Electronic Arts Inc.
Q4 2006 Earnings Call Transcript

Published: 4 May 2006

[Operator:]

Good day, everyone, and welcome to the Electronic Arts fourth 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, ma'am.

[Tricia Gugler:]

Welcome to our fourth quarter and 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 would like to remind you that you may find copies of our SEC filings, our earnings release and a replay of the webcast on our website at investor.ea.com. Shortly after the call, we will post a copy of Warren's remarks on our website. Throughout this call, we will present both GAAP and non-GAAP financial results. Non-GAAP results exclude charges and related income tax effects associated with acquired in-process technology, amortization of intangibles, employee stock-based compensation, restructuring charges and certain litigation expenses. 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 non-GAAP to GAAP results. In addition, in anticipation of expensing stock options next quarter, we have expanded our non-GAAP disclosures to include a reconciliation of our GAAP to non-GAAP statement of operations. Information regarding our use of non-GAAP measures, along with a schedule demonstrating how we calculate ROIC, will also 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 2006 estimated market outlook in a supplemental schedule on our web site. 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 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 May 3, 2006, and disclaim any duty to update them. And now, I would like to turn the call over to Warren.

[Warren Jenson:]

Good afternoon, everyone. Fiscal 2006 was a year in which we held our own competitively, but at the same time we felt the impact of a challenging marketplace. There were, however, several highlights. Overall, our titles performed well. We ended the year with 27 platinum hits, of which 12 were double platinum. We ended the year as the number one publisher in North America on Xbox 360 and were number two behind Microsoft in Europe. On the PSP, we were number one in both North America and in Europe. On the Nintendo DS, we are the number two publisher behind Nintendo. We were also pleased with the launch of our first open-world game Godfather, which sold close to 2 million copies in the first week. Harry Potter and the Goblet of Fire sold more than 4.5 million copies, outperforming last year's Harry Potter and the Prisoner of Azkaban. We continued to expand our revenue base from wholly-owned IP. This past year, roughly 41% of total revenue came from owned intellectual properties, up 4 points from last year. Need for Speed Most Wanted was our top-selling title for the year. We are also pleased with our newest IP, Black, which has sold approximately 1.5 million copies. We now have six $1 billion lifetime franchises at retail, two more than last year. NBA Live and Harry Potter join Madden, Need for Speed, Sims and FIFA. Madden has now become our first franchise to exceed $2 billion. Our sports business continues to thrive. Madden '06 unit sales were up over 10% year over year. FIFA '06 unit sales were up more than 20%. NBA Live continues to set the pace in pro basketball, with 69% revenue share for the fiscal year. NCAA football sold more than 2 million copies. Our two new sports titles, MVP NCAA Baseball and Arena Football, both had solid performances. Again this year, our teams won several important awards for creative excellence. We took seven awards at E3 in 2005. At China Joy, EA won four PC awards. We received five awards from the Academy of Interactive Arts and Sciences. In Europe, EA won four top awards at Leipzig. This recognition summarizes what we are all about

[Operator:]

(Operator Instructions) Our first question comes from Mike Wallace, UBS.

[Mike Wallace:]

A couple of questions. Let me just start looking longer-term. If you look at where the earnings are now, and looking at where they peaked in '04 and look at where the margins peaked in '04, my question is, how do you get back up there? Is R&D spending going to maintain a much higher pace? Assuming gross margins at best are flat with where they were this past cycle, R&D is a lot higher. How are you going to get the margins back to where they were in fiscal '04? Or at this point, do you think that that is something that's not going to happen over the next couple years?

[Warren Jenson:]

What I will tell you is I will go through the factors and what we are focused on. Above the line, we are clearly focused on building great entertainment for next-gen products, and we are really pleased with what we see. We think there's some, hopefully, great things to come. The second thing on the content side is we are really focused on building new forms or new revenue streams from fundamentally online-based content and also mobile. So some of those revenue streams carry with them much higher margins. Secondly, we're also focused, as I mentioned in our priorities, in building wholly-owned intellectual property. I think, if there's one thing that we can do to help the cause for increased margins in the next cycle, it is to build our base of wholly-owned intellectual property. As you know, we're up 4 points this year to 40%. Obviously, we hope to expand that. I think the other thing that we will look to is to see how the market expands in the next cycle, when thinking about top line revenues.

