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Sony Corporation (NYSE:SNE)

F4Q06 Earnings Call

May 16, 2007 9:30 am ET

Executives

Sam Levenson- Vice President, Investor Relations America

Takao Yuhara - Vice President, Investor Relations

Robert Wiesenthal - Executive Vice President, Chief Financial Officer

Analysts

Jason Mauricio - Arete Research

Evan Wilson - Pacific Crest

Jessica Reif Cohen - Merrill Lynch

Colin Sebastian - Lazard Capital Markets

Ben Atkinson - Gagnon Securities

David Gibson - Macquarie Securities

John Taylor - Arcadia

John McPeake - Prudential

Helene Wu - WR Hambrecht+Co.

Presentation

Operator

Good day, ladies and gentlemen and welcome to the Sony Corporation fourth quarter and fiscal year ended March 2007 earnings call. My name is Michelle and I’ll be your audio coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Sam Levenson, Senior Vice President of Investor Relations at Sony Corporation of America. Please proceed, sir.

Sam Levenson

Thank you very much for that introduction, Michelle. Thank you all for joining us today for the discussion of Sony's results for the fiscal year ended March 31, 2007. I’m Sam Levenson, Senior Vice President of Investor Relations at Sony Corporation of America. I am joined this evening in Tokyo by Mr. Yuhara, Corporate Executive and Senior Vice President of Investor Relations for Sony Corporation, and by Robert Wiesenthal, Group Executive in charge of Corporate Development and M&A for Sony, and EVP and CFO of Sony Corporation of America. Thank you very much for joining us, Mr. Yuhara and Mr. Wiesenthal.

In just a few minutes, I am going to give you a brief summary of today’s announcement. Then, Mr. Yuhara and Mr. Wiesenthal will be available to answer your questions.

Please be aware that statements made during the following remarks and Q&A session with respect to Sony's current plans, estimates, strategies, press release and other statements that are not historical facts are forward-looking statements about the future performance of Sony. These statements are based on management’s assumptions in light of the information currently available to it and therefore you should not place undue reliance on them.

Sony cautions you that a number of important factors could cause actual results to differ materially from those discussed in the forward-looking statements. For additional information as to risks and uncertainties, as well as other factors that could cause actual results to differ, please refer to today’s press release which can be accessed by visiting www.sony.net/ir.

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With that, I am now going to turn to today’s announcement. I will begin with a discussion of our consolidated results for the fiscal year ended March 2007 and then review our forecast for the year ended March 2008.

For the full fiscal year ended March 31, 2007, consolidated sales increased 10% year on year to achieve a new fiscal year record. Although we recorded a YEN 51.2 billion provision for charges related to the notebook computer battery pack recalls and subsequent global replacement program, the electronic segment showed remarkable recovery with sales increasing 17% and operating income increasing YEN 149.8 billion.

Profits in the television business improved significantly as we focused resources on LCD TVs and took action to improve profitability. Our BRAVIA LCD TVs captured the number one global market share in terms of value for calendar year 2006. Our Cyber-shot digital cameras and Handy-cam video cameras produced a strong level of profit, and the semiconductor business, which began shipping chips for the PS3, contributed to the large increase in profitability in electronics.

In the games segment, the PS3 went on sale in Japan, the U.S. and in Europe, and we achieved production shipments of 5.5 million units for the year. While sales of PS3 increased, the segment recorded a large operating loss due to the sale of the PS3 at a strategic price lower than its production cost during the introductory period.

The picture segment recorded a large increase in operating profit from hit movies such as The Da Vinci Code and Casino Royale, among others.

The financial services segment, on the other hand, posted a large decrease in operating profit due to a decrease in valuation gains from investments in the general account, including valuation gains from convertible bonds.

Our equity affiliate, Sony Ericsson, recorded record unit sales, revenue and net income as Walk-man, Cyber-shot and other phones contributed strong sales. By tailoring its product portfolio to the needs and lifestyles of its customers and by rolling out an attractive mid-level product offering, the joint venture managed to grow its business in Europe and in the growing markets of Latin America and Asia-Pacific. The company ascended to the number four market share position among global mobile phone manufacturers and it continues to target the number three spot while focusing on profitable growth.

I will now discuss each P&L line item. Consolidated sales for the fiscal year increased 10% year on year to YEN 8,295.7 billion, due to the strength of the electronics and picture segment. Operating income decreased by 68% year on year to YEN 71.8 billion. Although electronics and pictures had significant increases in operating income, overall operating income decreased due to losses recorded in the game segment, as well as decreased operating income in financial services.

A YEN 21.7 billion gain on the sale of a portion of the site of Sony's former headquarters is included in this fiscal year’s operating income. Operating income in the previous fiscal year included a one-time net gain of YEN 73.5 billion from the transfer to the Japanese Government of the substitutional portion of Sony's employee pension fund.

