Electronic Arts F1Q09 (Qtr End 6/30/08) Earnings Call Transcript

 |  About: Electronic Arts Inc. (EA)
by: SA Transcripts

Electronic Arts Inc. (ERTS) F1Q09 Earnings Call July 29, 2008 5:00 PM ET


Good day, everyone and welcome to the Electronic Arts first quarter fiscal year 2009 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, Senior Director of Investor Relations. Please go ahead.

Tricia Gugler

Welcome to our first quarter fiscal 2009 earnings call. Today on the call we have John Riccitiello, our Chief Executive Officer; Eric Brown, our Chief Financial Officer; John Pleasants, our Chief Operating Officer; and Peter Moore, our President of EA Sports.

Before we begin, I’d like to remind you that you may find copies of our SEC filings, our earnings release, and a replay of this webcast on our web site at investor.ea.com. Shortly after the call, we will post a copy of our prepared remarks on our website.

Throughout this call we will present both GAAP and non-GAAP financial measures. Non-GAAP measures exclude the following items: amortization of intangibles, stock-based compensation, acquired in-process technology, restructuring charges, certain litigation expenses, losses on strategic investments, and the impact of the change in deferred net revenue related to certain packaged goods and digital content.

In addition, starting with its fiscal 2009 results, the company began to apply a fixed, long-term projected tax rate of 28% to determine its non-GAAP results. Prior to fiscal 2009, the company’s non-GAAP financial results were determined by excluding the specific income tax effects associated with the non-GAAP items and the impact of certain one-time income tax adjustments.

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

This quarter, we’ve expanded the supplemental information on our website. In addition to the detailed GAAP to non-GAAP reconciliation and our trailing 12-month segment shares, we’ve also added our SKU count and a summary of our financial guidance.

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 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 July 29, 2008 and disclaim any duty to update them.

Now I would like to turn the call over to John.

John S. Riccitiello

Thanks, Tricia. Let me touch briefly on our agenda for today: I will start with an update on the quarter and the year; Eric will then discuss our Q1 results and provide our detailed guidance for FY09; Peter Moore will update you on our sports business; and then I’ll wrap up with a few closing thoughts. After that, Eric, Peter, John and I will be happy to take your questions.

Let me start with the quarter. We beat our expectations on the bottom line and came in slightly below on the top line. The top line results were driven by Battlefield Bad Company and UEFA EURO 2008 and continued strong sales of Rock Band, offset by weaker than expected catalog sales.

Our bottom line over-performance reflected expenses coming in below plan. Other key metrics we follow, from on-time delivery to product quality, were strong. Overall, we had a very solid quarter.

Eric will cover this in more detail; however, at this point, we feel good about the year and are maintaining our top and bottom line non-GAAP guidance for fiscal 09.

There are four areas that will determine the shape of our fiscal 09 year and that are critical for us to deliver on for our plans: EA Sports, our FY09 slate, our Nintendo products, and our digital/direct to consumer businesses. Let me talk about each of these four areas.

First, EA Sports -- the early indicators for our EA Sports business are mixed, with two positive and one negative. Peter will get into this in more detail but I will touch on these indicators briefly. The first indicator is quality, and that’s up. Quality on NASCAR and NCAA were up as reflected by stronger meta-critic scores. We expect this trend to continue as we launch the rest of our sports slate, especially with Madden, which is looking particularly strong. Frankly, I’m pleased with the level of quality and innovation in our EA Sports titles across the board. A special thanks to our Tiburon studio for stepping up the innovation in our 09 football titles.

A second key indicator is pre-orders, and they have been down both on NCAA and Madden. Pre-orders are not a hard metric of performance but they are one external measure we follow very carefully.

The third and very important indicator is sales. On NCAA, sell-through is consistent with last year. Although still early, this suggests that pre-orders are not the whole story. Consumers seem to be responding to a better and more innovative game. This year, even though pre-orders are down on our football titles, it feels like we have the quality to deliver.

Now let me talk a bit about the rest of our FY09 slate. It’s strong. Some of you had a chance to see and play many of our games at E3 a few weeks ago. I feel even more bullish about the innovation and quality of our slate than I did three months ago.

Let me hit on just a few recent launches: Battlefield Bad Company from DICE has exceeded our sales expectations and had a strong average meta-critic rating of 84; Boom Blox from EA Casual continues to sell well and is judged by many to be one of the best Wii titles so far this year; SPORE Creature Creator from Maxis is incredibly innovative, addictive and fun. To date, 2.5 million trial and paid versions are in the hands of users and this gives us confidence on the prospects for SPORE.

We are off to a great start this year and it only gets better from here. For the sake of brevity, let me talk about a few games that I’m very excited about and which will help drive our sales growth in fiscal 09.

Dead Space and Mirror’s Edge, two entirely new IPs that showed well at E3, Harry Potter and the Half Blood Prince -- this year our Harry Potter game ships day and date with the movie in the peak holiday season. And from the Sims label, we’re launching The Sims 3 in Q4.

Our entire line up represents a significant step up in innovation and quality from a year ago. While we are still waiting for the details of the critics and their final decisions, we were pleased that several outlets, including G4 and IGN, nominated SPORE, Dragon Age, Mirror’s Edge, Warhammer, Dead Space and NBA Live for top honors, and that the early nominations which we received earlier today from the critics awards suggest that we’ve been nominated for over 21 awards this year. That’s a record for Electronic Arts and number one in the industry. Realistically, critics don’t pay our bills, but it’s good to see that others are recognizing the up-tick in quality at EA.

Frankly, I am very proud of the many games we’ve shipped and I’m even more excited about the line-up that’s coming. I think we are in very good shape here.

Third, our progress on the Nintendo platforms -- we have 40 SKUs slated to ship in the year, up from 26 last year. It’s not just about quantity, it’s about quality and this year we have both. Most of our slate is specifically designed for these platforms. We believe this will pay off in greater sales and share.

We shipped two key Wii titles in the quarter and they are doing quite well. Rock Band was the top selling Wii title in June in North America and Boom Blox charted at number 10.

We have much to come; let me focus on two important entries. Skate it, a new take on our successful Skate franchise but this time designed ground up for the Wii and NDS. The Wii version will take advantage of the Wii-fit board.

And MySims, introduced last year, selling over 2.5 million copies on the Nintendo platforms. This year we are back with MySims Kingdom and MySims Party for both the Wii and the NDS.

These entries and others promise to make FY09 a good year for EA on the Nintendo platforms.

And finally, I want to touch on our digital/direct to consumer businesses. This is a strategic initiative for Electronic Arts. During the quarter, we generated $90 million in digital/direct to consumer sales, up 21% year-over-year.

