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Executives

Mary Vegh - Manager, Investor Relations

John S. Riccitiello - Chief Executive Officer, Director

Eric F. Brown - Chief Financial Officer, Executive Vice President

John Schappert - Chief Operating Officer

Frank D. Gibeau - President - EA Games Label

Analysts

Heath Terry - Friedman Billings Ramsay

Justin Post - Banc of America Merrill Lynch

Brian Pitz - UBS

Sean MacGowan - Needham & Company

Eric Handler - MKM Partners

Benjamin Schachter - Broadpoint Capital

Anthony Gikas - Piper Jaffray

Daniel Ernst - Hudson Square Research

Jeetil Patel - Deutsche Bank

Colin Sebastian - Lazard Capital

Shawn Milne - Janney Montgomery Scott

Doug Creutz - Cowen & Company

Atul Bagga - ThinkEquity

Electronic Arts Inc. (ERTS) F2Q10 Earnings Call November 9, 2009 5:00 PM ET

Operator

Good day, everyone and welcome to the Electronic Arts second quarter fiscal year 2010 earnings conference call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the call over to Mary Vegh, Manager of Investor Relations. Please go ahead.

Mary Vegh

Thanks, Sarah. Good afternoon. Welcome to our second quarter fiscal 2010 earnings call. Today on the call we have John Riccitiello, our Chief Executive Officer; Eric Brown, our Chief Financial Officer; John Schappert, our Chief Operating Officer; and Frank Gibeau, President of the EA Games Label.

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. 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.

Please see the supplemental information on our website for our trailing twelve month segment shares, additional GAAP to non-GAAP reconciliations, a summary of our FY10 financial guidance, and our title slate.

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-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 9, 2009 and disclaim any duty to update them.

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

John S. Riccitiello

Thank you, Mary. Earlier today, EA announced strong Q2 FY10 results. Our non-GAAP revenue for the quarter was a record for Q2, and we delivered our largest quarter for digital direct revenues in EA’s history. Our Q2 revenues exceeded street expectations. In a sector that has struggled for growth in recent quarters, our non-GAAP net revenue is up 13% fiscal year-to-date. So far this fiscal year, EA has out-performed on share in a down retail market.

EA is performing. We attribute this to strong execution and great product quality. Our aggregate packaged goods share is up four percentage points in the first half of the fiscal year in North America and Europe combined. In both Europe and North America, EA was the number one overall publisher in the quarter -- number one on the PS3, Xbox 360, and PC, and number two to Nintendo on the Wii. We have improved marketing, and we are seeing continued growth in digital revenue streams. We are aggressively managing costs.

Although we performed well in the first half of this year, we are cautious on the second half of the year. Industry packaged goods software sales are down approximately 12% year-to-date. We believe October was another down month. Retailers remain cautious and report that foot traffic remains slow. In a tough economy, the consumer is not showing up at retail as consistently as we would like. EA’s P&L is highly dependent on Q3 and Q4. FX, while positive for our revenue reporting does not fall through to our operating margins. Taking these considerations into account, we have decided to add a bottom range to our guidance. While we have not given up on our $1.00 EPS target, we believe it is prudent to guide to FY10 non-GAAP revenue between $4.2 billion and $4.4 billion and non-GAAP EPS to be between $0.70 and $1.00.

Looking more closely at the industry, we see a tale of two sub-sectors. The various digital sectors are performing very well. The packaged goods sector is under pressure. Retail data services do not tell the full story. For the global industry, including online and mobile, we expect growth in 2009 with gains on the digital side more than offsetting temporary weakness in the packaged goods sub-sector.

Calendar year-to-date, packaged goods software sales are down 12% in North America and we estimate minus 13% in Europe. While the recent hardware price reductions are driving higher console sales, the improvement is not enough to get the industry back to flat software sales for the calendar year. We now expect packaged goods software to be down mid-to-high single digits in North America and Europe combined. This is well below our initial expectations for the year.