[Mike Wallace:]

So, in order to pick it up and get back up there, it would have to come through market share gains and maybe a little on the gross margin, if the mix changes?

[Warren Jenson:]

Here is what I will do, is I will go through the factors, and then what will happen will be dependent upon those mix of factors and how they play out. On the expense side, I would tell you that every organization in the Company is focused on scalability. We know that as we move into '08 and beyond, we are going to look to scale this organization, as we expect revenues to grow more significantly. So the combination of those factors will be determinative in where we get to, margin-wise.

[Mike Wallace:]

Let me just follow up then on the revenue guidance for this year. It looks like, I don't know, flattish to down 10% or so. In past transitions, the Company has picked up market share. If you are adding $100 million plus from the JAMDAT deal, does that mean that you're going to lose some share? Are you doing less PC titles? What is behind the revenue guidance for this year?

[Warren Jenson:]

I will give a macro view of that, and then maybe Frank or Larry wants to jump in on the market side of things. What we tried to do when we went through our guidance, just as I said, Mike, was to take everything into account we could in setting a range. The reality is we are in a very uncertain year, for all the reasons that I mentioned, whether it's actual shipment dates, launch quantities, development risk; you name it, it exists today. So, as we debated back and forth, this is the appropriate range. Yes, we will have more revenue from mobile, and we certainly expect to be highly competitive in the marketplace. But, that said, that's the right range.

[Mike Wallace:]

Okay, just two more quick ones. Spore, is that not this fiscal year? And you mentioned the PS3 is a higher-margin platform. Is the royalty rate $1 lower than it was?

[Larry Probst:]

Spore is not in this fiscal year, and we don't have any details on the business model on the PlayStation 3 yet.

[Mike Wallace:]

The assumption is the economics will be a little bit better?

[Larry Probst:]

I don't think we can make any assumptions, because we don't have any details.

[Mike Wallace:]

Thanks.

[Operator:]

Our next question comes from Evan Wilson, Pacific Crest.

[Evan Wilson:]

Thanks for taking the question. First, I was hoping you comment on a little more detail in terms of JAMDAT, what you expect for not just the wireless industry as a whole, but some of the slowness we have heard of, not as it relates to your business but as the industry is it churning a little bit more than we expected? So just comment there. I was just hoping you could also go back a little for me as well, and talk about how in the last transition you guys experienced one down year of EPS during the transition. Now this is three consecutive down years. If you could just point to the main differences between what is going on now, what happened then, considering the strength in your balance sheet and market position now?

[Warren Jenson:]

I'll take the first part, on mobile. We're very pleased with what we're seeing in the integration that we have had with JAMDAT. I think we're off to a great start, working very well together and already starting to get the EA content integrated into the JAMDAT system of development and deployment. The second thing and it's not really a market, and I'll come to that. But we've also really expanded our production base, as JAMDAT is truly a global publisher and a global developer. And I think that's very helpful. What I will tell you is we anticipate solid growth this year. As I said on the last call, we would expect our combined revenues to easily pass through $130 billion next year. I think one thing to keep in mind, which many of you already know, is that this business is not launch-driven. The things that will accelerate revenue growth are handsets and the introduction of new handsets. So you'll have to get used to some different dynamics that will affect the ebb and flow of the revenue streams.

[Larry Probst:]

With regard to your question about what is different, I would say the following things. Fundamentally, it's just a more complex and more complicated market environment these days. In addition to navigating the console transition from current-generation to next-generation, we have to be paying attention to the PC platform and online play, casual games, the handheld business, the mobile opportunity, the business that's developing in Asia. So there just are a lot more moving parts. It's more complicated, it's more challenging and we have to get in position for all those things going forward.

[Operator:]

Our next question comes from Chris Kwak, SIG.

[Chris Kwak:]

Just in terms of the hiring that you did, in terms of getting the head count from 4,200 to 5,200 on the R&D side, you said 8 points came from acquisitions. Where was the other significant portion of that from?