Let me hit on a few highlights: Pogo continues to grow with subscriptions and micro-transactions driving the business; on Mobile, our business is back on track, delivering growth of 33% year-over-year; Mid-Session Games, we launched FIFA Online 2 in Korea last fall and sales continue to expand, both direct to consumer and in game rooms. Today, NBA Street Online has gone to open beta in Korea and we’re looking forward to expanding the game to other Asian markets. We are also planning to launch Battlefield Heroes globally this fiscal year; Warhammer Online -- EA is getting back into the MMO space in a meaningful way with one of the most anticipated online titles in the industry, from our Mythic studio.

And recently we gave you an early look at key aspects of our online strategy, including our Nucleus registration system and the community features we are building across our games. We just launched the Sims Store, which is off to a great start. We look forward to updating you on our plans in the months ahead.

Net, we delivered a solid Q1 and feel good about the balance of the year. The industry is robust and we’ve got a competitive slate. On balance, we’re tracking on each of the four drivers that we need to for us to deliver on our FY09 plans -- from EA Sports to our non-sports slate, from our Nintendo titles to our digital direct to consumer initiatives. We look forward to updating you on our progress.

Now I would like to pass the call over to Eric.

Eric F. Brown

Thank you, John. Good afternoon, everyone. During the quarter, several titles stood out: Battlefield Bad Company sold 1.6 million copies, exceeding our expectations. With only one week of sales, it was a top five title in the month of June in both North America and Europe on the PS3 and Xbox 360; UEFA EURO 2008 sold over one million copies, charting in the top-ten in Europe on the Xbox 360, PS3, PS2 and PSP during the quarter; NASCAR 09 sold nearly a half of million copies; Boom Blox sold 450,000 copies, meeting our expectations. In North America, it charted at number 7 on the Wii in May and number 10 in June; and finally, Rock Band continued to gain momentum. During the quarter, Rock Band sold over 800,000 copies. Rock Band debuted on the Wii in June and was the number one title on this platform.

I would now like to spend some time discussing Q1 in more detail. Please note that all of the following references to first quarter results are non-GAAP, unless otherwise stated.

Non-GAAP revenue was $609 million. As expected, our Q1 revenue was primarily driven by the launches of Battlefield Bad Company and UEFA EURO 08 and the continued sales of Rock Band.

Relative to our internal expectations, non-GAAP revenue came in slightly lower than expected due to lower catalog sales which were partially offset by higher frontline revenue. On non-GAAP EPS, we came in above our expectations as a result of a shift of expenses to later in the year and some cost savings.

By geography, North America non-GAAP revenue was $340 million, up $169 million or 99%, primarily due to growth in distribution and console revenue.

International non-GAAP revenue was $269 million, up $9 million or 3%. Excluding a $26 million positive impact from foreign exchange versus last year, international non-GAAP revenue would have decreased 7%. Revenue was driven by EURO UEFA 2008, Battlefield Bad Company and Rock Band, partially offsetting the strength of Harry Potter last year.

Moving to the rest of the income statement, GAAP gross profit in the quarter was $508 million, up 122% primarily due to the benefit from the deferred revenue rollout and greater overall net revenue. GAAP gross margin was 63.2% versus 58%, up 5.2 points. Non-GAAP gross profit was $317 million, up 17% year-over-year.

Non-GAAP gross margin was 52.1% versus 63.1%, down 11 points due to a higher mix of co-publishing and distribution revenue.

Operating expenses -- before getting into the details, let me remind you that this year we are recording our bonus expense in a straight-line fashion instead of recognizing the expense in proportion to quarterly profitability, as we have in the past. This impacts the quarterly phasing of our bonus expense. As we said on our last call, this change will negatively impact Q1, Q2, and Q409 and have a corresponding favorable impact on expenses in Q3.

During the quarter, this resulted in a $26 million overall increase to operating expenses year-over-year.

Marketing and sales -- non-GAAP marketing and sales expense was $123 million, up $45 million primarily due to increased advertising to support our Q1 releases and higher personnel-related costs, including the bonus phasing. During the quarter, we released seven titles versus three titles last year.

General and administrative -- non-GAAP G&A was $74 million, up $11 million. The increase was driven by higher personnel-related costs, including the bonus phasing.

And research and development -- non-GAAP R&D was $322 million, up $88 million. Of the $88 million, $35 million is related to the acquisition of VGH and $18 million is related to bonus phasing.

R&D headcount ended the quarter at roughly 7,200, up approximately 1,100 from a year ago. Excluding the impact of acquisitions, headcount was up 5% year-over-year.

Restructuring -- during the quarter, we recorded $20 million in restructuring expense primarily related to an additional impairment on our Chertsey facility that was restructured under our previously announced reorganization plan.

Below the operating income line, non-GAAP other income and expense was $15 million, down $12 million from a year ago due to a decline in interest income.

Income taxes -- on a GAAP basis, we incurred $7 million of tax expense, including $25 million of tax charges associated with the integration of VGH. On a non-GAAP basis, we recorded taxes at 28%.

GAAP diluted loss per share was $0.30 versus diluted loss per share of $0.42 a year ago. Non-GAAP diluted loss per share was 0.42 versus diluted loss per share of $0.22 a year ago.

Our trailing 12-month operating cash flow was $239 million versus $243 million for the prior period. Capital expenditure for the quarter was $31 million versus $14 million a year ago.

Turning to the balance sheet, cash and short-term investments were $1.95 billion at quarter end, down $340 million from last quarter due to cash used in operations and the acquisition of Hands-On-Mobile and ThreeSF.

Marketable equity securities and other investments were $752 million, roughly consistent with the balance at year-end.

At quarter end, we had a net unrealized gain of $505 million, comprised of a $516 million gain on Ubisoft and The9, and a $11 million loss on Neowiz.

Gross accounts receivable were $455 million versus $299 million a year ago, an increase of 52% primarily due to the growth in revenue and the timing of our release schedule.

Reserves against outstanding receivables totaled $186 million, up $10 million from a year ago. Reserve levels were 12% of trailing six month non-GAAP revenue, down five points. As a percentage of trailing nine month non-GAAP revenue, reserves were 6%, down two points.

Inventory was $223 million, up $55 million sequentially, primarily due to Rock Band inventory.

Ending deferred net revenue from packaged goods and digital content was $192 million, down $195 million sequentially primarily due to the rollout of deferred net revenue recognized in Q1.

Now to our outlook, and let’s start with the industry. Calendar year-to-date software sales are up 38% in North America and we estimate up 28% in Europe. Even though we are coming up against harder comparables, we are feeling more bullish about the industry. We now expect software sales to grow 20% or more this year combined for North America and Europe, up from our previous expectations of 15% to 20%.

