美商藝電 (EA) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to the Electronic Arts second quarter fiscal year 2008 earnings conference call.

Today's call is being recorded.

For opening remarks and introductions I would like to turn the call over to Ms.

Tricia Gugler, Director of Investor Relations.

Please go ahead.

Welcome to our second quarter fiscal 2008 earnings call.

On the call we have John Riccitiello, Chief Executive Officer and Warren Jenson, Chief Financial and Administrative Officer.

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 the webcast on our Web site at investor.ea.com.

Shortly after the call we will put a copy of our prepared remarks on our Web site.

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

Non-GAAP measures exclude charges and related income tax effects associated with the impact of the change in deferred net revenue related to packaged goods and digital content, [required] in-process technology, amortization of intangibles, certain litigation expenses, restructuring charges, and stock-based compensation.

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

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

In addition, we include a detailed GAAP to non-GAAP reconciliation on our Web site.

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

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 all the investors to consider all measures before making an investment decision.

All comparisons made in the course of this call are against the same periods for the prior year unless otherwise stated.

All references to current generation systems include the Xbox 360, the PlayStation 3 and the Wii.

We are now referring to the PS2, Xbox and GameCube as legacy systems.

We also included a summary of our financial guidance with our prepared remarks as well as our trailing 12-month platform shares in a supplemental schedule on our Web site.

During the course of this call we may make forward-looking statements regarding future events and the future financial performance of the Company.

We caution you that actual events and results may differ materially.

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

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

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

Thanks, Trisha.

Before we get into our Q2 results, let me take a few minutes and update you on our activities over the last few months.

Our label based structure is now largely in place.

Employees are essentially in the right seats and our system migration is underway.

Peter Moore, Nancy Smith, Frank Gibeau and Kathy Vrabeck are in command of four labels that can now run faster and smarter.

They and their teams are acutely focused on product quality and innovation, driving segment shares and improving our cost structure.

We are in the process of completing our acquisition of BioWare and Pandemic and I want to congratulate the BioWare team on Mass Effect.

The early reviews look great.

We look forward to having them join us in January.

And we're in the midst of building our strategic and financial plans for FY '09 and beyond.

As the teams build out their plans, they are focusing on the four long-term priorities we discussed on the last call.

First, increase our segment shares.

Although there's much work to do, we've already begun to execute.

Our long-term relationship with Hasbro will bring incredible casual and family oriented franchises to our lineup, like Monopoly, Littlest Pet Shop, Tonka and Nerf.

Titles from BioWare and Pandemic Studios could add up to two additional share points and will also expand our presence in the MMO space.

Our pipeline of wholly owned IP is robust.

We've been investing in new IP, some of which has begun to ship this year and we've made progress on the Nintendo platforms.

This has been a priority for the Company.

While it will be a battle for the year, we are now pleased to report that we are the number one third party publisher on the Wii in both North America and Europe year-to-date.

Still work to do, but we're on it.

These strategic actions will help us grow share in FY '09 and beyond.

Second, expand the digital revenue streams.

We're extremely focused on driving our digital revenue streams including wireless, advertising, subscriptions, digital downloads, micro transactions, and our Asia-based online business.

These segments will grow at a faster rate than the traditional packaged goods business and will be a significant part of our long-term growth and margin story.

Third, smart growth through acquisitions.

As I mentioned, we recently announced our acquisition of BioWare and Pandemic.

We expect this deal to generate significant returns for the Company over the long-term.

Going forward, we will continue to pursue the right acquisitions to further build our business.

And fourth, leverage our P&L through cost efficiency and productivity.

Let me update you on some recent actions.

Today we announced a restructuring which includes headcount reductions and facility closures.

This was a difficult decision because it impacts the careers of some very talented people.

Some of the talent will be assigned to new projects.

Permanent full time employees that leave the Company will be offered severance and outplacement assistance.

While these actions are small in relation to our worldwide employee base, it is a step to align our cost structure with our business.

In summary, we are focused on increasing segment shares, expanding our digital revenue, growing through smart acquisitions and leveraging our P&L through cost efficiency and productivity.

I recognize that we have a lot to do, but we are making progress.

I look forward to sharing more with you on our next call and at our analyst meeting in Redwood Shores that we have scheduled for February 12, 2008.

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

Thanks, John, and good afternoon, everyone.

We are pleased with our Q2 financial performance.

Both top and bottom line results were above the high end of our GAAP and non-GAAP guidance.

For the quarter GAAP revenue was $640 million, down $144 million year-over-year driven by a $296 million sequential increase in net deferred revenue.

Revenue ex deferral was $936 million, up 19%, or $152 million.

Excluding the impact of foreign exchange, revenue ex deferral was up 16% year-over-year.

GAAP diluted loss per share was $0.62 versus earnings per share of $0.07 a year ago.

Non-GAAP diluted earnings per share were $0.27 versus $0.21.

Q2 as usual was a big sports quarter.

FIFA 08 had a strong international launch selling 2.9 million copies in just one week.

In Europe all platforms experienced unit growth with estimated sell through up 18% year-over-year.

FIFA 08, which launched in October in North America, is also off to a strong start.

Madden NFL 08 was our best-selling title in the quarter selling 4.5 million copies.

Although units were down year-over-year, revenue was roughly flat given the higher price points on current generation software.

NCAA Football sold 1.7 million copies on four platforms.

Both revenue and units were down year-over-year driven by declines in legacy consoles.

Tiger Woods PGA TOUR sold 1.6 million copies.

NHL 08 hit the mark critically with an 88 rating selling 700,000 copies in the quarter.

Overall, a solid performance from EA Sports.

In the quarter several other titles stood out.

MySims had a successful debut selling 1.2 million copies on the Wii and NDS with over 60% on the DS.