Consolidated restructuring expenses, which are recorded under operating expenses, were YEN 38.8 billion for the fiscal year, as compared with YEN 138.7 billion in the previous fiscal year.

Non-operating income decreased YEN 29.6 billion to YEN 30.3 billion. This was mainly due to lower gain on change in interest and an increase in foreign exchange losses. As a result of these factors, income before income taxes decreased 64% year on year to YEN 102 billion.

Equity and net income of affiliated companies increased year on year by approximately 6 times to YEN 78.7 billion. Sony Ericsson contributed equity and net income to Sony of YEN 85.3 billion, an increase of YEN 56.3 billion due to its continued strong sales. The joint venture with Samsung, known as SLCD, contributed YEN 6.4 billion, an improvement of YEN 13.6 billion. Sony BMG contributed YEN 5 billion, a decrease of YEN 0.8 billion, and MGM on the other hand yielded an YEN 18.9 billion equity and net loss to Sony, a YEN 2 billion increase in loss over the previous year.

As a result of these factors, net income increased by 2% year on year to YEN 126.3 billion.

Now, please allow me to compare our reported results for the year to the forecast we announced in January. Our consolidated operating income outperformed the January forecast by YEN 11.8 billion. Improvements in the game and financial services segments were the primary reasons that we exceeded our forecast. In game, PS2 hardware and software sales exceeded our expectations, while in financial services the stock market rose during the fourth quarter, causing us to record valuation gains on convertible bonds that exceeded expectations.

Now I would like to take a few minutes to discuss the results for the fiscal year ended March 31 on a segment-by-segment basis.

First, electronics; sales in the electronics segment increased 17%, or 13% on a local currency basis. Inter-segment sales increased significantly, mainly due to sales of PS3 semiconductors. Sales to outside customers increased 13%. By product, BRAVIA LCD TVs and Cyber-shot digital cameras had strong sales in all regions. VAIO PCs, which had strong sales of notebook PCs outside of Japan, also contributed to the increase in sales.

Operating income in the electronic segment increased YEN 149.8 billion. The largest profit contributing products were, in order of magnitude: video cameras, digital cameras, broadcast equipment, and PCs. The largest loss-making product was batteries due to the provision for charges relating to the notebook computer battery pack recall and subsequent global replacement program.

In the television category, overall sales in the television category for the fiscal year were approximately YEN 1,235 billion, an increase of 32% year on year. Operating loss was approximately YEN 22.5 billion, an improvement of approximately YEN 74 billion year on year.

Large screen full HD models of LCD TVs sold very well and we had shipments of 6.3 million LCD TVs. However, the market for LCD rear projection TVs was difficult and losses on those models increased.

We aim to make the TV business profitable for the full fiscal year ending March 2008.

In the semiconductor category, sales for the fiscal year were approximately YEN 780 billion, an increase of 57% year on year. Operating loss was approximately YEN 10 billion, an improvement of approximately YEN 24 billion year on year. Sales of chips for the PS3 contributed to the increase in sales and decrease in loss.

We also aim to make the semiconductor business profitable for the full fiscal year ending March 2008.

Next, Sony Ericsson; adjusting for Sony's fiscal year, which is from April to March, Sony Ericsson sales increased 49% year on year to EUR 11.892 billion. Unit sales were 83.3 million, an increase of 51%, and income before income taxes increased approximately 2.5 times to EUR 1.509 billion. Walk-man and Cyber-shot phones primarily contributed to the improved results. Sony recorded YEN 85.3 billion of equity and net income from the venture, an increase of almost 3 times.

Next, the game segment; sales increased 6% year on year or 2% on a local currency basis. Approximately 70% of the sales came from hardware and accessories, as compared with 66% of the previous year, and the rest came from software. First, a look at hardware. There was an increase in overall hardware sales due to the launch of PS3. PS2 sales decreased year on year due to a decrease in unit sales and a strategic price cut. Even though we’ve reached the seventh year since the PS2 went on sale, demand continues to exceed expectations and production shipments for the fiscal year just ended reached 14.2 million units, significantly more than our original forecast. For the fiscal year ended March 2007, the PS2 sold the most units of any home use game console.

PSP hardware sales decreased due to a decrease in unit sales. Because we prioritize clearance of channel inventory, production shipment units were only 8.36 million units for the year. In Europe and the U.S., sales have been strong since the year-end selling season and have increased even more since we cut the price in April. Penetration of the device is rebounding in all regions as actual sales in Japan continue to exceed the previous year due to an enhancement of the software lineup, with one title selling more than a million units since the beginning of the year.