Now our guidance, and let’s start with GAAP. For the full year, we expect: GAAP Revenue to be between $4.9 billion and $5.15 billion; GAAP EPS to be between $0.21 and $0.48 -- we have lowered the range by approximately $0.04 primarily due to an additional impairment on our Chertsey facility; GAAP gross margin to be between 55% and 58%; and diluted share count to be approximately 331 million shares.

We expect to end the year with roughly $500 million in deferred net revenue related to online-enabled packaged goods.

Now, our non-GAAP guidance. For the full year, we are confirming our guidance. We expect: non-GAAP revenue to be between $5.0 billion and $5.3 billion; non-GAAP EPS to be between $1.30 and $1.70 per share; non-GAAP gross margin to be between 57% and 59%, and we continue to expect our gross margins will be in the lows 60s for the second part of the year; and diluted share count to be approximately 331 million shares.

Please see our press release for the difference between our expected GAAP and non-GAAP guidance.

Let me provide some additional detail on our guidance. On Non-GAAP revenue: we now expect Tiberium to ship in FY10; in digital/direct to consumer, we continue to expect to generate over $450 million in non-GAAP revenue, up 35% versus fiscal 08; in online, we estimate our online non-GAAP revenue will be in excess of $285 million, up approximately 50% year-over-year; in EA Mobile, we expect our wireless non-GAAP revenue will be in excess of $185 million, up approximately 20% year-over-year.

On Non-GAAP expenses, R&D -- consistent with our original guidance, we expect non-GAAP R&D will increase roughly 30% year-over-year.

Confirming what we said on our last call, $120 million of the increase is driven by our acquisition of the BioWare and Pandemic Studios, which includes developing an MMO that will launch in a future year. Keep in mind, although we are incurring 12 months of expense for this acquisition, the bulk of the revenue will be recorded in the back half of the year, given the timing of their release schedule; $40 million of the increase relates to our R&D investment in Hasbro games. Even with these costs, we expect the profit margins in our Casual Label to increase year-over-year.

Excluding the foreign exchange impact on expenses and the assumption of funding bonus at 100%, R&D in the rest of the business will be up about 10% year-over-year, related to new IP investments and our online and mobile initiatives. In online, in addition to investing in communities and features that cut across all of our games, we are also supporting a second new MMO, Warhammer, launching later this year.

We expect sales and marketing to be down one point as a percentage of revenue versus last year, and we expect G&A to be down 1 to 1.5 points as a percentage of revenue versus last year.

On Non-GAAP operating margins, we continue to expect non-GAAP operating margin of 12% to 14% for FY09, or an increase of 4 to 6 points from fiscal 2008.

Below the operating income line, we continue to expect that non-GAAP other income and expense will be roughly $50 million this year, down significantly as a result of a steep decline in interest rates.

In income taxes for FY09, we expect a GAAP tax rate range of 40% to 55%, which includes the tax charges associated with the integration of VGH. Excluding VGH tax charges, our GAAP tax rate range is 27% to 32%. Our rate will fluctuate from quarter-to-quarter. For non-GAAP, we expect our rate for FY09 to be 28%. You can also use this 28% rate to model the quarters, including loss quarters.

And finally, two things you need to keep in mind for fiscal Q2: first, we project a non-GAAP loss in the quarter; and second, on bonus phasing, we expect to incur $35 million to $40 million in bonus expense versus none in the prior year, due to the straight-line recognition of bonus expense which began this year.

Now our Q2 releases -- we expect to ship 13 titles and 36 SKUS in Q2 versus 13 titles and 45 SKUs a year ago. To date, we have already shipped NCAA 09 on 5 platforms. We also expect to ship the following: Madden NFL 09 on 7 platforms; Madden NFL Collectors Edition on the Xbox 360 and PS3; Madden NFL 09 in Spanish on the Xbox 360 and PS3; NFL Head Coach on the Xbox 360 and PS3; SPORE on the PC and NDS; Tiger PGA Tour 09 on 5 platforms; Face Breaker on the Xbox 360 and PS3; Mercenaries 2 on 4 platforms; NHL 09 on the Xbox 360 and PS3; Sim City Creator for the Wii and NDS; Sims 2 Apartment Life Expansion Pack for the PC; Sims 2 Apartment Pets for the NDS; Brain Quest on the NDS.

From EA Partners, we expect to ship: Crysis Warhead Expansion Pack; Rock Band Expansion Pack; Rock Band 2 in North America on the Xbox 360; Rock Band on the PS3 in Europe.

And for EA Mobile, we’ve launched three games for the iPhone -- Tetris, Scrabble and Sudoku -- and expect to launch an additional eight games in the quarter. On wireless devices, we also plan to release eight games, including SPORE, Life and Madden.

Please note FIFA 09 is shipping in Q3 globally this year. Last year it shipped in Europe in Q2.

That concludes our guidance and outlook commentary. I would like to now turn the call over to Peter Moore, President of our EA Sports Label.

Peter Moore

Thanks, Eric, and good afternoon to everyone. At EA Sports, our strategy remains the same as we outlined in the February analyst day. We are working along two paths to accelerate profitable growth. First, improve the innovation and quality in our core franchises with a special focus on the Wii; and second, make our business more digital and direct to consumer with new business models.

So where are we today? We are pleased with the quality and innovation in our sports titles this year. For example, NCAA received an average meta-critic rating of 83 on the Xbox 360 and PS3, up five points on the PS3 from last year and up two points on the Xbox 360. The early reviews on Madden NFL 09 are strong and I’m confident that we will beat last year’s meta-critic rating.

In NBA Live, dynamic DNA is one of the most innovative features we’ve added to the franchise in years. We think it will resonate with consumers and help set our game apart from the competition.

FIFA 09, Tiger PGA Tour 09, and NHL 09 also look great.

We are also pushing on wholly-owned IP and the Nintendo platforms, with Face Breaker, our first new wholly-owned game since 2002; our All Play Wii brand targeted at the Nintendo audience; and another yet to be announced title we expect to ship later in the year.

We expect the quality and innovation in our games to take a leap forward this year and I couldn’t be more proud of our creative teams.

Now as John indicated, one area that we are spending time understanding is the pre-order activity on NCAA and Madden. On NCAA Football, pre-orders were down over 20% year-over-year; however, sell-through for the first two weeks has been consistent with last year. Pre-orders for Madden are also down, although the number of pre-orders has risen sharply in the last week. Gamers are smart and we believe the higher quality will translate into long-term equity for the franchise. We can’t be 100% sure, but we’re hopeful for Madden, like with NCAA, quality will prove the more relevant indicator of sales.