This is a big win for us on the Nintendo platforms and a great example of what can be accomplished by focusing on innovation specifically for these platforms.

Harry Potter and the Order of the Phoenix continues to do well with close to 3 million copies sold since launch.

SKATE, with a Metacritic rating of 85 had a strong opening, selling over 500,000 copies on the 360 and PS3.

SKATE brought innovation and accessibility to the skateboarding genre and has given us a new franchise.

We also moved forward on several strategic fronts.

Owned IP.

We're pleased with the reception of our three new owned IPs, SKATE, MySims and Boogie.

New platforms.

This quarter we launched nine SKUs on the Wii and NDS with MySims and Boogie only available on these platforms.

We generated $130 million in revenue ex deferral on the Nintendo systems.

Online revenue was $42 million, up 58% year-over-year.

We're continuing to make progress on all online initiatives.

In September we launched the new EA online store which should make it even easier for consumers to buy our content directly.

And finally, we announced our proposed acquisition of BioWare and Pandemic.

This acquisition does a few things for us strategically, helps fill out the gap we have in the RPG, action and adventure genres, brings high quality talent, builds on our presence in the MMO space and expands our portfolio of owned IP.

In summary, a great quarter, a solid season for EA Sports, a stronger strategic position and acquisitions for our future.

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

First, I'll review our Q2 financial results, second, I'll go over our outlook and guidance, and then following my comments, John and I will open the call to your questions.

Q2.

Revenue ex deferral was $936 million, up 19% from a year ago.

Excluding the impact of foreign exchange, revenue increased 16% year-over-year.

Revenue was driven by Madden NFL, FIFA 08, NCAA Football 08, Tiger Woods PGA TOUR 08, and MySims, each of which went platinum in the quarter.

We released 45 EA SKUs versus 43 a year ago.

Console revenue ex deferral was $618 million, up 20% from a year ago.

Current generation revenue offset the declines in legacy console.

Current gen revenue ex deferral was $399 million, or 65% of total.

Mobile phone revenue was $37 million, up 6%.

We had three of the top 10 games in North America and four of the top 10 in the U.K.

Although the mobile business is up year-over-year, we are reducing our full-year estimate for fiscal 2008.

We now expect the mobile business to generate $155 million in revenue versus our previous estimate of $175 million.

We have temporarily lost the momentum given a weaker than expected North America segment and a few execution issues.

That said, we have every confidence that the team is doing the right things to grow this business.

Handheld revenue ex deferral was $94 million, up 9%.

NDS was our best-performing handheld platform with revenue of $47 million, over 3X that of last year driven by MySims and Harry Potter.

Revenue ex deferral from both the PSP and GBA were down year-over-year.

PC revenue ex deferral was $116 million, up 35% driven by The Sims and Medal of Honor franchises.

We had eight of the top 20 titles in North America, and we estimate 10 of the top 20 in Europe.

Copub and distribution revenue was $32 million, down $7 million.

Internet licensing, advertising, and other revenue was $39 million, up 63% primarily due to growth in Club Pogo and in-game advertising.

Club Pogo was driven by a 15% year-over-year increase in subscribers and an increase in the annual subscription fee.

In-game advertising was $5 million in the quarter.

Geographically North America revenue ex deferral was $525 million, up $13 million, or 3%.

The increase in current gen consoles, subscriptions, advertising and the NDS offset the declines from legacy consoles in the PSP.

Legacy systems declined 50% year-over-year.

International revenue ex deferral was $411 million, up $139 million, or 51%.

Excluding a $23 million positive impact from foreign exchange, international revenue ex deferral would have increased 43%.

Europe revenue ex deferral was $375 million, up $130 million, or 53% driven by the strong launch of FIFA 08 and MySims.

Excluding a $21 million benefit from foreign exchange, Europe revenue ex deferral would have increased 44%.

Legacy systems declined 11% year-over-year.

In addition, NDS and PC each had growth of $25 million year-over-year.

Asia revenue ex deferral was $36 million, up $9 million, or 33%.

Moving on to the rest of the income statement, GAAP gross profit in the quarter was $245 million, down 45% due to the revenue deferral.

GAAP gross margin was 38.3% versus 56.8%, down 19 percentage points also as a result of the revenue deferral.

GAAP, non-GAAP gross profit was $549 million, up 21%.

Non-GAAP gross margin was 58.7% versus 57.8%, up 90 basis points primarily due to a higher mix of owned IP.

Op ex.

Sales and marketing.

Sales and marketing expense excluding stock-based comp was $159 million, up $55 million primarily due to higher advertising spend to support our Q2 releases including new IP launches.

For the year we continue to expect sales and marketing to decline 1 to 2 percentage points as a percentage of non-GAAP revenue.

G&A.

G&A excluding stock-based comp was $74 million, up $11 million primarily due to higher contracted services associated with system and outsourcing initiatives in North America and Europe and higher personnel related costs.

R&D.

R&D excluding stock-based comp was $237 million, up $18 million, or 8%.

For the year excluding the impact of BioWare and Pandemic acquisition, we expect R&D to increase in the low single digits year-over-year.

R&D headcount was 6,100, up 9% from a year ago and up 2% sequentially.

GAAP diluted loss per share was $0.62 versus diluted earnings per share of $0.07 a year ago.

Non-GAAP diluted earnings per share were $0.27 versus $0.21 a year ago.

The $0.89 difference between GAAP loss per share and non-GAAP EPS was due to the change in deferred revenue, $0.74, stock-based comp, $0.10, amortization of intangibles $0.03, restructuring $0.01, and the difference between basic and diluted share counts of $0.01.

Our trailing 12-month operating cash flow was $145 million versus $571 million for the comparable period.

The decline was primarily as a result of lower non-GAAP net income and the timing of our sales.