[Warren Jenson:]

In terms of where the hiring was done? The bulk of the hiring took place in our studios, and I would say broadly, across the board, in all of them, perhaps with a little bit of a heavier focus in Montreal, for example, and to some extent in Vancouver.

[Chris Kwak:]

And just as a clarification, when you said the higher margin, did you say PS3 or PSP?

[Warren Jenson:]

I did say PS3 in my remarks. So to Larry's point, I want to clarify. We do not yet have our business terms worked out with Sony. What we do know is that we have launched, at least our pricing on the Xbox 360 titles has been at $59 and, we think, well-received in the marketplace. Now, what we don't know is what pricing will be on those titles in the future. We will be market competitive. But that said, our titles have been very well-accepted on the Xbox.

[Chris Kwak:]

Is that higher margin assumption or expectation on the PS3, is that much different than what you have seen on the Xbox 360?

[Warren Jenson:]

No.

[Chris Kwak:]

Lastly, on Superman and Medal of Honor, it sounds like both of them are delayed, one to coincide with the DVD release, the other one in Q4. Can you just walk us through the thinking behind that or what is causing that?

[Frank Gibeau:]

With regards to Superman, really what the gating objective was to deliver a great game experience. The ambitious nature of the open-world design proved to be fairly challenging, with regard to hitting the launch window for the film. We wanted to look at a long-term opportunity here with Superman, so as a result we moved the product release to the fall to coincide with the DVD at holiday. Actually, from a publishing standpoint, the DVD release at holiday is a nice combination. There are more vehicles for us to market and promote the game, and we're going to get a better game this fall than we would have with the movie release. So that was a basic story on Superman. With regards to Medal of Honor

[Operator:]

Our next question comes from John Taylor - Arcadia.

[John Taylor:]

I've got a couple of housekeeping questions and a couple of bigger ones. The tax charge related to the American Jobs Creation Act, could you give us that? Was there anything concentrated in license revenue in the fourth quarter that really boosted that? Those are the housekeeping. The bigger questions are, what percent of revenue did you guys did last year direct with consumer, via subscription or -- actually, I want to make it broader than that. Maybe include advertising, the direct digital download stuff in one form or another. What do you think that number might look like percentage-wise, say, in a couple of fiscal years, maybe fiscal '08 kind of thing? That's a bigger question. Larry, maybe for you, with all the stuff that's coming online since the PC has been the dominant online platform and definitely is in Asia, is the stage set for a comeback of the PC as a gaming platform?

[Larry Probst:]

I think the PC platform has continued to represent a meaningful part of our business, specifically anywhere from 20% to 25% of our annual revenue. We've got some very important intellectual properties that live on that platform, like The Sims, SimCity, Spore. So we're going to continue to be active on that platform. I think Microsoft probably has some aggressive plans in mind in conjunction with the launch of Vista later on next year. So yes, we think the PC is going to continue to be an important platform, and it clearly is the most important platform in most of the markets in Asia, outside of Japan.

[John Taylor:]

So, let me just follow up on that. So, with the online piece really driving growth and packaged goods sales dropping off, is there an opportunity that the PC can actually take share back, do you think, from console usage in terms of the amount of time eyeballs are spent there, or money is spent on that platform?

[Larry Probst:]

If you think about it on a global basis, I think the answer is probably yes.

[John Taylor:]

Do you think there's much chance it can recover in the Western markets?

[Larry Probst:]

In the foreseeable future, over the next two or three years, I don't see a huge shift away from consoles back towards the PC. But again, if you look at the opportunity on a global basis, the PC is going to continue to be significant, as long as that's what's driving the business in the key Asian territories.

[Warren Jenson:]

I'll answer your other couple of questions. On the Homeland Investment Act, it was $18 million or roughly $0.05 to $0.06 a share. The second question dealt with how much in direct digital distribution-related revenue, and I probably want to go through and measure how we are thinking about Pogo as an example from a subscription basis. If you talk about just pure digital downloads, the number is relatively small and about $10 million. And that is cash, $2 million of which we deferred, but in total, $10 million in cash. The good news is, I think, on that front we're just getting started. We clearly are making investments in the digital downloader. People love it, and I think you'll see expanded use of it as we go forward. On the license revenue side, going back through my thoughts in the closing review, I don't know of anything really in particular that stands out. But I'll go back through, and if there is anything, I would be happy to let you know.