Net, the key indicators to date are mixed and are difficult to interpret. This year we conservatively planned our core franchises -- NCAA, Madden, Tiger, FIFA, NBA and NHL, expecting total units to be roughly flat year-over-year. We expect a single digit revenue increase for our core sports franchises, given higher ASPs on current generation platforms.

We are not changing our forecast today, but we are watching it carefully. If quality and innovation don’t trump pre-orders, then we have some exposure which is currently reflected in our guidance range.

And finally, we’ve been making strides to drive our business digital direct to consumer. In a digital world, we think we can augment our retail packaged goods business with profitable direct to consumer revenue streams that expand the whole category.

On mid-session games, we expect to expand our portfolio beyond FIFA Online 2 and beyond Korea. This year, we plan to expand FIFA to Thailand, Vietnam, Singapore, Taiwan and China. And we expect to commercialize NBA Street in Asia later this year.

As many of you probably noticed, this year we cut back on our PC sports games, but only for a year. We are retooling these titles to take advantage of the online connectivity in a bigger and a more meaningful way -- stay tuned for more on this.

And finally, we are working on subscription programs that will provide our large base of EA Sports consumers with greater value for their loyalty.

To sum it up, we are making good progress on the core, starting with game innovation and quality. We’re going after wholly-owned properties and the Nintendo opportunity in a bigger way and creating new direct-to-consumer revenue streams to augment our great packaged goods business.

Now I would like to turn it back to John.

John S. Riccitiello

Thanks, Peter. Before we take your questions I want to emphasize a few quick thoughts. 2008 is another strong year for the interactive entertainment industry. We had previously expected to see to a growth range of 15% to 20% and now feel confident enough to raise our expectations to 20% or more.

EA set strong goals for FY09, targeting non-GAAP revenue growth of over $1 billion and a doubling of our non-GAAP operating profit, showing the start of the operating leverage a great title plan can deliver. On a non-GAAP basis, we’re reconfirming the year, top and bottom line.

And we’ve got our eye on FY11 and we are taking steps now to drive both our core business and increase our digital/direct to consumer revenue to meet the FY11 targets we set in February of this year.

With that, we would be happy to take your questions.

Question-and-Answer Session


(Operator Instructions) We’ll take our first question from Arvind Bhatia with Stern Agee.

Arvind Bhatia - Stern Agee Leach

Good afternoon. My first question is on the catalog side of the business, you guys indicated it was weaker than expected. Can you tell us what it represented this quarter and what your expectation is for the year?

And my second question is what is your thesis on why this works, business at this point, the pre-orders at least on Madden appear to be a little bit tough.

John Pleasants

I’ll start off and I’ll probably pass it to Peter here as it relates to the Madden question. On our catalog, I think John and Eric both mentioned that we had stronger front line sales and slightly down catalog sales, and obviously those two things offset each other a bit. Again, we were talking about very small differences in the two, so these really are not big differences. And the only thing we can say is that we’ve seen a little bit of softness in catalog overall for the industry because we had such a strong quarter with both our lineup, our strong front line as well as competitive front line, with GTA, Mario Kart, Wii Fit and Metal Gears.

So something we’re keeping our eye on but not -- again, kind of marginal differences.

Peter Moore

It’s a great question. I mean, we’re watching this very closely but I think in a world where we now do a lot of street dating and we build events around our launches, consumers are feeling less pressed to actually place preorders. You may know we’ve never done anything, for example, in the example of Madden, to actually spur preorders during events. We’ve been doing the launches recently with Gamestop, which I’m sure you’ve seen with ads in Sports Illustrated and other consumer magazines. But I think NCAA has taught us a couple of lessons: A, that preorders are not quite the key indicator that they may have been in the past, and secondly they shouldn’t be seen as any kind of indicator for sales in the first couple of weeks. We were down over 20% in preorders and yet when here we are just in week two entering into our third week and we are actually flat year to year. So something we are watching and I think we’ll have a better idea once we see where the Madden numbers lie in the next few weeks.

Arvind Bhatia - Stern Agee Leach

Peter, what about the special edition? What do you think that will represent as a percentage of that category?

Peter Moore

It’s a good question. We’re not quite ready to talk about the percentage yet. I’ll have some better ideas after it ships. I think it’s one of those where people will actually see it in store and be tempted to actually sell up, if you will, when they see it versus the regular version. So early days yet, certainly have some information for you in the next four or five weeks on that.

Arvind Bhatia - Stern Agee Leach

Final question is on the second quarter rough guidance you guys provided on the loss for the quarter, is that an operating loss or is that a net income loss you are expecting?

Eric F. Brown

It’s specifically a non-GAAP EPS loss, and to give you the specific number for your catalog question, it was 26% in the current quarter versus 46% same quarter year ago and 36% in the last Q4 FY08.


We’ll move on to Brent Thill with Citi.

Brent Thill - Citigroup

Thanks. There’s been a lot of questions around your fiscal year ’09 guidance, and if you get to the midpoint, you’re assuming that a high 20% year-over-year growth rate. Can you just walk through how much wiggle room you’ve baked into certain things, such as --you provided evidence around the sports franchise. It seems like it’s gotten off to a little bit of a slower start than most would have hoped. Can you just walk through the second half of the year and as it relates to how much wiggle room there is to this?

John Pleasants

Specifically regards to sports, the data we have in hand on NCAA is that sales are consistent with year over year, so that’s the data point that we do have here. And in terms of the overall guidance, what we’ve done is we’ve selected all the information that we have for certain titles that might slip out of the year. We announced one. We’re also factoring in operating expense control. We’ve realized and seen some of that in Q1 already, and so we think it represents a fair and balanced view of our latest expectations for FY09.

John S. Riccitiello

I’ll just add a little bit of color. The original plan for EA Sports was essentially flat units in the core franchises and growth coming out of the new franchises we’re putting in the market, and then that cascades as Peter mentioned into some direct-to-consumer digital initiatives that will augment and expand the growth in years to come, and we still feel that that’s the right story. And of course, Peter was careful because the biggest event in the year for us in North America is Madden, and that’s still in front of us.

In terms of wiggle room, I wouldn’t know how to frame wiggle room exactly as a tight guidance statistic, but I would point out that really starting with Mercenaries this year, there’s a number of things that are sort of new and incremental for Electronic Arts to prior years. The strong -- again, with Mercenaries and Spore coming out this summer, the summer/fall, and what we’ve got, titles like Mirror’s Edge and Dead Space. We’ve got our own MMO coming with Warhammer.

You know, frankly, you just see the quality and the depth of our lineup take a qualitative shift, you know, sort of starting in the July, August, September window and moving from there, which is why we are confident in guiding to $1 billion plus in growth.

Brent Thill - Citigroup



And we’ll move to Jeetil Patel with Deutsche Bank.