We do not believe that calendar 09 packaged goods weakness is a permanent condition. Two factors give us confidence. We believe there is room on the console price points. In the last cycle, the bulk of console sales occurred at $149 or below. Secondly, the console add-ons coming in 2010 will bring new consumers to the market. These factors will drive growth and extend this cycle.

EA’s definition of the game industry also includes digital businesses such as mobile, micro-transactions, subscription and advertising. As recently as five years ago, we estimated that digital was less than 10% of the global industry. Today, we estimate digital is 35% of the total.

Our sense is that the various digital businesses will grow at 20% or higher this year and for the next several years. When we combine digital growth and the packaged goods business, we expect that the total sector will grow in 2009 and the years beyond. Given our longstanding view on the evolution of our industry, EA continues to transform itself from being nearly entirely packaged goods dependent to being a leading player on the digital direct side of the industry.

I’d now like to turn to two bold steps we are taking toward that transformation. The first is a targeted cost reduction which will allow greater investment in our hit titles and digital businesses. The second is our acquisition of social gaming leader, Playfish.

This year, we have had success putting more resources behind fewer packaged goods titles. We’ve decided to narrow our title slate further in preparation for FY11. We are implementing a thoughtful, targeted action that will reduce titles, close several facilities and decrease headcount by approximately 1,500 positions, of which 1,300 will be included in a restructuring plan.

Laying off employees and closing facilities is never pleasant. We have a lot of compassion for those impacted but these cuts are essential for transforming our company. Our operating expenses will be reduced by at least $100 million compared to our current run rate.

Second, our acquisition of Playfish, which is an exciting and fast growing company focused on the social games area. They have the number two position on Facebook and have built a reputation for making the best games among competitors in the space. Their management team is strong and will assume leadership for EA’s global push into social games. We see it this way -- Playfish will continue to be Playfish, but they will have the added benefit of EA’s powerful intellectual property and access to EA resources globally.

Two bold steps. The first -- a narrowing of focus and cost reduction to enable investment in hits and digital. The second-- a strategic M&A investment on the digital direct side.

EA is playing offense -- positioning ourselves for the future.

With that, I will turn it over to Eric.

Eric F. Brown

Thank you, John. For Q2, we delivered non-GAAP net revenue of $1.147 billion and non-GAAP diluted earnings per share of $0.06. We came in slightly better than we expected on the bottom line, with lower costs driving the upside. In a down quarter for the packaged-goods sector, EA’s revenues were up year-over-year and ahead of street expectations.

Our non-GAAP net revenue was a record for Q2, driven by FIFA 10, Madden NFL 10, The Beatles Rock Band and Need for Speed SHIFT, all selling north of 2 million copies in the quarter. On a GAAP basis, net revenue was $788 million and GAAP diluted loss per share was $1.21.

EA’s segment share has risen this fiscal year-to-date. Across all platforms, our packaged goods business has 21% share in North America and Europe combined, up four points year-over-year. Excluding distribution, we picked up four points of share year-over-year in North America. In our digital businesses, we achieved an all time record quarter with $138 million in non-GAAP net revenue up 23% year-over-year, driven by Battlefield 1943. Subscription revenue was $32 million. Wireless revenue was $50 million, up 9% from a year ago primarily due to revenue generated on the iPhone.

I will now review Q2 in more detail. Please note that all of the following references to Q2 results are non-GAAP, unless otherwise stated.

Non-GAAP net revenue was $1.147 billion, up 2% year-over-year, driven by the growth in digital revenue. At constant currency rates, net revenue increased 6%. Frontline non-GAAP net revenue was $609 million, flat with the prior year. For the first half of the fiscal year, our revenue was up 13% year-over-year.

Moving to the rest of the income statement, non-GAAP gross profit margin was 48.4% versus 50.9% a year ago, down as expected due to less wholly owned IP revenue and more distribution revenue from The Beatles Rock Band.

Operating expenses -- non-GAAP operating expenses were $536 million, down $72 million or 12% year-over-year. We ended the quarter with 8,828 employees versus 9,671 a year ago. Twenty-one percent of our employees are now located in low cost locations. Non-GAAP operating income was $19 million versus an operating loss of $35 million a year ago.