We expect our cash flow for the full fiscal year to rebound and exceed the $397 million from the prior year.

Our return on invested capital on a trailing 12-month basis was 8% versus 20% a year ago.

Now on to the balance sheet.

Cash and short-term investments were $2.2 billion, flat to last quarter.

Marketable equity securities were $716 million, up $56 million sequentially due to the overall market appreciation in our investment.

Gross accounts receivable were $609 million versus $439 million a year ago, an increase of 39% primarily due to the growth in revenue ex deferral and the timing of our release schedule.

Reserves against outstanding receivables totaled $185 million, up $13 million from a year ago.

Reserve levels were 14% as a percentage of trailing six-month net revenue ex deferral consistent with last year.

As a percentage of trailing nine-month net revenue ex deferral, reserves were 9%, also consistent with the prior year.

Inventory was $103 million, up $36 million from last year.

Other than NBA LIVE, FIFA and Madden NFL, no one title represented more than $5 million of net exposure.

This quarter, in addition to building inventory for the FIFA launch in North America, we also manufactured inventory for the October release of NBA LIVE 08.

Deferred net revenue from packaged goods and digital content was $364 million, up $296 million sequentially.

Now our outlook.

First on the industry.

We expect that software sales in North America and Europe will be up 15% to 20% for the calendar year.

We have increased our range based on the strength of the Nintendo platforms.

In addition, the recent actions by Sony and Microsoft should fuel demand for the PS3 and Xbox 360.

Second, we have a strong lineup for the holidays.

We're coming to market with a balance of perennial blockbusters and new IP.

In addition, we have a strong lineup for the Nintendo platforms.

We have over 10 titles this holiday including NBA LIVE 08, Half-Life 2 -- Orange Box, Hellgate -- London, NCAA March Madness 08, Need for Speed ProStreet, The Simpsons, SimCity Societies, Playground, Smarty Pants, Crysis and Rock Band.

By platform we expect to have seven titles on the Wii including two originals, Smarty Pants and Playground.

On the Xbox 360 and PS3 we will have five titles for each platform.

On handhelds we will have five titles for the NDS and four for the PSP, and on the PS2 we expect to ship seven titles.

A lot of terrific entertainment is on the way this holiday.

There should be something for everyone.

Now our guidance and a few observations.

First, as John mentioned, today we announced a restructuring that will result in facility closures and staff reductions of approximately 350 people across the studio, publishing and corporate divisions.

In the U.K.

we are consolidating our operations which will result in the closure of our Chertsey facility.

We expect to incur charges of $90 million to $110 million, the majority of which will be incurred in our fiscal third quarter.

This will significantly impact our 2008 GAAP EPS.

We expect these actions to result in an annual operating cost savings of approximately $25 million to $30 million.

Second, we are increasing our revenue range by $150 million and adjusting our non-GAAP EPS by $0.05 for the dilutive impact of the BioWare and Pandemic acquisition.

This guidance reflects the strength of our year-to-date performance, favorable foreign exchange rates and the expected strength of our lineup, especially our EA partner titles, which typically carry a lower margin, offset by the negative financial impact of moving Army of Two from Q3 to Q4, Warhammer shipping in fiscal 2009, and our revised estimate for our mobile business.

Keep in mind that Army of Two and Warhammer are higher margin products.

Also please remember that foreign exchange upside does not automatically fall to the bottom line.

Our local currency COGS and operating expenses naturally offset much of the benefit.

Finally, we want to highlight that we have several titles launching in Q4.

There is always development risk.

Should one or more of these titles move out of the fiscal year, this would further impact our guidance.

Now the numbers.

Let me again remind everyone that a one-page summary of our financial guidance will be included with the call script on our Web site.

Hopefully this will assist you to build your GAAP and non-GAAP models.

Our estimates include the projected impact of the BioWare and Pandemic acquisition.

First our GAAP guidance.

For the full-year we expect revenue to be between $3.35 million and $3.65 billion which is a $150 million increase to our previous range; diluted loss per share to be between $1.91 and $1.60; gross margin to be between 51% and 54%; and basic share count to be 314 million.

We still expect that between $350 million and $450 million in revenue will be deferred and recognized in fiscal '09.

Now our non-GAAP guidance.

For the full-year we expect revenue ex deferral to be between $3.8 billion and $4 billion, which is a $150 million increase to our previous range; non-GAAP diluted earnings per share to be between $0.85 and $1.15; non-GAAP gross margin to be 57% to 59%; diluted share count to be 322 million.

In addition, one point on headcount.

In fiscal 2008 we plan to end the year with roughly [8,300] people, a 5% increase excluding Pandemic and BioWare.

This is down 5 percentage points from our original operating plan.

It's also important to note that all of the increase is occurring in lower-cost regions of the world including Shanghai, India, Romania, Montreal and Spain.

We expect our headcount in higher cost regions of the world to be down year-over-year.

Overall we expect our non-GAAP EPS to be roughly $2.06 to $2.45 better than our GAAP results.

The estimated breakdown of these adjustments is as follows -- change in deferred revenue related to packaged goods and digital content to be between $0.86 and $1.10, acquisition related charges associated with our purchase of BioWare and Pandemic of approximately $0.48 to $0.61, charges related to the reorganization plan we announced today, approximately $0.19 to $0.21, stock-based compensation approximately $0.39, amortization of intangible assets roughly $0.15, restructuring charges related to the reorganization and establishment of an international publishing headquarters in Geneva, approximately $0.01, the difference between diluted and basic share count approximately $0.02 of a loss.

For the quarter ending December 31st, first our GAAP guidance.

For the quarter we expect revenue to be between $1.325 billion and $1.575 billion, earnings per share to be between a loss per share of $0.28 and earnings per share of $0.12, gross margin to be between 47% and 50%, basic share count to be 314 million, and diluted share counted to be 323 million.