Jeetil Patel - Deutsche Bank

A couple of questions -- I guess can you just clarify the comment on NCAA? Was that flat on dollars or flat on units, since I guess the industry looks still pretty healthy on growth and I’m just trying to understand whether units are down and sales are flat. And then secondly, I’m just -- not to be anymore of a cynic here than I’ve been, but you had just the largest quarterly loss that you’ve ever had in the company’s history this past quarter. Do you think this is just the old strategy kind of working itself out of the system right now, or is it just you have a bit of a hard time ramping up in terms of showing some operating leverage? I know it’s obviously a seasonally light quarter but I just want to get your thoughts on that. Thanks.

Peter Moore

The answer to the first question is units -- we are flat year on year on units.

John S. Riccitiello

In terms of the quarter, realistically what it is, we’re in a 12-month business. One of the reasons we’ve pulled back on quarterly guidance is we tend to think quarters are a little bit hard to use as a projective measure. You need to add a few of them together to get a good picture. In this quarter in particular, of course, we made some accounting shifts, including moving the way we recognize our bonus, adding $26 million in expense to the quarter. And for those tracking GAAP, it’s particularly complicated because of revenue recognition.

Where we are right now is we’ve guided to the move of 8% pretax margin to a range of 12% to 14%. That is in fact the leverage we indicated that we would be seeking as we entered into this planning process and then announced our guidance for the year and we’re remaining consistent with that. And this -- you know, for what it’s worth, relative to our own internal expectations, we had, if you will as good information as any of us could have and full visibility on how we are moving things like bonus around, which is not a cash charge but it’s a recognition of a later obligation, we came in ahead of our bottom line expectations.

Jeetil Patel - Deutsche Bank

And just a quick follow-up -- is it if I just take the loss for the second quarter that you just talked about, I mean, that implies about an 80% incremental margin in the back half of the year to get to your guidance at the midpoint or so. Is that how we should think about the business, that it should have that high type of leverage in the business? I mean, I know you’ve got those charges that are being spread out but assuming the back half looks to be relatively smooth on that basis, it seems like a fairly high leverage target.

John S. Riccitiello

Look, there’s two factors going on. I would tell you that I’m not working with your model, so I can’t give you precisely how you might want to adjust it, because I don’t have it in front of me. I would tell you that the way I would think about is that we have let people know that the second half of the year has better gross margins as a percentage of revenue and that we have a back-ended year relative to revenues, and that’s a consequence of shipping a number of very important, wholly-owned properties at the back half of the year, and including titles like SPORE, Dead Space, Mirror’s Edge, et cetera.

So this is what drives the complexion of the year, is the combination of moving bonuses around, they come out of Q3, goes into Q4, Q1, and Q2, and [that is our title slate]. I think for you to try to describe this as leverage quarter to quarter would be sort of a pure spreadsheet exercise and I don’t think indicative of the way the business works.

We’ve got roughly 150 SKUs, a few more than that, and this is really where they are falling in the quarter and how we are required to reflect our expenses, including non-cash charges like bonus.


We’ll move on to Edward Williams with BMO Capital Markets.

Edward Williams - BMO Capital Markets

A couple of questions; first of all, Eric, can you clarify, just to be clear, you are expecting a GAAP Q2 loss as well as non-GAAP Q2 loss?

Eric F. Brown

No, we only said that we are expecting a non-GAAP EPS loss in Q2.

Edward Williams - BMO Capital Markets

Okay, and then a couple of questions for Peter, if you could; just comment a little bit about the non-core sports properties this year. How significant could they be, how material will the all play properties on the Nintendo platform be, and what sort of life cycle should we look for on the all play? Is that more of a casual life cycle or more of a typical sports property [life cycle] you’re expecting?

Peter Moore

Let me take that last question on all play. I think we just shipped two weeks ago our first of the all play titles. There’s five as you know slated for this year, and NCAA shipped. I think that when we see the balance, particularly the big dogs in Madden and FIFA go out, we’ll have a better indicator. I do see it less of a core cycle and more of a Wii typical cycle in which we are not expecting blockbuster first weeks but more of a consistent sell-through, particularly as we get through to the holidays. From the perspective of the upside, which we’ve talked about repeatedly over the last few weeks, we truly believe that there is tremendous upside for EA Sports on the Wii platform. As you know, this is the first year we’re building the games from the ground up, so it’s going to be a great test but this is really a crawl, walk, run.

We’ve invested 15 years into building EA Sports to what it is, which is authentic simulated sports games and we are not readjusting that brand image to this new consumer that’s coming in, with a new game mechanic.

As regards to the new IP, Face Breaker will be the first of that. As you may have read coming out of E3, we got tremendous response from what was previously a cynical group of press reviewers and we are expecting to get the first reviews in the next few weeks. We think it’s a great opportunity for us not only to show to a new batch of consumers a new side of EA Sports. Of course, it will be the first title we ship on the freestyle sub brand, but also the ability for us to apply technology with our gamer face that you can drop onto any of the boxes in the game itself, and it’s the first new IP that we at EA Sports have shipped in six years, so I think it’s a great test and obviously it’s going to be integral to us building our margins going out over the next few years.


And we’ll move on to Douglas Creutz with Cowen & Company.

Douglas Creutz - Cowen & Company

Thanks. I think the [FTC] is due to make a determination on the Take Two proposal fairly soon. Are you frustrated with the pace that’s been going on there? And do you think once they do make a determination, that could be a gating item for some progress to be made on your decision of what to do with the [bid]? Thanks.

John S. Riccitiello

Realistically, we’re not putting out new information at this point regarding the process with the FTC or our interaction with Take Two. We have released all the required information and unfortunately, we’re not prepared to go further today so I don’t think we can address your question head on.


Next we’ll take John Taylor with Arcadia.

John Taylor - Arcadia

I’ve got a couple of questions; the first one, I wonder if you could segment your R&D headcount between low and high cost locations for us?

John S. Riccitiello

While we get that exact detail, why don’t you go on to your next question? Eric will take that.

John Taylor - Arcadia

Okay, next question is in your forecast, you talked about sales and marketing coming down as a percent of revenue. This is a -- I mean, you guys are in the middle here of ramping up as new a slate, or as large a mix of new product as I’ve seen in a long time and yet that number is going to go down. So I wonder if you could talk about that a little bit, how do you launch all this new stuff, keep your ad budget at a lower level as a percent of revenue and maybe address if you were to take out the affiliate label or co-publish, maybe talk about what’s going on with percent of published revenue or EA created product.