Below the operating income line, non-GAAP other income and expense was positive $7 million – consistent with a year ago. Currency gains partially offset lower interest income year-over-year.

On a GAAP basis, we recorded a tax benefit of $27 million, primarily due to a reduction in our deferred tax valuation allowance related to the purchase of our headquarter facilities. We haven’t recorded any other net benefits for U.S. deferred tax benefits due to the valuation allowance. On a non-GAAP basis, we reported taxes at 28%.

GAAP diluted loss per share was $1.21 versus a diluted loss per share of $0.97 a year ago. The increase in GAAP loss per share year-over-year was primarily the result of higher deferred revenue associated with the deferral of Xbox 360 revenues starting in FY10.

Non-GAAP diluted earnings per share was $0.06 versus a diluted loss per share of $0.06 a year ago.

In Q2, we generated $6 million of operating cash flow versus an outflow of $124 million a year ago. In the first half of FY10, our operating cash flow improved by $93 million versus last year.

Turning to the balance sheet, cash and short term investments were approximately $1.6 billion at quarter end, down approximately $200 million from last quarter primarily due to the purchase of our corporate headquarters at the expiration of the synthetic lease. Marketable equity securities were $387 million, down $53 million from last quarter primarily due to a decline in the value of our UbiSoft investment. At quarter-end, we had $241 million of net unrealized gains.

Gross accounts receivable were $840 million, up $125 million from last year, or 17% due to the timing of our release schedule. Reserves against outstanding receivables totaled $194 million, up $26 million from a year ago. Reserve levels were 10% of trailing six month non-GAAP revenue, up 1% from a year ago. As a percentage of trailing nine month non-GAAP revenue, reserves were 8%, up two points from last year.

Inventory was $250 million, down $78 million from a year ago.

Ending deferred net revenue from packaged goods and digital content was $792 million, up $368 million from a year ago due to the additional deferral for all console and PC on-line enabled games.

Now for our outlook and guidance, first I would like to provide more detail on the cost reduction program. These changes will make us more efficient in our core packaged goods business while allowing us to focus investment on our key titles and to expand our digital direct initiatives.

We expect this program will reduce our current annualized expense run rate by at least $100 million. We are eliminating a total of approximately 900 positions in development; 500 in publishing and label support and 100 in corporate functions.

Now for guidance: revenue on a GAAP basis, we expect revenue of $3.6 billion to $3.9 billion. On a non-GAAP basis, we expect revenue of $4.2 billion to $4.4 billion. We expect an increase to full year revenue of at least $100 million due to changes in FX versus our original FY10 assumptions. This increase is more than offset by the sector softness in packaged goods, particularly the Wii and NDS platform. As noted earlier, we expect packaged goods to be down mid-to-high single digits for the calendar year.

While we have added a bottom end to our revenue guidance, we expect that our digital revenue will be up year-over-year. We also expect that our distribution revenue mix will be up versus what we thought last quarter.

Gross margins -- we expect GAAP gross profit margins of approximately 49.5% to 52% and non-GAAP gross profit margins of approximately 57% to 58%.

Operating expenses -- we expect GAAP operating expenses to be approximately $2.5 billion and non-GAAP operating expenses of approximately $2.1 billion. Operating expenses are being reduced as a result of our cost containment but increasing as a result of the weaker U.S. dollar.

Below the line, we expect GAAP diluted loss per share of $1.20 to $2.05. We expect non-GAAP EPS of $0.70 to $1.00. We expect that non-GAAP other income and expense will be approximately $15 million. On taxes, we expect a GAAP tax benefit of approximately $30 million to $40 million for the year. On a non-GAAP basis, we expect to report taxes at 28%.

For share count, please use 324 million shares to compute the GAAP loss per share and 326 million shares to compute non-GAAP EPS.