Now our non-GAAP guidance.

For the quarter we expect revenue ex deferral to be between $1.625 billion and $1.8 billion, non-GAAP diluted earnings per share to be between $0.75 and $0.95, non-GAAP gross margin to be between 55% and 57%, and diluted share count to be 323 million.

Overall, we expect our non-GAAP EPS to be roughly $0.83 to $1.03 better than our GAAP results.

The estimated breakdown of these adjustments is as follows.

Change in deferred revenue related to our packaged goods and digital content to be between $0.54 and $0.74, charges related to the reorganization plan we announced today of approximately $0.17 to $0.19, stock-based compensation approximately $0.09, amortization of intangible assets roughly $0.03.

The difference between diluted and basic share count approximately $0.02.

In Q3 from our EA studios we expect to ship 37 SKUs compared to 41 a year ago.

To date we have shipped NBA LIVE 08 on six platforms, The Simpsons on six platforms, Playground on the Wii and NDS, the Sims 2 Castaway on four platforms.

In addition, we plan to ship Need for Speed ProStreet on six platforms, NCAA March Madness 08 on three, SimCity Societies on the PC, Smarty Pants on the Wii, the Sims 2 Teen Style Stuff on the PC, Boogie on the PS2 and NDS, Madden NFL 08 Espanol on the 360 and PS2, Medal of Honor Airborne on the PS3, Medal of Honor Heroes 2on the Wii and NDS.

The Wii SKU will be available for the Nintendo Zapper.

EA Partners has already launched Half-life 2 -- Orange Box for the PC which is off to an excellent start.

Hellgate -- London for the PC including the collector's edition just shipped yesterday.

In addition, we expect to ship Rock Band North America only on the Xbox 360, PS3 and PS2, Crysis and Crysis collector's edition on the PC, Orcs & Elves on the NDS.

EA Mobile plans to launch 11 games on cellular handsets, Sims, DJ, Need for Speed ProStreet, Blastdown, SimCity Societies, Harry Potter Classes, NBA LIVE 08, Pictionary Multi-player, ESPN Darts, Dakar 08, Orcs & Elves 2, and FIFA 08.

In summary, let me conclude with a few thoughts.

First, we're making good progress on the reorganization, label strategies and operating plans and look forward to updating you at our analyst meeting in February.

Second, we've begun to take steps to reshape our P&L and strengthen our long-term trajectory, and, third, we're looking forward to the holidays and the back part of the year.

We've got some great titles on the way.

Now, we'd be happy to take your questions.

(OPERATOR INSTRUCTIONS) We'll take our first question from Edward Urban with Bear Stearns.

Thanks.

Good afternoon.

I was wondering if you could talk about what you're seeing currently with development of PS3 SKUs and if you think there's an inflection point in the hardware, what you're looking for in that regard.

And then also, I was just wondering if you could update us on the development of the Spielberg Wii title and is that still anticipated for fiscal '08?

This is John.

In terms of inflection for PS3, what we'd be looking for more than anything is increased hardware sell through which is going to be pricing driven and title driven, and, frankly, I think I'd rather give you an answer to that question with more specificity after the Thanksgiving holiday when we see where the hardware picks up.

But as we've said many times in the past, we remain supremely confident this is a three-horse race and it's going to end up with each of the three principal platforms on next gen, the PS3, Xbox 360 and Wii being strong.

So in sum, I think what I'm telling is I am seeing an inflection point, but it's not a sharp corner.

It's one that we're going to be watching carefully between our Christmas quarter and the first quarter of next year.

In terms of the Wii title from the Spielberg partnership, that's shipping in Q4.

Okay.

Great.

Thanks.

We'll take our next question from John Taylor with Arcadia Investment.

I was wondering if you might be able to kind of give us a ranking or some kind of priority of some of the factors that are reflected in your increased confidence?

And I guess a couple of things I might throw out there, are you seeing next gen grow faster than you thought?

Is it Nintendo driven?

Is it co-publishing business or is it maybe a lesser erosion rate on the legacy systems?

Maybe give us a sense of where those things are coming in relative to your expectation.

Thanks.

A lot of different things there.

That could be a novel rather than a short answer.

Industry in general I would say is performing relatively in line with our expectations, but a little bit stronger, and as Warren mentioned in his opening remarks, we trace most of that optimism for sector growth to Nintendo.

If you ask me about some of the legacy systems, a little bit of better performance, particularly out of secondary markets on the PS2 in Europe is also helping out so the PS2 continues to do strong in Eastern Europe and a few other markets.

So that's sort of holding on for that, a little bit better performance there, and you'll see if you ranked or stack ranked the platform sales in Europe the PS2 still remains very strong, at the higher percentage of the total business there than it does in North America.

In terms of our business, I think higher confidence comes out of a couple of things.

One, it's three months later and many of the titles we were looking at [Alpha Soft] where it earned the box and on the shelf and highly rated.

So just getting the experience under the belt makes us feel good.

And in particular, what we've seen on a couple of the EAP partners' titles have been very, very strong.

So we're pleased with the way The Simpsons finished.

We are very pleased with the way titles are getting out in terms of Orange Box and a few others from EAP, and we're highly confident in Rock Band.

So in terms of tenor or sense of confidence, I think it's a lot easier to talk about the Christmas quarter now than it was three months ago.

Quick follow-up on that.

When you're looking at sell through of the sports titles and maybe how the order book is looking for Need for Speed, are those coming in pretty much where you thought they would either in aggregate or highlighting any of the major platforms?

In terms of the sports titles, there's a couple of different stories going on here.

One of them is FIFA which has got a strong centering on both legacy platforms and both the Microsoft and Sony next gen platforms is doing particularly well in Europe.

It had a very, very strong introduction.