John S. Riccitiello

I’ll take the first part of that, and then I’ll have John pick up and then Eric will answer your question on headcount. So the broad point about marketing sales as a percentage of revenue is frankly scale leverage. We’re adding north of $1 billion in revenue and you just do the math, we just get a pick-up there. And in some titles, like SPORE, et cetera, tend to be a little bit less TV intensive, and I think that’s actually the bigger answer, is we are working to transform some of our marketing mix to a more efficient vehicle, and John might want to expand on that a bit.

John Pleasants

I think the example you gave, John, is probably one of the better ones, which is if you think about what we’ve done with SPORE in launching the creature creator as an advanced release, it’s really marketing and PR and promotion for the game that’s forthcoming, and in this case it’s actually a revenue generating prequel to the game itself. So we’ve been spending a lot of time on things like that and we’re looking across all of our portfolios, of what we can do with viral and online and community applications, which is why we’ve invested in some real capital in that this year to go ahead and over time be able to adjust our marketing mix to get more efficiencies out of it, lower cost of acquisition for our customer, and start to think of our business that way -- cost of acquisition, lifetime value of a customer. So we’re putting a real emphasis on that, but back to John’s main point, again we’ve got a lot more titles, a lot more revenue, so therefore the revenue mix of hard dollars is staying basically equivalent.

Eric F. Brown

And then to respond to your R&D question, to recap we ended the quarter with just under 7,200 people in R&D and 16% of those personnel were in low-cost locations.


Next we’ll move to Mike Hickey with Janco Partners.

Mike Hickey - Janco Partners

Thanks for taking my question. I’m curious on SPORE if you could break out how many uses were paid versus unpaid, and then if you can give us some qualitative or quantitative data on how the users break out across North America, Europe, and Asia. Also curious if you can quantify what Madden preorders are down year over year. And then the last question on the -- you increased your guidance for the market to 20% but nothing flowed through to your sales guidance for the year. I’m curious why there was no movement there. And for Q2, the street was looking for $0.10. You just said you are looking for --

John S. Riccitiello

I’m going to have to ask you to repeat some of these questions, because this is the longest, fastest list of questions we’ve had in a while.

Mike Hickey - Janco Partners

All right.

John S. Riccitiello

-- even the rest of the listeners on the call are keeping track.

Mike Hickey - Janco Partners

Well, it’s hard to take notes on you guys too, believe me.

John S. Riccitiello

Why don’t we take the first three or four and I’ll ask you to repeat them as we go along, because I didn’t learn short-hand in college and I was starting to lose track there.

On SPORE, what I would tell you is we did not and have not released the break between paying and non-paying. What we’ve been pleased with is it’s gotten really strong pick-up in both North America and Europe. We will tell you that some of the sites from which it downloads are hard to read as to their location and so we don’t have precise figures.

Another factor that we are pleased by is what we’ve seen I believe shows us about two-thirds male, one-third female. We thought it might be more strongly tilted towards male, given the science fiction storyline but apparently the creative part is there. And reminding you why we don’t give out an enormous amount of this is it is a PR program. It wasn’t really a business move. It happens to have come with revenue, which we are pleased with. It’s sort of a self-paying program but it was more about generating awareness and sort to a good feeling and recognition of what the product is [that will come too].

What’s the second question you’d like us to answer?

Mike Hickey - Janco Partners

Madden, if you can quantify what the preorders are actually. I know NCAA is down 20% year over year for preorders. Can you quantify what Madden is tracking at right now?

Peter Moore

I’m not going to give you the actual [inaudible] but what I will tell you is that we are in better shape three weeks out than we were with NCAA. We’ve yet to have our demo launch. That launch is on August 1st. It is a spectacular demo that plays into the adaptive AI message we’ve been hammering home with our consumers, and in the next two weeks you will see every Gamestop, every Best Buy, every Walmart. Have end caps featuring the game itself, as well as 7-11s and Blockbusters all converting to Madden headquarters. And then of course, all of this culminates on August the 11th with Maddenpalooza the Rose Bowl.

So when we look at the activities we’ve got over the next few weeks, we’re incredibly optimistic we will continue to catch up, but again my original point of not reading too much into preorders is backed up by the sales we’re seeing on NCAA versus where we were in preorders when we actually launched the product, which was down over 20%.

John S. Riccitiello

I want to add one notion on Madden that’s interesting. I’m not sure everybody captures what we mean when we say adaptive AI. But if you ever were to sit in a focus group or review research on Madden, what you discover is there is a core of consumers that absolutely love the product but that one of the big challenges with the product is you feel like you need a PHD in football-ology or whatever -- it’s a particularly demanding product both in skills and football knowledge, and consequently it feels a little bit stand-offish relative to new consumers or consumers that may have lapsed.

One of the most incredible things our team in Tiburon has done is built a game that adapts to you, meaning it plays you competitive no matter where your skillset is, and there’s a number of features, from a holographic interface for training to a rewind clock that allows you to replay certain parts of a play to get better. This is probably the first time a video game of this caliber teaches you how to play and teaches you how to get better. I personally find that very rewarding and a big step up in sports innovation. I’m very proud of our team for delivering it. I think it’s going to help us this year but I also think it’s going to be the kind of innovation that puts Madden back on top after a few years, because it’s sort of an open door versus sort of a velvet rope over the door to get into the franchise.

Peter Moore

And in fact, I would encourage you all -- I know many of you certainly during E3 and during the analyst day had expressed to me some of your concerns about how hard the game was. You’ll recall I’ve talked a lot in the last few weeks about approachability and accessibility. The demo will actually feature the holographic trainer that John has just referred to and will actually allow you to set your football IQ going into the launch of the title on August 12th.

John S. Riccitiello

Mike, do you want to try one more before we pass the mantle over to someone else with a list of questions?

Mike Hickey - Janco Partners

Yes, thank you very much. You increased your market growth expectations to 20% but no flow through into your sales expectations for the year. Just curious as to why.

John Pleasants

Again, we believe our forecasts are accurate. We still believe that we are going to be picking up share for the year. Again, what we took up -- if you’ll remember, we are taking up our estimate for the industry for the calendar year and in this calendar year, we are still projecting that we are going to increase our share by at least a share point, so we feel comfortable with that and of course, all of our numbers that we are guiding to are fiscal numbers, so there is a quarter difference and obviously a big difference in the rhythm of those two businesses.

So for the apples-to-apples comparison, we believe that the industry is up for the calendar year and we believe we are taking our share up for the calendar year at least a point.

John S. Riccitiello

Mike, we’re going to move on to other folks now. Next question, Operator.


And we’ll move on to Tony Gikas with Piper Jaffray.