[John Taylor:]

Let me just follow up on the direct to consumer piece. I guess what I'm looking for here is, can you measure for us the amount of business you are doing directly? That you're generating through non-retail channels, as opposed to through retail channels with intermediaries that have some of those higher margins, and maybe how big that number might look after a couple years.

[Frank Gibeau:]

Again, the numbers that Warren gave you are where we are at right now. In fact, it has proven to be quite an effective channel for us, not only to deliver content in the form of booster packs and micro transactions, but also to market it in a form against some of our retail games. As that grows in the next two years, we think that it can be significant. But at this time, it would be too difficult to handicap it as a percentage.

[Operator:]

Our next question comes from P.J. McNealy, American Technology.

[P.J. McNealy:]

Good afternoon. A couple questions on pricing assumptions for fiscal year '07. Are you assuming that $39.99 holds up at retail for current-gen software? Are you assuming $499 for the PS3 for hardware price points? Just one related question to the PS3. Should we expect any online revenues through the PS3 in this fiscal year, and any thoughts on what their online structure looks like?

[Larry Probst:]

I will take the question on PlayStation 3 hardware pricing. The answer is that Sony is going to have to provide that information; we're not going to speculate about that. They may or may not announce that at E3. We're just going to have to wait until next week and see what their strategy is.

[Frank Gibeau:]

With regards to retail software pricing, we really let the market determine that, and we approach it on a SKU-by-SKU basis. Part of our short-term strategy, however, is going to be to leverage the recent hardware price moves from Sony on the PS2 and the PSP; leveraging Xbox 360's hardware availability as that increases, as the year goes on; and then, finally, prepare the channel for Q2 and Q3 from an inventory standpoint.

[P.J. McNealy:]

With online revenues from the PlayStation 3, should we expect anything in the fiscal year?

[Warren Jenson:]

I would not. I think it is way, way too early. Secondly, I know I have said this before, a lot of these trends are very positive for the long term, but are going to be smaller dollars in the near term. So I would not expect anything material in this fiscal year.

[Operator:]

Our next question comes from Mike Hickey, Janco Partners.

[Mike Hickey:]

Looking at your fiscal '07 overall R&D, the upper end of your range here looks like kind of what we're expecting for fiscal '08. Thinking about fiscal '08, should we see any sort of sequential pullback in R&D spend? The second question is on your mobile side. As you broke out your R&D spend, it looks like that business is probably not profitable for you in fiscal '07. Could you clarify that, and do you expect it to be profitable in fiscal '08?

[Larry Probst:]

I'll take the question on R&D spending. Obviously, it's pretty early in the game to be speculating about fiscal '08. But I would say that it would be our goal to reduce R&D spending as a percentage of revenue in fiscal '08.

[Mike Hickey:]

But you would see a sequential growth to that number? I don't understand.

[Larry Probst:]

Too early to speculate.

[Mike Hickey:]

On the mobile side, can you clarify profitability for '07, at least?

[Warren Jenson:]

So remember that the numbers I gave you include what we call mobility, which are things related to the trend toward mobility, which would be both handheld and cell phones. The combination of that business next year is clearly profitable.

[Mike Hickey:]

But for just the mobile cell phone side? Can you comment on that?

[Warren Jenson:]

The mobile cell phone side, on a non-GAAP basis, clearly, we would expect to make money.

[Operator:]

Our next question comes from Jeetil Patel, Deutsche Bank.

[Jeetil Patel:]

First of all, as you look at this upcoming fiscal year, can you just give us a sense of if you back out the JAMDAT contribution, it looks like you're down 5% to 10%. Just give us a sense of, in aggregate, what you're thinking in terms of average pricing moving down versus the volume trend in the business? Just to get a better handle of consumption in the industry. Second, it looks like you're investing ahead of the curve in terms of future opportunities on different platforms. Globally, as you look out over the next cycle, there's going to be plenty of different opportunities out there. Do you think that, as you think about the marketplace, are you looking at a CAGR of 15%, 20%, 25%? Can you give us a sense of how you think about the growth playing out over a multi-year standpoint as you look forward beyond fiscal '07?