PS3 went on sale in Europe and the PAL territories in March, following the November launch in Japan and the U.S. While cumulative production shipments by the end of March only reached 5.5 million units due to production delays, all of the production problems have been resolved. Because we did not have enough units when the device went on sale in Japan and the U.S., we did not have an ideal launch. However, in Europe where we launched in March, sales have been strong because we had sufficient units and were able to deploy a strong software lineup. We are working to enhance our software lineup in every region.

Turning to software, PSP software sales increased as penetration of the platform increased. PS3 software sales made a contribution to overall software sales due to the launch of PS3. PS2 software sales continued to make a large contribution to sales and profit but decreased year on year due to a decrease in unit sales and price.

As a result of the decrease in sales of PS2 software, overall software sales for the segment decreased.

Operating loss in game was YEN 232.3 billion for the year compared to YEN 8.7 billion of operating income in the previous fiscal year. By platform, losses were recorded from the sale of the PS3 at strategic price points lower than the production costs during the introductory period, and the recording of other expenses associated with the launch of the PS3. YEN 81.4 billion of these expenses were write-downs of in-transit and component inventory.

While the PS2 business continued to be strong, exceeding our expectations particularly in Europe and North America and contributing a large amount of profit, operating income from that business declined year over year due to decreased software sales.

Operating income from the PSP business increased due to continued hardware cost reductions and increased software sales.

Next, let’s look at the pictures division. Sales increased 30% year on year or 26% on a U.S. dollar basis. Motion picture sales increased significantly due to higher worldwide theatrical and home entertainment revenue from films released in the current fiscal year. These films included: The Da Vince Code, Casino Royale, Click, Talladega Nights: The Ballad of Ricky Bobby, and The Pursuit of Happyness. Television revenues also increased primarily from higher averages, advertising and subscription sales, and from several international channels.

Operating income in the pictures division increased 56% to YEN 42.7 billion. This increase resulted from the substantially higher revenue from films released in the current fiscal year. Partially offsetting the increase was a decrease in the profit of television, resulting from the recording of production and marketing expenses associated with several shows combined with the absence of a licensing agreement extension for Wheel of Fortune, which was recognized in the previous fiscal year.

Now, financial services; financial service revenue decreased 13% year on year, mainly due to a decrease in revenue at Sony Life. Although revenue from insurance premiums increased, revenue at Sony Life decreased by 15% to YEN 545.1 billion due to lower valuation gains in the general account and the separate account when compared to the previous fiscal year in which the stock market increased significantly.

Operating income in financial services decreased by 55% to YEN 84.1 billion due to a decrease in operating income at Sony Life. That operating income at Sony Life declined by 57% to YEN 81.7 billion. This decline was due to a decrease in valuation gains from investments in the general account, including valuation gains from convertible bonds.

In the other segment, sales decreased 11% year on year, primarily reflecting the deconsolidation of StylingLife Holdings, a holding company that comprises six of Sony's retail businesses, following the sale of the majority of stock in the company during the current fiscal year as well as a decline in sales at Sony Music Japan. Sales at Sony Music Japan declined mainly due to the transfer to another part of Sony of the disc manufacturing activity that Sony Music Japan carried out during the previous fiscal year.

Operating income in the other segment increased 58% year on year. The improvement was mainly due to the recording in the previous fiscal year of a loss on impairment of assets resulting from the sale of a U.S. entertainment complex.

Finally, Sony BMG. Adjusting again for Sony's fiscal year from April to March, sales at Sony BMG decreased 4% year on year to YEN 4.101 billion. Although digital product sales increased, the physical market for music continued to decline. Income before income taxes decreased 10% to $135 million, mainly due to lower sales. The decrease in profit was partially mitigated by lower overhead costs, decreased restructuring expenses and the favorable impact of an industry-related legal settlement.

Income before income taxes includes $140 million of restructuring expenses, a decrease in restructuring expenses of $45 million year on year. As a result, Sony recorded YEN 50 billion in equity and net income from Sony BMG.

Before we turn to the March 2008 forecast, I would like to describe the progress of our restructuring plan. Our progress to date continues to be ahead of plan. Excluding one-time charges, such as those from restructuring and the provision made for charges relating to the notebook computer battery pack recalls and subsequent global replacement program, we achieved our goal of a 4% operating income margin in the electronics segment one year ahead of schedule. By improving operating income in the product categories we eliminated or shrank, consolidating manufacturing facilities, and reducing administrative expenses we managed to eliminate by the end of the March 2007 fiscal year YEN 175 billion, or 88% of the YEN 200 billion yen in cost we plan to reduce by the end of next fiscal year. Since we had expected to achieve YEN 160 billion, or 80% of the YEN 200 billion goal by the end of the March 2007 fiscal year, we are YEN 15 billion ahead of plan.