Anthony Gikas - Piper Jaffray

Good afternoon, guys. I want to continue a couple of more questions on the sports franchises. With the PlayStation 3 and the Xbox 360 hardware sales in the U.S. down roughly 40%, 45% at this point in the cycle compared to where the PS2 and the Xbox were at the same point in the last cycle, how are you dealing with this? Because the core gaming community historically for these sports franchises was on the PlayStation and Xbox platforms. Is there any risk of losing any of those core customers? Have any of those core customers moved to the Wii? Can the Wii offset some of that? I know there’s been such a big shift to the Nintendo platform this time around. How are you getting there? Is it marketing efforts, et cetera?

And then last question, when would you expect that units would be up for the sports franchise? Would that be next year, guys?

Peter Moore

Tony, let me start at the beginning there, your question on this year with the hardware. We certainly, and it all focuses on having the opportunity for us to have a bigger impact than we’ve had in previous years on the Wii -- that all boils down to making games from the ground up and then packaging of course with the all play brand that we launched this year. We’re doing well on both the Xbox 360 and the PS3. The PS2, of course, was pretty much where EA Sports in the previous generation really showed some outstanding growth. We are looking to continue to see positive migration from the PS2 to the PS3, but also recognize that some PS2 owners are moving over to the Wii, and I think that again, per my earlier comments about being early obviously with all play, there is a huge opportunity for us to have an impact on the Wii, much more so than we’ve had in the previous couple of seasons.

So watch out for what we are doing, particularly I think on Madden and FIFA on the Wii. And then I think the ability for us to continue to build on the Xbox 360, our online efforts and to make that Xbox Live consumer keep coming back for more is going to be very, very important for us going forward here. So we are feeling good so far about our impact on the Wii. There’s a lot of upside potential for us and hopefully we see ourselves moving towards some stronger growth in units over the next fiscal year or so.

But as it currently stands, I think it’s a little early, Tony, right now and check back with me after we ship Madden.

Anthony Gikas - Piper Jaffray

Okay. Last question, any update on the next Rock Band SKU and launch?

John Pleasants

We have announced -- or excuse me, MTV has announced that there will be Rock Band 2 coming to North America in the second quarter, in September, and we expect to obviously extend out across additional platforms as the year goes on. But that’s the information we have today to share.

Anthony Gikas - Piper Jaffray

Okay. Thanks, guys.


We’ll move on to Benjamin Schachter with UBS.

Benjamin Schachter - UBS

A couple of question on sports to beat a dead horse and then some other broader questions on pricing. For the sports, can you just remind us what percentage of total revenue is sports and what percentage of sports is Madden? And then also give us an update on the marketing dollars that you plan on spending on Madden this year versus last?

Peter Moore

We don’t break that out, Ben, as I think you know. One of the things -- I want to go back to John’s earlier point -- we are finding a better media mix right now with our sports titles. You can see -- a lot of what you’ve seen with NCAA, which I’m sure you’ve been seeing, while we are doing TV, we’re doing a lot more of a percentage basis online and getting directly to the consumer.

We don’t break out sports as a percentage of the overall revenue, nor do we break out individual franchises as a percentage of the sports label. Sorry.

John S. Riccitiello

The farthest we’ve gone on that is at the analyst day, we did show the rough shape of the top line. If you go back to the video, which is still online, you’ll see that sports is approximately a quarter, but we didn’t get into any finetuning. We don’t usually forecast but there is a place to look for a bit of hint if you want to get to the rough shape of it, Ben.

Benjamin Schachter - UBS

Okay, and then given all the anticipation for Madden, can we expect an update on sales before the NPD release in September? And then one follow-up on pricing.

Peter Moore

No, we don’t update prior to NPD, but based on the activities we’ve got over the next few weeks, I think there’s great reasons for optimism here and if we do have something to announce, which if we hit a milestone early, I think typically EA has announced some major milestones in sales and if that happens, certainly we’ll make an announcement.


And we’ll move to Justin Post with Merrill Lynch.

Justin Post - Merrill Lynch

Two things; first, on FIFA, did you say you pushed that out into the holiday quarter, and is that a change versus last year? And how much dollars did it contribute last year, if you can give us a range on that?

And then secondly, John, a bigger picture question -- about $1 billion of growth. I’m assuming that’s all publishing. Can you just simplify that for people and just say it’s this many SKUs or it’s this many new titles? Can you provide any help, helping understand where the $1 billion is going to come from?

Peter Moore

As regards FIFA, it was always planned for Q3. It is very early in Q3 but it was always planned for Q3. It did come in Q2 of last year but in the final week of Q2.

John S. Riccitiello

And for what it’s worth, one of the reasons that we’ve always been a tad discomforted by quarterly guidance is we can move a title into the end of Q2 and substantially shift the year-over-year compare, which we think can often be very misleading and it sometime yields inappropriate outcomes. We think it’s actually a better window for FIFA to be in the early part of Q3 than the tail part of Q2 relative to market demand, and so we think we are in a better place and we think we’ve made a better business decision.

In terms of the $1 billion in year-over-year growth, I can give you a little bit of color but I think without necessarily wanting to apply a peanut butter answer, I think you’d see that we are driving growth across the board at Electronic Arts. Our packaged goods business, our digital businesses, and the [inaudible]. In terms of the single largest component of that, it would be the EA Games label and what’s driving the EA Games label, yes, there’s some EAP in there but what’s really in that and driving it is new IP. And principal among those IPs are Dragon Age and Mercenaries 2 that come by way of the acquisition of VGH. It’s Mirror’s Edge and Dead Space, which are brand new IPs created by EA Studios. It’s Warhammer, which comes from Mythic which gets us back into the MMO space.

Now, we’ve mentioned, for example, in our script earlier that we were showing 33% year-over-year growth in mobile. We’ve got big growth plans in Pogo. We’ve got growth really across the board, so I think in answering your question, what I would tell you is it’s not one part of our business that’s leaping forward and driving it for us, is exactly what we would tell you. We’re driving our packaged goods business across four labels and we’re driving to the digital direct to consumer to augment packaged goods revenue streams and right now, the numbers are showing that’s working well.

John Pleasants

I just would add to that saying there are 15 new titles in the lineup this year which I think may have been mentioned earlier, and our SKU count itself is up about 30%. And when you mentioned publishing, that strong growth is occurring across all three of our publishing territories, so whether it be Asia, North America, or Europe, all three are balance and all three are growing strongly.


Next we’ll move to Colin Sebastian with Lazard Capital.

Colin Sebastian - Lazard Capital

Thanks for taking my questions. Just quickly first as a follow-up to an earlier question on leverage, notwithstanding the quarterly volatility or change in margins, I am wondering though if there are any specific steps you are taking in the near-term to rationalize the cost structure, or if this is the wrong time in the development cycle for your new IP to be more aggressive on that front.