So we feel strong about FIFA.

I frankly think that's attributable to the fact that we've just built a better product.

It's highly innovative both in player controls and the AI.

Feels like a good win for us.

When I look at the bulk of our sports titles, though, I think in North America it is not getting the growth this year that we would have otherwise liked.

I think it's relatively straightforward to understand what's happened.

Part is we're comparing to an extremely strong prior calendar year.

It was frankly a banner year for sports.

Secondly, a larger portion of the growth in the industry, particularly in North America has ended up on the Nintendo platforms, a higher percentage than we had anticipated at the start of the year.

We underrepresent ourselves on Nintendo.

Even though we're the number one third party on the platform so far this calendar year, our market shares on Nintendo are lower than they are in Sony or Microsoft platforms.

That has an impact.

And as I believe we discussed on the last call, to a degree we shot ourselves in the foot on PS2 pricing on NCAA and Madden.

We were a little overconfident.

We pushed it out at $49, we should have gone out at $39.

We held pricing on the platform for seven years and it probably should have been six and three quarters years.

So we pulled up a bit short.

In terms of Need for Speed, I, frankly, you're pushing me into a world of crystal balling because we haven't shipped the title yet.

I can tell you that the title looks fantastic.

It's one that we're most confident in.

The preorders are strong, but I'd rather give you an estimate if I even had a week of information.

I don't have that yet, so it's part of the bundle of things that are aggregated in our Q3 forecast that Warren outlined.

Okay.

Great.

Thank you.

We'll now go to Doug Creutz with Cowen and Company.

Yes, hi.

You took up your estimate for industry software growth for the year.

I'm wondering if you can tell me given how strong Nintendo first party software has been and also if you throw in the performance of Halo, how much of that bump was due to sort of incremental first party growth versus third party growth?

Thanks.

I don't think we've sort of aggregated this in the way you've asked the question, but I will tell you that you are spot on.

By and large Nintendo has 57% of both of their platforms, which is a much higher ratio than either Microsoft or Nintendo or, frankly, traditionally the leading platform has had in the marketplace, so Nintendo is clearly getting a good chunk of the growth in the industry.

Lots of pundits would like to point out that absent Nintendo the industry is actually slightly down.

I think that's a bit of a false analogy because virtually any industry is down when you strip out the impact of the market-leading growth engine, so I think that's a little bit circular.

I don't know if I'm answering your question exactly other than to say that because Nintendo has a high share on their own platform and they're a key reason why we've upgraded the industry sector software growth guidance for the year, that Nintendo's a key beneficiary of that.

The surprising note, I think, for most anybody that's been tracking EA for the last couple of years is that EA is showing up as the number one third party on the Nintendo Wii.

I frankly do not even believe I would have forecast that on the basis of what I was seeing when I came in in April, so better performance there which bodes well for the future.

A lot of folks have been wondering if EA could make up for lost ground there, and while we're nowhere near out of the woods or achieving the goals we'd like to be achieving on the platform and we're not yet achieving what we'd like to on the NDS, it's positive trends on market share.

Okay.

Thanks.

Our next question comes from Ben Schachter with UBS Securities.

John, you were quoted in some media reports talking about some potential experiments and changing pricing structure I think at a lecture you gave at Berkeley.

I was wondering if you could perhaps summarize some of those comments?

And then perhaps related to that, could you discuss a bit more about your strategy, what you see going forward in China, what you're learning over there?

Thanks.

I think I just learned never to speak at your alma mater.

But to answer your question about pricing, what I was referencing, and I was very clear to point out this is sort of a decade-long issue for our industry, is the fastest-growing pricing model, successful pricing model on the industry, is software that is essentially given away for free in Korea and followed on with micro transactions, a nickel, a dime, a quarter for one aspect of game play or another.

Now what's exciting about that is that EA is achieving on its FIFA franchise a great deal more revenue and a great deal more margin per user than we did on the similar product in packaged goods.

The question is whether the uptake in the western markets is going to be as good as the uptake in Korea.

That's something we can't know yet and because our business model is so robust and the stakeholders all have a vested interest in North America in the current model meaning us with $59 pricing, first party with a royalty structure, retailers with their share of $59 pricing, and oftentimes license partners like the [leagues], the transition will not take place overnight.

I think we all waited for about a decade to get the first sort of inspiration of convergence that we've been hearing about for such a long time.

So what we're doing now is we're very aggressively experimenting in Asia with what we call mid-session games and what that's allowing us to do is test this exact model.

We have several titles slated for fiscal '08 and '09 in Korea, China, a couple other markets in Asia, and we're also looking to test some of these on non-core titles in the western market.

In terms of China and what we're learning over there, I think in a simple term we're learning it's slow.

We're working through a lot of issues.

We have a great partner in The9.

We are rapidly moving through the process of engineering and launching FIFA Online, on an MSG model with The9 in China, and there's several titles slated to follow on.

It's actually progressing to scale and (inaudible) to the time scale we'd originally anticipated.

From a personal level, this stuff just takes time and it frustrates me a little bit but the good thing is we've got a great partner and it seems to be working.

So simple summary, high growth in Asia, the growth is coming on different pricing models and EA's right in the thick of it gaining and learning along with the rest of our Chinese and Korean competitors.

Great.

Thank you.

We'll now go to Brent Thill with Citi.

Thanks.

Regarding Rock Band, can you just give us a sense in your level of comfort addressing the demand environment over the holiday season?

Yes, this is John.

If I were you on the 19th of November I would get in line outside your favorite retailer because we've got one hot product.

It's a $169 band in a box.

We've got a lot of inventory coming and my expectation is it'll sell through.

So just remember November 19th you're going to be waiting in line.

Unless you've got a buddy that works at one of our retailers, you're not going to have it at Christmas.