Although we are not announcing any additional manufacturing facility closures today, we plan to achieve our goal in this category during the fiscal year ended March 2008. We have already achieved, as of the quarter ended December 2006, the 20% model count reduction, 10,000 person headcount reduction, and YEN 120 billion asset sale goals we had set for ourselves.

Of the 15 product categories we intended to eliminate or shrink, 10 have already been announced and today we are announcing three additions to this list: computer display, CRT projection TV, and standard desktop computers.

Finally, while continuing to manufacture and sell CRT TVs in countries and territories where demand remains, we are actively shifting focus in those areas to BRAVIA LCD TVs. As a result, we plan to cease manufacturing Cathode Ray Tubes by March 2008, after we have stockpiled a sufficient quantity for future use. We are currently deliberating what other product we will manufacture at our CRT facility in Singapore after Cathode Ray Tube manufacturing ceases there. We will announce details once we have made a final determination.

Finally, I would like to cover our forecast for the March 2008 fiscal year. Our foreign exchange assumptions for the year are YEN 115 to the dollar and YEN 150 to the Euro. We expect to record YEN 440 billion in consolidated operating income, a 5% operating income margin, for the year. Our equity and net income of affiliates is expected to increase and we believe we can earn a record YEN 320 billion in net income, as compared with YEN 126 billion for the year just ended.

Our forecast on a segment by segment basis is as follows: in electronics, we expect sales to increase due to the contribution of BRAVIA LCD TVs and semiconductors, including those for the game business. Segment operating income should increase significantly due to improvements in the operating performance of television and semiconductors and the absence of the YEN 51.2 billion provision recorded in the March 2007 fiscal year for charges relating to the notebook computer battery pack recalls and subsequent global replacement program.

In game, we expect to record increased sales from the expansion of the PS3 in Japan, the U.S. and Europe. Operating loss of the segment should decrease significantly due to rapid production cost reductions of PS3 hardware and enhancement of PS3 software.

In pictures, we believe sales will decrease due to fewer film releases, but operating income should increase significantly due to contributions from films released in the prior year and motion picture library product.

In financial services, we expect sales and profit to increase, primarily as a result of the expansion in business at Sony Life. No impact on gains and losses on investments associated with the stock market fluctuation in Japan are currently included in our forecast.

Before Mr. Yuhara and Mr. Wiesenthal take your questions, I would like to summarize the key points discussed today. During the fiscal year ended March 2007, the electronics business achieved a meaningful improvement in its operations. Operating margin excluding restructuring costs and the impact of the battery recall was over 4%, achieving our goal a year ahead of plan.

Sony Ericsson capped an exceptionally strong year and contributed significantly to the company’s earnings. In the games business, we have seen continued success with PS2, a resurgence of sales in PSP and the launch of PS3. The pictures business achieved strong year-over-year growth and is poised to record even higher profits in the coming year on the strength of the home entertainment pipeline. Finally, our financial services business continued to grow its core product areas. However, the results were muted by the tepid performance of the Japanese stock market.

As we look forward to the coming fiscal year, our expectation is for a 6% increase in revenue, operating income is expected to grow six-fold, and operating margin is forecast to be 5%.

At this time, we will be pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Jason Mauricio of Arete.

Jason Mauricio - Arete Research

Good morning, good afternoon, good evening, gentlemen. Just a few questions; can you discuss perhaps PS3 and what your view is on sell-through to the end consumer is, and what the appropriate levels of channel inventory should be going forward?

Also, the game inventory that you have built up that you announced that you are keeping on the balance sheet, can you discuss what the makeup of this inventory is, i.e. components, work in progress, finished goods, et cetera?

Maybe one for you, Rob; in pictures, Sony is calling for a decrease in sales this year. Obviously Spider-man 3 has been doing fairly well, plus the DVD is coming out. Can you just discuss what the impetus of that sales decline is? You mentioned fewer titles but is there a particular strategy behind that, i.e. a risk management strategy or just budget constraints? Just perhaps elaborate more on why we should see less titles this year than historically. Thanks.

Takao Yuhara

I’m answering your question on PlayStation 3. This year our production shipment was 5.5 million. Our sales figure was 3.6 million, so therefore around 2 million is inventory because we have changed the shipment from by air to boat, so therefore this 2 million inventory, on the land or on the water, should be a reasonable quantity.

Sell-through quantity, it is very difficult to say because the distribution is varied from region to region. Obviously we see that some quantities should be in the inventory in the distribution channels. So far, we believe that the PS3 and the inventory in channel is a reasonable quantity.

At the end of March this year, the game inventory is about 200 video games. I will not disclosed the portion between the finished goods and the materials but a significant portion is obviously in the finished goods.

Operator

Our next question comes from the line of Evan Wilson of Pacific Crest. Please proceed.