[Warren Jenson:]

I'll try to go through several of those questions that you've asked. In terms of the long-term growth rate, we're not going to speculate. What I can tell you is that we know there is an exploding online market that today is not really even being measured. We have said next year that we think global cell phone or mobile phone growth would be in the 25% to 35% range. We feel pretty good about that. And we also know that as we go forward, with better technology, the trend is just going to increase. We think all of those things are positive. I think, relative to long-term growth rates, this business with online, with mobility, is going to benefit from the ever-increasing presence of Web-based technology. So I think, while I won't speculate as to a rate, I think that we will clearly be a beneficiary of those trends. The other part of your question?

[Jeetil Patel:]

This year, fiscal '07, if you look at the decline in revenue modestly in terms of your guidance, how much do you think is related to just simplistically pricing trends in the industry as you are competitive, as pricing comes down on the hardware side and you're pricing your products more aggressively versus the unit volume on a year-on-year basis? And then a quick follow-up to that.

[Frank Gibeau:]

In the transition years, the consumption is going to have some pressures on it. And clearly, current-gen pricing is declining. That is somewhat offset, obviously, by next-generation pricing being higher than last cycle. So for us individually, as a Company, we anticipate that consumption is going to be slightly down, but that is pretty typical in a transition.

[Jeetil Patel:]

The overall debt cost for next cycle or this upcoming cycle is much higher. Can you just give us a sense of whether you think the financial returns are different, similar? And maybe what the variables are to getting comparable returns in this cycle relative to the previous cycle, in terms of the margins in the business?

[Warren Jenson:]

Here are the variables. Variable one is price. Variable two will be our ability to generate follow-on revenues, which will clearly be available in online. And I would say the principal beneficiaries of the micro transaction are going to be the big games, the ones that really have an established community around them and people keep playing them. We're fortunate that we have a lot of those games in our stable. The third thing, which we don't know right now, because we have not built a game for the PlayStation 3, we have not yet been able to work to port the PlayStation 3 game to an Xbox 360 game or an Xbox 360 game to a PlayStation 3 game, we will work to try to scale the development cost. But again, that is something that it's way too early to speculate on, given the fact that we haven't really gone through it.

[Larry Probst:]

The other component to that equation is the percentage of our business that is represented by wholly-owned intellectual property. As Warren mentioned earlier, that's around 40% now. We have a big focus going on within the Company to drive that number higher, and you're going to see us continue to expand our wholly-owned intellectual property portfolio.

[Operator:]

Our next question comes from Heath Terry - Credit Suisse.

[Heath Terry:]

I was wondering if you could just give us an idea, realizing it's only been a couple of weeks, what you're seeing on the initial price cut on PlayStation 2, what kind of an impact it's having on hardware sales and on your software business? As well, to the extent that you can comment on it, the improvement in 360 volumes and any impact that you might be seeing from the value price point or value pack on PlayStation portable?

[Frank Gibeau:]

Sure. What we are hearing from retailers is about a 20% to 30% lift in the PS2 business, post price reduction. That has been sustained; that wasn't just a one-off. So we are feeling pretty good about that. We are seeing that impact in our catalog and in our new releases on PlayStation 2, so there is good news there. With regards to the PSP, the new price point at $199, we believe, is opening up and addressing a new market that the $249, more expansive SKU was not getting to. But they are working in conjunction to stabilize and grow PSP sales. With regard to Xbox 360, there is good flow on inventory. We actually believe that in May and June, retailers will actually be building inventory positions for the first time in the cycle on that hardware. The good news is the tie ratios on the 360 are around 4, which is a really solid number for us, and as the hardware improves, May or June we expect to be a good time for the 360.

[Heath Terry:]

How do you interpret that strong tie ratio on 360? Does that give you any more confidence about the $60 price point on next-generation software being sustainable for maybe longer than you were thinking about initially?

[Frank Gibeau:]

The market feedback on that price point is good, so far. The quality of the games and the quality of that hardware with the Xbox Live service, from a customer standpoint, they are seeing that value proposition as fair and in their interest.