But, no, seriously, it's going to be a hit title.

We're going to be following it through with a subsequent launch in Europe at the end of our Q4, and we expect it to be similarly strong there.

This is definitely not a sprint.

We're not going to be able to place enough inventory to meet demand in North America and Europe this calendar year or this fiscal, and we expect this to sell through through both the balance of F '08 and through F '09 with songs coming every week, add-on SKUs, all sorts of stuff, and we could not be more pleased with our partner at MTV.

The muscle they bring to this, the intelligence they bring to it, the drive, the marketing, the cross-selling, these guys are doing a great job.

Collectively we worked together on the operating side to pull off something that's almost impossible which was to get this inventory on this time line in the marketplace with a product this good.

It feels great.

Thanks, John.

Our next question will come from Mike Hickey with Janco Partners.

Hey, guys.

Thanks for taking my questions.

If you could please update us the three titles, SPORE, Sims 3, and Warhammer and if you can give a little bit of the details into the delay of Warhammer and we're heard there's job cuts already.

That's probably part of your reorg or restructure or whatever you call it.

But if if you could us some insight there, that's be great.

And then on the PS3, I mean, certainly the installed base needs to increase before it's a more relevant market for you but also it seems like the attach rate appears to be lagging.

If you look at how Sony is positioning the product to the market this holiday with the Spiderman Blu-ray, it looks like it's a low-priced and always has been, I guess, Blu-ray player, but do you feel that the attach rate will continue to lag in particular the 360 and how does that impact your forecast moving forward?

Okay.

A couple.

Let me take the last one, the Blu-ray issue last.

I don't know if you recall, but they launched the PlayStation 2 with a DVD drive, with a movie.

At the time it was The Matrix, and it proved to be a very smart strategy for increasing the installed base, and helped propel them to a market-leading position.

They're doing the exact same thing.

It appears to be a smart strategy.

I would applaud what they're doing.

Attach rates are not something you measure in a period of a couple of weeks.

Attach rates are something you measure in two, three and four-year timeframes.

We're going to be paying very close attention to attach rates, particularly in Q3 and in Q1 and 2, calendar Q1 and 2, calendar '08.

The reason is we are now starting to see titles that demonstrate the power of this platform.

One in particular that I'd draw your attention to is when we're shipping in January, which is Burnout coming out of our U.K.

studios, I don't want to jinx it by telling you how highly rated I think it's going to be, but it's going to be a very highly rated and very successful title.

It's the kind of thing that you say, hey, ma, come into the living room.

Look what my TV can do.

I didn't know it was possible.

That kind of stuff is what drives attach rates.

And unfortunately, Sony hasn't had enough of that until now.

And starting this Q and then in January and following with things like GTA and Killzone and Metal Gear Solid, you're going to see it flesh out and the good part is EA's got more of those titles than anybody.

In terms of the titles you asked about, SPORE, we pulled it out of the fiscal year in April of this year.

The title continues to progress very well.

We're confident in the decision we made.

Above all, for a title like this and for everything we do, we need to stand for quality, and that was a decision for quality.

Relative to Sims 3, I appreciate you asking the question, we haven't put any information out on the title yet, and we will certainly give you a private call when we do.

Jokes aside, we'll let you know when we make the announcement.

Great.

In terms of Warhammer, count on the first half of our fiscal year.

Frankly, this is a pretty straightforward situation, and I want to emphasize to the team in Mythic, no, we are not having you be part of our restructuring.

Just because you asked the question, I'm sure there's somebody there listening.

That's not the plan.

We are investing in the growth of that studio, and Warhammer's slip is a simple one.

They missed part of a milestone.

Mark came forward and said it would affect quality if he held the March date.

We made the decision with the big investment we've got behind it, and frankly the talent and inspiration of the team to invest behind quality, we're going to give it a little bit more time, a little bit more money, and we think we're going to have a little bit more of a hit on our hands, so simple.

Thank you.

And you're safe, Mark.

Our next question will be from Heath Perry with Credit Suisse.

Great.

Thank you.

I was wondering if you could just talk to us a little bit about what your -- in a little more detail about what your outlook for the Wii market is?

We're obviously seeing a ton of Wii product coming into the market in the holiday season, attach ratios on the system have been relatively low, and really outside of Madden and Zelda we've yet to see kind of a real successful title on the platform.

As you're planning for the future, particularly given the low, seemingly low barrier, low cost to creating a Wii game and the proliferation of product, how are you thinking about your development for the system versus the others and where would you say you're kind of weighting the three platforms as you're putting new product into development today?

Let me tell you that we're very excited about the Wii.

I will admit that there is a massive number of titles coming forward.

My sense is it's got a pretty wide range of quality, and I'll touch on that in a second.

Ours is an industry that's never been about the number of titles.

In a given year our industry sees 3,000, 4,000, 5,000 releases and no one in this room, including myself, can name more than 100, so it's not really about the large numbers, it's about the titles that matter.

So far other than Nintendo there have been precious few titles produced for the Wii that matter.

One of the titles that does matter and it's doing extremely well is MySims.

But that's an example of somebody, in this case us, our Sims team, building a game that's tailored for the platform and the audience and is well-crafted and the numbers are solid.

We need to do more of that type of thing to take advantage of the platform, and it's just precisely what we are doing.

We've made progress in sports this year with our family mode, yet again, something tailored for the platform.

To be honest with you on a 10-point scale, how tailored is it?

It's 2 on a 10-point scale so we've got 8 points to go.

But it's better than not tailored at all and we will make further progress in the coming year.

And then you've heard about titles that we've announced, new intellectual properties like Playground and our Spielberg partnership title coming out in Q4 that are specifically tailored for the platform.