Sam Levenson

Hold on one second. We had one more question to answer.

Robert Wiesenthal

With respect to the picture company and the outlook for this year; yes, the revenues we are forecasting to be not as high as this year but we are really focusing on a more concentrated film slate with fewer, more profitable films. The Revolution deal is winding down. We are really focused at SP on profits, not revenues. I won’t call it a shift in strategy but it’s been more of an evolution where we are just much more efficient in terms of the greenlight process, more efficient in terms of marketing costs and we are very optimistic in terms of profitability for the next year. Spider-man already, by the end of the day will be at $650 million worldwide and probably about 400 of that is internationally, so it’s been a great showing by the picture company and they are off to a great start.

Sam Levenson

Okay, next question, please.

Operator

Our next question comes from the line of Evan Wilson of Pacific Crest. Please proceed.

Evan Wilson - Pacific Crest

Thanks for taking the questions. As it relates to the increase in PSP shipments in the upcoming fiscal year, is that purely due to the recent price change or have you factored in a future price decrease or product refresh in the coming year?

Also, as it relates to the electronics division, I think the gross margin -- I’m disappointed versus a few of our models. You said in the press release it was due to price competition. Could you speak specifically in what element or in what piece of the electronics division did that gross margin disappointment come from?

Finally, if you could speak to the channel inventory of LCD televisions. Thanks.

Takao Yuhara

The PSP shipment, as you know, we had a price reduction both in the U.S. and the European market. It would make a [provision] on the sales. Also, in these countries such as Japan, there was one million sales -- you know, the first day in Japan, so for -- this has also boosted the sales for the PSPs. It was a good start, starting from January onward. That’s the reason why that we have some production shipment quantities forecast for fiscal year 2007.

I cannot discuss about the future price. It is a very strategic issue.

What is the second question? Gross margin?

Evan Wilson - Pacific Crest

Gross margin in electronics, please.

Takao Yuhara

What do you mean gross margin of electronics? Operating profit margin or gross margin?

Evan Wilson - Pacific Crest

I guess the cost of sales in the gross margin division was disclosed in the press release to have been affected by price competition. I’m just curious what segment within electronics was affected by that and if you could give any detail.

Takao Yuhara

In the electronic segment, there is the significant growth of sales in the flat TV market. As you can see, we are increasing the sales of LCD TVs, particularly the last year and continuing this year. So as far as last year is concerned, we could make a profit of the LCD TV business by increasing the gross margin such as the large size of LCD TV, and also the high definition TVs. So those are some of the positives, the effect on that profit increase in electronics.

Generally, typical products is the digital still camera and the camcorder. These, we could make cost reductions in the program for these, such as change of production site from Japan to China and such things. Because the quantity has increased and we could have a good benefit of material cost reductions. So therefore, the gross margin of the digital still camera and the camcorder also includes. So we like to maintain those, the group, the operations of this.

Your last question is LCD channel inventories?

Evan Wilson - Pacific Crest

Yes.

Takao Yuhara

Channel inventory, we just look at a maximum eight weeks. That is what we see as the maximum. If it is more than eight weeks, we just obviously make it correct, the inventory of it. So far, I don’t see a region or any product that exceeds more than eight weeks.

Evan Wilson - Pacific Crest

Thank you very much.

Operator

Our next question comes from the line of Jessica Reif of Merrill Lynch.

Jessica Reif Cohen - Merrill Lynch

I have a couple of questions. First is related to pictures, a margin question; just curious of what your [inaudible] in the fourth quarter and talk about the next few years -- what do you think can drive the margins up?

Robert Wiesenthal

You’re going to have to repeat your question. We can’t hear you.

Sam Levenson

Could you speak up a little bit? We’re having a hard time hearing you.

Jessica Reif Cohen - Merrill Lynch

The fourth quarter margin was down a bit. I’m just wondering what was going on there. It sounds like margins will pick up as sales and profitability is increasing for ’08. I’m just wondering if you could outline what the drivers are of margin improvement in coming years. That’s the first question.

Sam Levenson

You can give us the other questions. We’re taking notes.

Jessica Reif Cohen - Merrill Lynch

Okay. How much of Spider-man ultimate profitability will come in fiscal ’08? And then, on home video, I was just wondering if you could discuss how many DVD units are sold per Blu-Ray machine? Can you talk about wholesale pricing on the DVD units? And then, overall trends in DVD on new releases and catalog -- within that, I wonder if you could just discuss what your expectations are for the fourth calendar quarter of ’07, given the summer release schedule? What are your expectations for video sell-through?

Robert Wiesenthal

Let’s talk about some of these questions one by one. In terms of the most recent quarter, we had a very heavy motion picture release, so obviously with the marketing costs on a quarter-by-quarter basis, the profitability can get pretty lumpy.