[Heath Terry:]

With this focus on growing your internally developed or your wholly-owned IP, can you talk to us about the differences in those margins and the business currently? How much more profitable are your wholly-owned IP titles versus the titles that you're licensing? And do you expect that to change as you put more of a focus on that?

[Warren Jenson:]

I think there are a couple of interesting things. One is that this isn't true across the board. But by and large, the biggest hits in this industry have been games that have been developed, original IPs, I think that's one side of it, is that if you get the right concept, specifically built for video games, it can really win. The second aspect is the margin, and you can expect easy 10 to 20 basis points of improved margin.

[Larry Probst:]

What I would add to that, Heath, is that there is increasing competition for significant licensed property, and those costs are going up. At a strategic level, we've taken a look at that. We're going to be very, very selective about what we license and what we don't license, and we are going to spend a lot more time trying to develop property that we own.

[Operator:]

Our next question comes from Edward Williams, Harris Nesbitt.

[Edward Williams:]

First, on the development side, I think you indicated that you are at 5,200 right now. Where is that headed by the end of the year? And then, as a follow-up to that, Larry, what steps are you taking to reduce the cost of developing a game as the next generation of consoles really builds out?

[Larry Probst:]

Well, we're doing all the things that you would imagine. We're trying to share technology across all of our studios. We're looking for which components of the development process we can move to lower-cost locations. That's going to be an ongoing process as we go through this transition period. The PlayStation 3 is a challenging platform to develop for it. It's going to be more expensive than the PlayStation 2, and we are going to try to make that as efficient a process as possible.

[Edward Williams:]

At this point, are you outsourcing much of the development? Or if we look back on the PS2 and Xbox, how much of the development is outsourced? And how much do you think that will change in the next generation?

[Larry Probst:]

Well, we're currently outsourcing more than we have previously, and we will continue to look for those opportunities in the future.

[Edward Williams:]

If you look at the new areas, the mobility and the online categories, when do you expect to generate significant returns off of those, significant increases in development expenses?

[Warren Jenson:]

I would say we're already benefiting from both of those. Clearly, on the handheld side, which is more of an established business. But one of the things we did on the development side, as I think we've mentioned, is to build, we call it fusion, which is more of a centralized capacity to build for the handhelds. These guys have done a great job in very effectively and efficiently building games for the handhelds. We expect to expand that and continue with it. Mobile, we are just getting started, really, with the acquisition of JAMDAT. And I think, if things continue to go the way they look they will, we would expect to be generating returns very shortly.

[Edward Williams:]

Just as a quick follow-up to that, if we look at the $130 million or so in revenue that you expect out of the mobile phone side of mobility, how much of that do you think will come from territories outside of North America in fiscal 2007?

[Warren Jenson:]

Where we intend to expand first is, one, we will do a lot in Europe this year and then continue to expand in Asia. But the primary focus will be Europe. I could be off here a little bit, but the number is around $25 million to $35 million.

[Edward Williams:]

Larry, just going back to you for a moment, if we look at the next-gen cycle, how do you think the console sell-through will play out differently, if at all, on a percentage basis, on a geographic basis? So do you think Europe will take a greater share of the global market, or will we see the hardware companies be able to get the household penetration of the consoles extended beyond where they have been in the last couple cycles?

[Larry Probst:]

Well, I think that there is an opportunity to increase the penetration level. Certainly, in some of the Western European countries like Germany, as an example, I think they are at 12% or 13% penetration rates, currently. So clearly, there's an opportunity there. I think what is going to be interesting is to see what Microsoft and Sony and Nintendo do in some of the emerging markets around the world, in Eastern Europe, in Latin and South America and in some of the Asian territories, where there really hasn't been much of an effort in the past. So when we think about cycle-to-cycle growth, I think that's going to be driven to some degree by markets that were unaddressed in previous cycles.

[Edward Williams:]

Thank you very much.

[Operator:]

Our next question comes from Shawn Milne, Friedman Billings.

[Shawn Milne:]

Warren, just a housekeeping question. The tax rate was higher than I expected in the quarter. What is your tax rate guidance for fiscal '07?