And then secondly on Battlefield Heroes, it sounds like that may be taking a little bit longer than expected in development, or maybe you could talk about how the beta is progressing there. And related to online, if you could talk about SPORE and the online components of that franchise. Thanks.

Eric F. Brown

I’ll take the first half of that question, so in regard to cost control and leverage, our approach is the following: we started the year with an internal operating plan and as soon as we put the plan together, we began to look for ways to reduce cost and rephase costs. We’re happy to report that through these efforts in the first 90 days, we’re able to reduce costs by about $20 million to $25 million versus our internal expectations. And so we’re doing a wide range of things -- we’re questioning every additional headcount that’s added, either incremental or back-fill. We’ve talked about our commitment to taking more of our R&D offshore into lower cost locations, and we’re making progress there as well. And we are renegotiating virtually everything we procure on a per unit basis to get better pricing, consolidate vendors, et cetera. So there’s no one, two, or three things that we are doing. It’s literally dozens, if not hundreds, of things. Bottom line is that we’re committed to meeting the overall top and bottom line number for the year and we expect to apply this inspection to our cost structure throughout the entire fiscal year.

John S. Riccitiello

Thanks, Eric. On Heroes, the answer I’d give you is this -- we put the product into beta. We got some good information back as to what the consumer liked. We decided to increase its focus on some of the social networking features that we think will enhance the experience and we are launching the product towards the end of this calendar year. That is roundabout what we had planned. At one point, we talked about it internally as being sometime late Q2, maybe Q3. The intention was always to learn from the beta. This is the first time we’ve seen a product like this in the west, and we’ve gone back and we are trying to apply that learning in a diligent and intelligent way. So that product still feels like it’s progressing much like we would have anticipated for it, and to be frank with you, I think it’s spectacular. I’ve had a chance to play it. It’s a lot of fun. It’s very inviting. It’s got a good business model, and the last thing we want to do is sort of jam it in the marketplace. We want to make sure we get it out there in the right way.

You know, vis-à-vis SPORE, job one with SPORE is to make the launch successful. It is something that -- I would love to imagine that two years from now or a year from now, the debate is whether we need a SPORE label inside of EA because the back-end system works so well that we are able to monetize, if you will, body parts, plant parts, car parts, and planets as a way to generate incremental revenue off an installed base of several million active users.

But it’s a little bit like pool -- I’m a little afraid that if we spend way too much time setting up the second shot, we miss the first shot. And I don’t know if that metaphor works for any of you but right now, it’s all hands on deck in making September 7th the event that matters and make that work.

Yes, we’ve got clear and obvious and very compelling post-launch monetization opportunities. This is a game where basically the parts are what make the sum of the product work, so selling parts as we do with The Sims Store online right now with Sims 2, is incredibly obvious. We have all the technology for it but that’s really not what the overwhelming portion of our focus is on right now -- it’s on making that a successful launch and making sure we have the right to ask ourselves that question down the road.

Tricia Gugler

Okay, we’ll take one more question, please.


And that will be from Shawn Milne with Oppenheimer.

Shawn Milne - Oppenheimer

Thank you. Eric, I just want to go back to your last comment. I’m not sure I fully understand that. You indicated that you had found ways to reduce cost by $20 million to $25 million. Can you give us a sense where -- what line items that would be hitting? And I guess it would be in the second half of the year. And then just again, I need to go back to what JT was talking about in terms of sales and marketing. This may have been lower than what you expected or you may have had a lower [bottom end loss] than what you were forecasting but the sales and marketing line was much higher than what we were looking for. I’m just trying to understand that line item a little bit better. Thanks.

Eric F. Brown

I’ll answer the first part of that. The savings that we did realize were specifically, they are headcount related, so the salaries and benefits and outside contracted services.

Shawn Milne - Oppenheimer

And is that coming in the second half or can we start to see that a little bit in September?

Eric F. Brown

We are committed to looking for similar savings in each and every quarter going forward, so we’ll be questioning the headcount ramp, new additions and back-fill additions on the headcount front, and we are renegotiating with all vendors that we can find to reduce the costs of everything that we procure -- outside services and other items.

John S. Riccitiello

Shawn, when we put together our February analyst day, what we sketched out for folks was basically three years, designed to get us to a level of profitability that we wanted to see with the business. And we know that these things are never smooth. What drives R&D as a percentage of revenue by way of example more than almost anything is the revenue part, so getting 5 million units out of a game versus 3 million units out of a game drops the R&D as a percentage of that total substantially; in this case, 40%. It’s a very big deal.

And so I think one of the things we have to be cautious about is percentages, especially when taken in the quarter. If you look at this particular quarter, I think people had a hard time understanding it because we’ve taken some non-cash charge in the quarter for bonus that we haven’t previously, it makes the comparison awkward and frankly non-comparable. When it comes to marketing and sales for the quarter, our marketing and sales tends to be lowest on our highest revenue titles and higher on our lower revenue titles. That would seem obvious I think to most folks on first [blush].

What happened in Q1 is we launched seven titles versus three in the prior year and most of what we launched, it was high marketing spend, was right at the end of the quarter. And the marketing spend has a more profound effect on our Q2 outcome than Q1, but the expense is recognized in Q1.

So again, we tend to caution away from sort of some of the ratio analysis on too short a time frame, which is why we’ve retreated to emphasizing that our guidance for the year is valid, that we are [inaudible] -- reconfirming and reaffirming that guidance, that it involves a 400 to 600 basis point pick-up. And again, if you go back to the February analyst day and our first quarter call, we stated specifically that we expected to get leverage out of both marketing and sales and G&A, both of which are in this year’s guidance. So it’s always been the plan, we’re comfortable with it.

Now, through the year, you’d also expect us when we have hit titles to consider we’re perhaps putting more marketing into titles if we think it can yield a payout. That can also affect percentages. You can expect us to sign titles that can cost money. You can expect us to reduce expenses in some areas where a team or a product isn’t performing as well as you’d like. There’s going to be adjustments through the year but I think the broader shape of this is we feel very comfortable about picking up gross margin this year over last year as a percentage, which is really a result of, if you will, exporting COGS into R&D. We’re actually getting R&D leverage this year. We made that explanation in the past relative to VGH and that’s about half of our pick-up, half of that 400 to 600 basis points, closer to 300 basis points of the 400 to 600, and the balance coming out of G&A and marketing and sales leverage, which is a consequence of scale, product mix, and exactly when our products hit.

So we thought carefully about that. We know that we are only one quarter into the year, so I don’t want to get too price with it, but that story remains 100% consistent.

Tricia Gugler

Okay, thank you and thanks everyone for joining us today. We look forward to updating you on our progress.


That does conclude today’s call. We do thank everyone for your participation.

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