Spider-man will obviously contribute in the third quarter when the home video comes out. We don’t disclose the profitability by film, but in terms of the margin increase, as I said previously, we are being much more efficient in terms of marketing costs. The days of all the budgets being totally geared towards network primetime and double truck Sunday newspaper ads are over. Take a look at what happened in Spider-man. A lot of the drive was things like Spider-man week in New York and strong web presences and a very strong mobile presence as well. So we are being much more efficient and much more targeted and smarter about how we spend our marketing dollars.

Overall in terms of profitability, I think that Sony Pictures targets a margin of 10%. I think that you will be seeing over the next couple of years getting in that realm for sure. Quarter by quarter, it is very difficult to take a look at the profitability. We look at it on an annual basis, but again a more focused film slate and much more efficient in terms of marketing, and very strong distribution internationally. Jeff Blake spent a great deal of time over the past couple of years bolstering international distribution. If you take a look at the kind of returns we are getting in terms of revenues, take a look at Casino Royale, the James Bond film, The Da Vinci Code, Spider-man, we are really doing well in terms of international.

In terms of home video, specifically Blu-Ray, there’s been over 1.2 million units sold in terms of Blu-Ray. I mentioned Casino Royale again. It was the first high-definition unit to ship 100,000 units and it was also the first time a Blu-Ray title entered Amazon’s best-seller list, so Blu-Ray is becoming more and more important in terms of sales of home video to the company.

I think in terms of the format issues out there in the market, the public is speaking in terms of the software side. In fact, the past year, of the top 20 DVDs past year, 15 are exclusive to Blu-Ray, four are both HD-DVD and Blu-Ray, and only one is exclusive to HD-DVD. So there’s finally a pick-up there.

The pricing, you mentioned pricing before, remains strong at retail in terms of it being not very heavily discounted on Blu-Ray and hopefully as this transition continues, we are going to be able to maintain pricing.

Takao Yuhara

One thing, your question about the fourth quarter margin; yes, it was down year on year. This is simply in the previous year we had a one-time license fee for Wheel of Fortune, which is a TV program. This was quite a significant amount in the previous year, so that’s the reason why the margin is down. It is not by operations.

Jessica Reif Cohen - Merrill Lynch

Could you actually tell us how much that was, the Wheel of Fortune license agreement?

Robert Wiesenthal

I don’t think we’ve disclosed that, Jess, but that’s why the comps are bad going from the previous year. The pictures profit was still over 11.5%.

Jessica Reif Cohen - Merrill Lynch

Can I just ask one separate question? On music, do you expect further restructuring charges for Sony BMG next year? In general, what are your expectations, given global music market trends?

Robert Wiesenthal

In terms of the music business, it remains challenged. We are going to still need to continue restructuring. I think that having the share platform that we now have between all the multiple labels has proven to be a good move from our perspective in terms of profitability, but as the core business is shrinking you still have to take a really good hard look at overhead.

However, in terms of the core functions, such as A&R, marketing and promotion, this is something that we really hold back and we are going to have to keep focusing because if we don’t have hits, there isn’t going to be much of a business. So when we talk about restructuring, it really isn’t on the artist development side, marketing and promotion. It’s really going to be in terms of shared services, overhead, distribution and such.

Operator

Our next question comes from the line of Colin Sebastian of Lazard.

Colin Sebastian - Lazard Capital Markets

Good morning. Thanks for taking my questions. I wanted to follow up briefly on the PlayStation segment. First, if you could provide a little more detail on the cost side of the PS3 production and related to what you mentioned in your opening remarks, what the timing is specifically for achieving some additional cost savings. Secondly, in terms of the unit guidance, 11 million PS3s. That implies a fairly steady monthly production rate, so it might be helpful to understand when you believe that production and shipments might be able to accelerate there. Thank you.

Takao Yuhara

As you know, we plan drastic cost reduction of our PlayStation 3. This is mainly caused by our in-house device, such as the facilities. As you know, we just moved to the production process of 90-nanode to 65-nanode, and already production [inaudible]. By utilizing these chips, you can see the drastic cost reduction of PlayStation 3 possibly in the second quarter.

Then, next year we are planning to make 11 million product shipments for PS3, and obviously the -- we have very heavy shipments toward Christmas, so therefore production will be better in September or at the latest, October. So those -- we are making every effort to make those PS3s and not to miss the sales chance of the holiday season. That is what we are seriously looking at as the product planning for this year.

Colin Sebastian - Lazard Capital Markets

Thank you very much.

Operator

Our next question comes from the line of Brian Gagnon of Gagnon Securities. Please proceed.