I would also like to emphasize a point we made when we first provided guidance for FY10. We made a purposeful decision to manage the quarters differently than in prior years and planned titles outside of Q3 in favor of Q2 and Q4. The result so far has been to deliver the highest second quarter revenue in EA’s history, even in a down market. As we look forward to the second half of the year, we have strong emphasis on Q4 with plans to release several major titles including Mass Effect 2, Dante’s Inferno, Battlefield Bad Company 2, and Army of 2 The 40th day. This will result in substantially more revenue in Q4 compared to prior years. Of our remaining fiscal year revenues we expect roughly 60% to fall in Q3 and 40% to fall in Q4.

Please note that guidance does not reflect the Playfish acquisition. The FY10 non-GAAP EPS impact of the Playfish acquisition is essentially neutral. There will be a dilutive GAAP EPS impact in FY10 of approximately $0.15 to $0.25 per share.

In FY11, Playfish will be non-GAAP EPS accretive to EA. The total transaction size consists of approximately $275 million upfront cash plus approximately $25 million in retention equity for the Playfish employees. And up to $100 million earn-out over the next 2 years based on the achievement of certain performance milestones.

Playfish will operate as a standalone unit and will lead EA’s worldwide efforts in social gaming, combining EA IP with the high quality IP that Playfish has built and deployed to date.

This concludes our guidance and outlook commentary and with that, I will the call over to our Chief Operating Officer, John Schappert.

John Schappert

Thanks, Eric. As John said, EA is performing well. Two years ago, EA put a stake in the ground and promised consumers that product quality would improve. Calendar year-to-date, we have shipped 17 titles rated 80 or higher, versus 13 a year ago at this time, and 5 two years ago. No other game company can match our track record for quality. Let me also note that none of our major titles have slipped their ship dates this fiscal year.

We also vowed to improve marketing execution -- great quality, long marketing ramps and big campaigns create blockbusters. In Q2, we saw that strategy pay out.

FIFA 10 -- we shipped this game the last week of the quarter in Europe, selling 4.5 million copies. The sell through at retail in Europe is 31% ahead of last year’s FIFA 09 on a comparable period basis and we are outselling Pro Evolution Soccer 4 to 1. FIFA has the highest quality rating for a sports game on this generation of consoles and is EA’s biggest European launch in history.

Madden NFL 10 -- we sold 3.9 million copies in the quarter. After a disappointing August that had Madden down 19%, sell through in September grew 8% year-over-year, with more than 60% growth on the PS3 according to NPD. Madden sales are now up 5% year-over-year on the Xbox 360 and PS3 combined.

Need for Speed SHIFT -- we sold over 2.5 million copies on consoles in the quarter.

And Dragon Age Origins -- last week we launched Dragon Age Origins with a great campaign backed by robust downloadable content. The early read on sell through is strong.

Next, we set a goal to improve our share on the Wii platform. Fiscal year to date, EA is the number one independent publisher on the Wii with share of 21% in North America and we estimate 14% in Europe, up 8 and 10 points, respectively. Our non-GAAP Wii revenue is up 50% year-over-year. While we have hit our share goal for the Wii business, revenue is well below expectations due to underperformance of the Wii platform.

EA also set aggressive goals for growing our digital business. In Q2, our digital revenue was up 23% year-over-year, driven by innovative hit titles like Battlefield 1943, a digitally distributed game for Xbox LIVE Arcade and PlayStation Network, as well as strong performances from EA Mobile, Pogo and ad sales.

EA Mobile has 7 of the top 10 games on the iPhone and 8 of the top 10 games on Verizon. EA Mobile continues to be the number one global publisher of mobile games.

Pogo posted growth -- revenue, registrations and subscriptions were all up versus last year. Ad sales were up almost 10% in Q2 and almost 15% fiscal year-to-date, great performance from our ad sales team in a challenging advertising market.

The digital business is very complementary to our packaged goods business. Digital downloads allow us to sell additional content to players and keep our titles fresh at retail. In short, downloads extend the life and profitability of our disc-based games. In addition, we’re seeing success in mobile with many of the same properties that are working in packaged goods, which helps us leverage IP and marketing budgets.

Our final goal was to aggressively manage cost. We have been successful to date and have recently taken further measures to improve our operating leverage in the future.