[Warren Jenson:]

I'm glad you brought that up, Shawn. A couple of things, let me preface this with. One of the things that -- and I'm sure many of you are aware of this, that in the current environment you have to expect our tax rate is going to fluctuate more. And that is going to be true for EA; it's true for every company in corporate America. It is just going to fluctuate more. The second thing is it can be up, as it was this quarter, and for the year, based on our ultimate mix for us between foreign earnings and US-based earnings. So mix can have an immediate impact on our tax rate. And then, oftentimes, there are just miscellaneous one-time adjustments that happen on a regular basis. Going forward, looking to next year, recognizing our GAAP guidance fluctuates around a loss and into a slight level of profitability, what I want to tell you is that minute adjustments in a tax item can have significant impact on rate. So what we would tell you to do for this coming year is I'd use a GAAP rate of 40%. Now, what you will see is, as you back out the non-GAAP items, you'll see that rate come down. But at the same time recognize there will be big levels of fluctuation, particularly where you have loss quarters. And this is a year where you're going to feel that. Longer term, you could continue to expect our tax rate to trend between 27% to 29%.

[Shawn Milne:]

Right. Going into the call, I was looking for 28%. The delta on 28% to 40% is a full $0.20 next year. Is that fair?

[Warren Jenson:]

Well, you have to, again, look at this on a non-GAAP and a GAAP basis.

[Shawn Milne:]

I'm looking on non-GAAP.

[Warren Jenson:]

So the non-GAAP number in our tax rate could come down significantly from the 40%. Again, what we will do is we go through and tax effect each of those numbers in calculating what the rate would be. Then again, remember that you have got some loss quarters where you're going to benefit from the operating loss, and then there will also be income quarters. So in absolute math, the spread between a 28% rate and 40% rate has an impact. But then you also have to look at what is the profit before tax, and you'll end up seeing that it's small; it has a relatively small absolute impact.

[Shawn Milne:]

I need to go back to the '07 guidance again. The R&D number you put out there was modestly higher than, I would say, consensus expectations but not off the charts. The other expenses seemed well controlled in the current quarter. So it then comes down to the revenue guidance of $2.7 billion at the low end seems incredibly low. If you take out JAMDAT, that would be modeling your core business down 14%. What are we missing here, given that Microsoft is talking about higher Xbox 360 production, higher price points are sticking? What am I missing here? Is there a couple games that you have dramatically reduced expectations for? Is there an FX headwind that you're now modeling? It just seems like too much of a haircut here.

[Warren Jenson:]

What we tried to do, and I can't say a lot more than I mentioned during the more formal part of the call; this is a period of heightened uncertainty, a period where there could easily be slips in production. We also have a lot going on with inside EA. And we tried to sit down and weigh those risks as best we could and say, okay, what is the range of our performance? And that is what we felt was appropriate.

[Larry Probst:]

We also have to take into consideration the potential uncertainty around the launch of the new platforms from Sony and Nintendo. If history teaches us anything, it's that the best laid plans sometimes don't turn out to be reality.

[Operator:]

Our next question comes from Justin Post, Merrill Lynch.

[Justin Post:]

I appreciate the R&D breakdown. On the $600 million for consoles, as the last cycle progressed, that grew. And then, did that really level off or start going the other way as the cycle progressed? And then I have one follow-up.

[Warren Jenson:]

It pretty much leveled off for a few years and then increased. I think, in general, in the last cycle, you saw the cost line in total continue to increase, although the market expanded at a faster rate, which expanded our margins. That's what happened last time.

[Justin Post:]

Can you give us any help with the SKU or title count for next year versus the last year? Obviously, it feels like there could be some upside to your revenue numbers if everything works right. Can you just help us compare the SKU and title count year over year?

[Larry Probst:]

The SKU count is roughly similar. I think it was about 131 in fiscal '06, and it's a number that's sort of high 120's in fiscal '07. So it's roughly the same.

[Justin Post:]

Is there any other major license out of IP that you are not going to be doing, like Bond, anything similar to that, that is going to slip out of the year?

[Larry Probst:]

Not that we know of at this point in time.

[Operator:]

Gentlemen, I will turn it back over to you for any closing remarks.

[Warren Jenson:]

Thanks, everyone, and we look forward to seeing you at E3.

[Operator:]

That does conclude today's conference. We do thank you for your participation.