Ben Atkinson - Gagnon Securities

It’s Ben Atkinson with Gagnon Securities. On your slide 10, where you go through the changes in operating income in the electronics division, some of the increase in operating profit this year compared to fiscal year ’05 was due to foreign exchange and a decrease in loss on sale, disposal or impairment of assets. I’m just wondering if you could tell us for those two categories, do you expect much of the profit improvement in fiscal year ’07 to come from either of these two categories?

Takao Yuhara

Well, you know the fiscal year 2006, as we mentioned, we have contribution of sales increase and also for-ex, particularly the Euro was quite favorable compared to the fiscal year 2005. This year, we assume that foreign exchange base is neutral. We consider the same level as current, the exchange rate, which is 160 Yen and also 150 for the Euro, as Sam mentioned.

However, we assume that the outside sales for the electronics increase, say another 4% to 6% in the next fiscal year, so you could expect the margin to increase from the outside sales.

Moreover, we also plan to develop a cost reduction program, so therefore cost of sales is also expected to be increased. Lastly, SG&A at this time we don’t think we would be -- so overall, those are the items that would be contributing to the increase of the operating profit for the electronics fiscal year 2007.

Ben Atkinson - Gagnon Securities

Thank you.

Operator

(Operator Instructions) Our next question comes from the line of David Gibson of Macquarie Securities. Please proceed.

David Gibson - Macquarie Securities

Thanks for taking the question. I noticed that net debt had a dramatic improvement in the quarter versus the end of December and versus the end of the fiscal period. Certainly an improvement of some trend in YEN 14 billion with the repayment of short-term debt. Can you just elaborate in terms of do you expect that’s sustainable going forward, and if so what your priorities are for allocation of looking like a very low balance sheet going forward?

Takao Yuhara

Which side are you talking about, YEN 14 billion debt?

David Gibson - Macquarie Securities

Just net debt, so taking reported long-term debt plus your current proportion of short-term debt less cash, so from year-end of December versus year-end of March, an improvement of approximately about YEN 340 billion, which appears to be the repayment of the current proportion of short-term debt.

Takao Yuhara

I see. I could not find out the figure you were talking about. This is in the balance sheet?

David Gibson - Macquarie Securities

Yes.

Robert Wiesenthal

If you are talking about the borrowing at the end of the calendar year, it is always higher due to year-end receivables from the holiday.

David Gibson - Macquarie Securities

Sure, but the change in the short-term borrowings in the liabilities, as I said, is a pretty significant change, which means that your net debt position is exceedingly low for the full year. Your net debt is --

Takao Yuhara

That’s right. Just as Rob mentioned, our sales has seasonality. At the end of December because of a high sales, we have the big accounts receivables. This will normally reduce toward the end of March. So therefore, that’s the reason why that our net debt position is always reduced from third quarter to fourth quarter. That is why.

Also, our cash flow was a negative YEN 120 billion. This was mainly caused by the outcome of accounts receivables more than we expected and also inventories was also reduced more than we expected at the end of December.

David Gibson - Macquarie Securities

If you look at last year, the change of December implied -- certainly in the order of 35 billion in net debt improvement.

Takao Yuhara

We should talk offline.

David Gibson - Macquarie Securities

We’ll do it offline. Okay. Thank you. In terms of the allocation of cash going forward? What’s the view on allocation of cash going forward in terms of free cash flow? What’s the priority -- implied debt or what?

Sam Levenson

Could you repeat the question one more time?

David Gibson - Macquarie Securities

Given the operating performance, do you expect it to be substantially improved through 2008? What is the company’s priority of where to allocate its free cash in the balance sheet?

Robert Wiesenthal

As you know, we have a lot of different businesses going on with different issues they are facing -- some positive, some negative. We want to maintain our credit rating. We are going to be opportunistic about acquisitions. We definitely have capital investment needs going forward, so it’s kind of a mix of all of the above.

David Gibson - Macquarie Securities

Thank you.

Operator

Our next question comes from the line of John Taylor of Arcadia. Please proceed.

John Taylor - Arcadia

I’ve got a couple of questions about the games business, if I can. In your forecast for next fiscal year, I’m wondering if you expect the value of software to be up. In other words, I think you said revenues would be up about 6%, if I heard that right. I’m wondering if you expect both hardware and software to be up in that.

Within the mix of software value in YEN, I’m wondering if you could give us a rough breakdown of what the mix of PS3 might look like as a total, or I’m looking for a mix of the three, if you can give me that detail. That’s the first question.

The second is I think you told us what the inventory write-down cost was for the PS3 chips. Were there any other sort of major non-recurring charges that were taken in your last fiscal year that you might break out for us?

And then, the third question is within the game segment, you are talking about an improvement in the operating loss. I wonder how much of that, if you could -- of 100% of the improvement, whatever it is, how much of that you think is going to come from improved margin on hardware versus a larger contribution of profitability from software.