So in a weird sort of way relative to tie ratio and what adds up on the top of the charts and the impact of this large number of titles most of which will amount to nothing, I would give you, given that we've just finished the World Series of Baseball analogy, it's the second inning and the game's not over and I wouldn't exactly count the score as final.

Great.

Thank you.

Our next question will come from Justin Post with Merrill Lynch.

Great.

A couple questions.

Warren, could you first reconcile the EPS guidance?

How much is the acquisition costing you and given you had upside this quarter just maybe if you can quantify the Warhammer effect.

And then secondly, John, long-term R&D is obviously a huge part of the street cycle peak EPS numbers.

Where are you with R&D after this cut and can you give us any thoughts on your efficiencies and what you think you can still do next year as far as getting efficiencies?

Thank you.

Justin, I'll go ahead and take the first part of the question.

As announced here a couple weeks ago with the VGH acquisition, the acquisition impact is $0.05, and we did obviously overperform in Q2.

I think you've also noted that there are a couple of things changing.

In terms of negatively impacting our financial performance, there is a negative financial impact associated with Army of Two moving from Q3 to Q4 for the fiscal year, but again, as John mentioned, that was a decision for quality and for the title, and we thought far better to sacrifice the short-term profitability for the long-term health of that franchise.

The second aspect, negative financial impact is Warhammer moving out of the fiscal year.

Again, we think the right long-term deal, but for the fiscal year it had a negative impact.

And then finally, the upside or the offset to all of that, as I said in the formal part of the call, is we've had strong foreign currency movements.

We also have confidence in our titles, and we have an exceptionally strong lineup for our EA Partners titles.

So net-net all of that sort of washed out with the only offset being the $0.05 of dilution coming from the VGH acquisition.

Okay.

To your question about R&D leverage, the impact of the adjustment we just made with our facility closures, let me start by telling you that I'm not going to give you a specific answer to sort of long-range guidance or the shape of our P&L in F '09.

We'll do that in a better way with long-range views at our February 12th analyst meeting.

I will tell you that we're getting significant leverage year-over-year as we've gone from 31% R&D to 25%, 27%, mid-20s this year, so we're getting a lot of leverage out of it.

We expect to continue to get leverage.

But I think the broader story is that we fundamentally shifted trajectory in terms of our headcount and cost.

We intend to continue to shift trajectory in headcount and cost.

In round numbers what we've been doing is moving the complexion of our work force.

So last year we finished the year with between 7,800 and 7,900 full time heads.

We currently have, we expect to finish this year between 8,200 and 8,300 heads.

But here's the trick.

We've added, of the total add of about 400 heads, all 400 are in low-cost locations in Eastern Europe, China, India and other comparable locations.

So that's what we get post this adjustment, post this restructure.

For the first time in several years we're pancake flat on heads in western markets where it costs a lot to employ people.

And that's the type of adjustment that I was referring to in recent calls when people were saying what are you doing to change your drive towards peak margins.

That's the kind of mechanical adjustment, there's strategic intent behind it, it allows us to continue to produce and excel on quality without driving costs as high as one might otherwise be projecting for the business.

Thank you.

Our next question will come from Rich Keiser with Stanford Bernstein.

Hi.

Thanks for taking my question.

Two quick things.

First, with respect to advertising, did I correctly hear you say that in-game advertising was $5 million in the quarter?

That is correct.

I'm just slightly surprised at how small that was.

I thought with Need for Speed you did $5 million on just that one game, and here you've had a couple major releases in the quarter.

Can you just help me understand that?

I think it'll build over time.

At the end of the day Need for Speed is a big title.

It's coming again this holiday season and we would expect these numbers to build over time.

To start for this quarter having $5 million we think is a success, and as we move into the holidays and beyond we hope to build from there.

But wouldn't we be thinking that Madden could generate $5 million in a quarter given 4 million units?

I think you have to look at a couple of things when you talk about in-game advertising.

One is recognize that where you have a licensed property you're also going to have different splits, there are different people that are involved.

Microsoft has a piece.

We have a piece, and the NFL has a piece.

And projections in terms of who the advertisers can be.

We're largely restricted to sponsors.

That's not the way it's always going to be.

Got it.

I really think when it comes to in-game advertising, the way to think about it is it will be someday a great business.

It is not today.

Most people involved in the business are investing spending to establish position and it's just currently not at all at scale.

It's a wobbler at the moment with lots of long-term potential.

And just to give you a little more perspective, if you look for our entire fiscal year, I'd estimate that this number's going to be somewhere in the $25 million to $30 million number for us.

But again, we hope just getting started and take things from there.

What was the inventory sell-through approximately?

Is it still around 30% like it was with Need for Speed or do you have any color there?

You know, that's just not something we can get into.

Okay.

Fine.

Then just another just really quick question.

This is more longer-term.

You've talked a lot about production value or what it will take to realize the full value of the different platforms.

Can you give us just given that we have very different platforms right now, can you give us a sense for are we one to two years out on PS, or sorry, on 360 and maybe four years before we hit that point in PS3?

And then with respect to Nintendo, just how we should think about when are the games really going to take full advantage of the different platforms?

Well, look, I think that's a really hard thing to answer without getting sort of specific.

Let me draw you back to the last generation.

I personally thought in 2001, 2002 when I was looking at and playing PlayStation 2 games I was looking at what was close to optimal.

And what I saw coming out in 2003, 4 and 5, frankly, astonished me relative to how much better those titles would get.

What was happening is people were getting off of the relatively standard tools, they were writing specific code to the metal and making better software, particularly graphics, they were getting faster frame rates, they were getting smarter about lighting, animations got better, it was a, frankly, an astonishing pickup in quality that I didn't see coming at the beginning of the cycle.

Each of the current platforms have different strengths and weaknesses.

