

That's a fair assumption.

Great.

And at our conference in December, you talked about Need for Speed having done at that point roughly $1 million in incremental downloads or is there an update to that number you can provide us with?

You know what?

Hold on and I will grab you one and come back with that, Heath.

Thanks a lot.

Ted Irvine with Bear Stearns will have our next question.

Thanks.

I was wondering if you could provide more detail on the increase in R&D in the quarter excluding stock compensation.

R&D was still somewhat ahead of expectation.

Was that primarily the Wii?

The R&D is really -- the growth is a function of several things.

Obviously the stock based compensation 123(R).

Second thing is overall incentive compensation, last year we did not meet our operating plan objectives.

This year, so far we are meeting them.

Now we have to bring the quarter home so this is not a done deal yet.

But that resulted in an overall significant increase in the expense [inaudible].

The third thing would be overall acquisition.

If I were looking at kind of normalizing all those things and looking at kind of a run rate expense, I would put the growth in R&D in the quarter around 10ish, slightly higher, but not a lot more.

Okay.

Great.

That's helpful.

And then I was wondering if you can comment on how the co-development of SKUs for the PS3 and Xbox 360 is going?

And what sort of benchmarks are you looking for during the coming year?

In terms of co-development, can you describe what you mean by that.

Well, in terms of currently co-development of SKUs on separate teams or together, just trying to get a sense of how that's progressing as you look for sort of efficiencies as that process goes on.

I can speak about it generally.

We have single franchise teams that are approaching each of these businesses.

And when we look at the PS3 and the 360, the development of those two platforms is more alike and more asset sharing than when you look at current-gen or the Wii for example, just given the architecture of the system, the multiple processors and high definition graphics, et cetera.

So we do see that that will continue in the future where they will continue to be 360, PS3 development being mostly the same.

You'll do some things on one versus the other to optimize and to make them better.

But on the Wii and the current-gen stuff that still continues to be a different type of development.

Okay.

While we're waiting for the next question.

Let me just come back, Heath, to your question.

On Need for Speed in Q3 and microtransactions, our average revenue per person purchasing content was about $11 in total retail revenue that amounted to roughly $0.75 million dollars.

The average purchase per item was about $2.50.

Moving on we will take our next question from Tony Gikas with Piper Jaffray.

Hi, good afternoon, guys.

Few quick questions for you as we enter a period here of improving cash flows over the next couple years, could you just comment on your thoughts for additional share repurchase?

Second question, I've heard from a couple of retailers here recently that sales during the month of January were particularly strong and gift cards continue to increase each year.

Do you have a view of what TIE ratios have been for the PS3?

Have they picked up now that most of the hardware is in the hands of the ultimate owner?

And then the third question, any update on China, opportunities and growth there?

Any partnerships or potential partnerships you see in that market?

This is Frank.

I will take the second question first.

January has been a good month, and in terms of the TIE ratio on the PS3, we seen great improvement on that.

The interesting thing to note about December was that weeks four and five were historically high as percentage of the business.

A lot of that is fueled by the increase in gift card consumer behavior and also I think the PS3 TIE ratio was depressed a little bit at the initial release because of the eBay effect.

A lot of people were out there buying them and then flipping them to other people for a premium.

As this ended up, as you stated, in the end user's hand we have seen the TIE ratio really go up appreciably.

And Tony, I will take the second question and pass it to Larry for the third.

On the share repurchase, it's something we talk about in terms of returning capital to the shareholders all the time with our board and we will continue to do so.

Our priority is to, say, stay strategically flexible, but as cash continues to increase depending on our other cash needs, it's something that is front and center for our Board of Directors all the time and will continue to be.

And with regard to China, we are continuing to develop our local development capability in that market and we are exploring potential partnerships with multiple people as we speak.

Okay.

Great job.

Thanks, Tony.

Operator, we will take one more question.

Okay.

Our last question will come from John Taylor with Arcadia Investments.

Hi.

I was going to ask about the reported story that Vista was going to block online gaming.

And I wonder if -- it sounds like as that gets set up, people are going to have to make a bunch of choices in terms of parental controls and stuff.

I was wondering if you could talk about that in relation to Pogo and give some assurance, or tell us what they told you on that front.

You will be able to play Pogo going forward on Vista as you can on XP.

We don't consider -- we don't anticipate that there's any problems.

Obviously we are constantly talking with Microsoft about their future plans.

From our perspective we don't see anything materially changing in Pogo going forward.

Does it -- is it going to impact anybody's ability to download games in case you move to that kind of a format?

We don't believe that's the case.

Okay.

Great.

Thank you.

Great.

Thanks everyone for joining us.

Thank you.

Ladies and gentlemen, this does conclude today's Electronic Arts conference call.

We would like to thank everyone for their participation.

Have a wonderful rest of your day.