Any color on any of those would be great. Thanks.

Robert Wiesenthal

John, let me just clarify one thing; the revenue up 6% was total company. We’ve not given increases by segment.

John Taylor - Arcadia

Okay, fine.

Takao Yuhara

Obviously the sales revenue for the game, the increase is much, much more than 6% in this year. Hardware and software mix is, as I mentioned that last year it was 70% between hardware and this year it is literally more or less the same. So that is what we are expecting.

We don’t have a breakdown of the software, the 250 million, by platform, but as you know the software for the PSP and the PS3 will be increased. PS2 software will be reduced.

John Taylor - Arcadia

If I could follow up on that, you’re giving the units. Because you have dramatically different average selling prices, I was wondering if we could get a rough breakdown in value, not units.

Takao Yuhara

Unfortunately, we don’t disclose the breakdown. As I just guided you about this total quantity and also the trend, you would find out the amount.

The PS3 chips, yes, we did write down for the inventories and as we mentioned that, which is YEN 106 billion remained as a write-down amount in inventory for the March 2007. We don’t have any non-recurring charges other than this write-down.

John Taylor - Arcadia

Did I hear you correctly, you said that the mix would be more in favor of hardware than software in your next fiscal year?

Takao Yuhara

Yes. As I said, more but a little more. It’s not too different compared to 2007, 2006.

John Taylor - Arcadia

Thank you.

Operator

Our next question comes from the line of John McPeake of Prudential. Please proceed.

John McPeake - Prudential

Thanks for taking my question. With the strong momentum that Blu-Ray is seeing right now, it really looks like it is going to win out, have you guys thought about the pricing dynamics between standalone Blu-Ray players and the PS3?

Robert Wiesenthal

As you probably heard, we have a version of a Blu-Ray player standalone that is coming out this spring. In terms of what we see in terms of the overall market, the PS3 is not only a game machine but a Blu-Ray player and we are very, very optimistic about the use as a Blu-Ray player. I think right now our surveys are showing that about 85% plus of all the people purchasing PS3s are intending to use it as a Blu-Ray player. As you may know, the PS2 was instrumental in the launch of the DVD format when it was first released. The packaging of the PS3 with Talladega Nights in the U.S. and the James Bond film, Casino Royale in Europe really got people to start experimenting with it. Right now, the HD penetration in the U.S. is still relatively low. There is a lot of upside there and when people connect a Blu-Ray player to an HD set with an HD cable and see true high-def for the first time, it’s relatively contagious. So we are very optimistic about it but again, I think you really have to look at the PS3 in your count as a Blu-Ray player. It is really a dual function machine as opposed to a game machine that happens to have a unique capability.

Additionally, I think you can expect hardware prices for Blu-Ray players to obviously continue to decrease as all our new products do in this early cycle. On the software side, we are actually pretty optimistic about how DVD pricing is holding in terms of Blu-Ray versus standard definition. There’s a lot of value there, a lot of interactivity, a lot of extra value for the consumer and they are recognizing that in their purchases.

Sam Levenson

Michelle, we’ve got -- I’m sorry, do you have a follow-up?

John McPeake - Prudential

I was just going to say in theory, you would think that the standalone might price lower than the PS3.

Sam Levenson

Sorry, we couldn’t hear you.

John McPeake - Prudential

I said in theory, do you think standalone player might price lower than the PS3?

Robert Wiesenthal

Well, again I think that it’s competitive out there. We are getting smarter about how to manufacture these devices. The yields are improving on the lasers, so I think all over, I think you are going to see much more competitive pricing across the board.

Sam Levenson

Michelle, we have time for one more question.

Operator

Our last question comes from the line of Helene Wu of WR Hambrecht. Please proceed.

Helene Wu - WR Hambrecht+Co.

Thank you for taking my question. I was just wondering, do you have any forecast for the PS3 unit for fiscal year 2008? Also, for 2007, do you see any possible price cuts or changes to the PlayStation 3?

Takao Yuhara

We cannot discuss the possible production shipment or sales quantity for fiscal year 2008, but we still should be more than 11 million of the current quantity for fiscal year 2007.

Helene Wu - WR Hambrecht+Co.

Thank you.

Sam Levenson

Thank you very much. With that, I would like to conclude today’s conference call. Thank you, everyone for joining us, including Mr. Yuhara, Mr. Wiesenthal. Finally, I would like to take this opportunity to remind everyone of our investor relations contact information. In Tokyo, IR can be reached at 813-5448-2180. In New York, myself, Justin Hill and Miki Emura can be reached at 212-833-6722, and in London, Shinji Tomita is available at 44-20-7444-9713.

Again, thank you very much for joining us and that concludes today’s call.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference call. This does conclude your presentation and you may now disconnect. Have a great day.

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