So on the PS3 I think you're going to see, frankly, start to finish in the cycle graphics and sound getting better and better and better because, frankly, it's a little bit of a hard platform to write to, and we are getting better and learning more as we go, but it's incredibly powerful.

When it comes to the Xbox 360, their sweet spot is the interplay between online and traditional high-end game play and graphics, and I think we're actually getting some pretty good experiences.

Halo's a particularly good experience that was released by Microsoft a short while ago.

On the Wii, Nintendo's mastered it better than anybody.

I don't know, if you're like me I find it pretty hard at this point in time to even go through menus on the Wii because most of it having done as good a job as we could, we've sort of -- a lot of the games, we've got menus that feel an awful lot like menus on a PS3 or menus on the 360 which are designed for a different input device, a different type of controller.

Simple things like that, as they get improved, as we get as good as Nintendo at these things we'll really start plussing out that platform.

And there's a lot of learning that needs to get into place on the Wii in terms of what's fun with that type of controller.

So I think -- think of it this way.

They're all probably going to get better in steps throughout the cycle.

I don't think there's going to be a point in time where it feels like it's night and day other than the PS3 about right now, so between some titles coming out late in this quarter and the first part of next year, you're going to see the first things that I think start to show the promise of the PS3.

It's a long-winded answer on that one.

Great.

Thank you very much.

We'll now take our next question from Tony Gikas with Piper Jaffray.

Hi, guys.

Good afternoon.

A couple quick questions.

John, maybe you could just update us on your market share expectations.

I think you talked about this a little bit on the last conference call and when you expect to start taking some meaningful share and where you might be at the end of the next fiscal year?

And then also, a quick update on the number of incremental new brands that you'll be launching over the course of the next fiscal year?

Incremental new brands?

Right.

Explorer, et cetera.

First off, I'm actually pretty pleased to tell you that the dismal share performance that we had in calendar '07, those quarters are largely behind us.

Sequentially we picked up three market share points to 19 in Europe in the last quarter, 16 moving to 19 and North America from 11 to 24.

We're expecting to do positive pickup from both those positions in quarter four to finish the year approximately with 20% of the game business in Western Europe and North America consolidated across all platforms.

So as a starting point that is, I will admit that is down 2 points from calendar year 2006.

But the decline is in the past.

We're holding our own in Q3 and Q4.

So would I rather be telling you that we have market share gains this year?

Absolutely.

What we really had was a hole in the first of half of the year and we're making up some of it in the second half of the year and coming out strong at the end to finish with a net 2 points down.

The good thing is it gives us something to shoot for in 2008.

Now in terms of new brands next year, there's a bunch.

We've talked an awful lot about SPORE partly because I got addicted to it even in pre-alpha software, and I think that's going to be a strong addition for us.

We've got the Hasbro family of products.

I think that's going to help us on a number of platforms including some that we've just been talking about like the Wii and the DS.

So we'll pick up there and there's a large number of products in development there.

We have announced that we're working on a horror thriller called Dead Space.

That'll be in the marketplace.

There's Warhammer, which we're going to bring out MMO, and then there's a bevy of things including Mercenaries 2 coming from VGH, our BioWare-Pandemic partners, and there's other titles coming there that we have not yet announced and aren't prepared to today.

If we had a long time I could give you a whole lot more, but EA's definitely coming into the swing of things relative to new title and brand launches.

Okay.

Great job.

Thanks.

One more question.

We'll take our final question from Arvind Bhatia with Sterne, Agee & Leach.

I was wondering if you could talk a little bit more about the Hasbro relationship?

You mentioned you're excited about that for next year.

What kind of margins should we expect in that?

Are they any different from your typical deal and just some color on the scale of that?

This kind of a partnership is relatively unprecedented in the game industry and the toy industry.

Most typically what happens is a company like Electronic Arts or Activision or THQ will work with a party on one or two or three or five properties at most, or multiple years around one property.

EA and Hasbro have joined together in what amounts to a very large-scale joint venture.

It's structured as a licensing partnership but the business partnership is much deeper than that.

We are working with each other in ways that I think most wouldn't imagine.

We spent, in fact, our team here was recently at Hasbro headquarters with their President and Chief Operating Officer, Brian Golder, going through line reviews for Hasbro and for EA and looking for ways our product could intersect in the years to come and finding a lot of good ways for that to happen.

So looking at it from that as a starting point, we're very bullish about the Hasbro intellectual properties and the ability to exploit them in a number of fronts.

If I start with mobile, I think all of you know our competitors have a number of mobile properties at the top of the charts.

On mobile they're not our properties, they're their properties but they'll soon be our properties and very we're pleased about that.

In the casual space on PC, clear application of Hasbro properties, whether it be Monopoly or Scrabble or Nerf, et cetera, we've got some projects in development against next generation consoles, which we haven't yet announced around, actually, some things we haven't yet announced but they're going to be pretty interesting and exciting.

I was about to give you something where you can triangulate on it, but it'll be shortly announced.

And we've also got a lot going on this one with what we believe we can do on platforms like the Wii and the Xbox 360 LIVE Arcade.

So think of this being a core pillar for EA in the years to come and a core pillar for Hasbro in the years to come, and look for some pretty interesting ways that our partnership will, I think, turn into something better when it's trade licensed.

In terms of margins, we really haven't divulged the details of the partnership, but we're projecting it to be a highly profitable business for Electronics Arts in the years to come.

Aren't they also doing some things, some toys based on what you're, some of your properties?

I'm sorry, what was that?

Are they also doing some toys and some other things with your assets?

We're working on a lot of things that are their toys that are inspired by interactive activity, and I won't go further than that.

And it's a possibility that they'll be making some things with some of our products, and that's contemplated in the partnership but not yet announced.

Excellent.

Thanks, everyone, for joining us.

That does conclude today's conference call.

We do appreciate everybody's participation and have a good day.