We can’t control the economy, but on the things we can control -- on cost, on quality and marketing, on the Wii and digital, on the goals we defined at the start of our fiscal year -- EA is performing well.

I would now like to touch on Playfish. Playfish is one of the leaders in the social gaming space with a terrific team and great games. They have three of the top games on Facebook with “Pet Society,” “Restaurant City,” and the recently-launched “Country Story.” They have 10 Facebook titles in total with over 60 million Monthly Active Users -- up over 96% from June.

The team will join EA Interactive, our group that is focused on games for the web and mobile platforms. We’re excited to welcome Playfish to the EA family.

And, with that I will now turn the call over to EA Games Label President, Frank Gibeau.

Frank D. Gibeau

Thanks, John. Good afternoon. Today I will provide a quick update on the progress we are making in the EA Games Label and an overview of our plans for the second half of the year. Q3 and Q4 is where the EA Games Label will deliver its biggest games of the year. All of our titles are going to be high quality and are tracking on-time. Now I would like to walk you through the key components of our plan.

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First, we are revitalizing our blockbusters. Need for Speed is one of EA’s most powerful and globally recognized franchises. But in recent years, we failed to put adequate resources behind this franchise and as a result, quality suffered. I’m happy to say we fixed that. This year’s game, Need for Speed Shift, launched six weeks earlier and posted a quality rating 22 points higher. We have already shipped 2.5 million units in the quarter. In September, it was the number one title in Europe and in the top ten in North America. Next year’s Need For Speed has been under development now for some time at our award-winning Criterion Studio.

In the months ahead, you will hear more about our plans to revitalize core IP, including the Medal of Honor franchise.

Second, we are expanding into new genres. EA has never been a player in RPG’s but now Bioware is set to launch three of the most anticipated games in that genre. Dragon Age Origins, our new fantasy RPG blockbuster, was just launched last week. The review scores are averaging 90 and initial sell through is strong. The game also has a very ambitious downloadable content plan for keeping players engaged long after release.

Mass Effect II is the stunning sequel to one of the most critically acclaimed games of 2007. It is coming out in Q4. We expect this one to be rewarded with very high quality scores and benefit from built-in audience appeal.

In addition to the two RPGs in this fiscal year, Bioware is collaborating with LucasArts on the development of an epic MMO in the Star Wars universe: Star Wars: The Old Republic. We couldn’t be happier with the vision and commitment to quality at our BioWare Studio -- they are simply best in class.

Third, we continue to deliver the hits through the EA Partners division. This group combines EA’s global publishing reach with the best of the best independent studios. Two launches will be top of mind with consumers this holiday. With Left4Dead2, Valve has created what critics say is one of the hottest games of the year. Pre-orders are tracking significantly higher than last year for this extraordinarily innovative single-player and multi-player online experience releasing on November 17. Also, from our partners at MTV Games and Harmonix, comes The Beatles Rock Band, a music game with incredibly broad appeal. According to NPD, The Beatles Rock Band has outsold Guitar Hero 5 by 2X in revenue. We are extremely pleased with the results so far and are excited about the upcoming holiday for this mass appeal title.

And finally, we are launching three strong titles based on original EA IP. Army of Two The 40th Day from EA Montreal is the sequel to the multi-million unit seller of 2008. It is set to release this January with a big jump in quality and innovative new ways to play co-op in a shooter.

In February, we will release a brand new IP from our Visceral Studio, Dante’s Inferno. An epic story about a hero’s descent into Hell to save his beloved wife, this M-rated action game is receiving great critical reception and is finishing very strong.

Earlier this year, our DICE Studio released Battlefield 1943, a console downloadable game that became the best selling Xbox Live Arcade and PlayStation Network game ever. In March, DICE will release Battlefield Bad Company 2 with all new destructible environments, expanded vehicle combat, and deep new online play with dedicated server support. We believe this will put Battlefield in head to head competition with Call of Duty for quality and online game play.

Revitalizing blockbusters, new genres with BioWare, new titles from EA Partners, and great original IP -- all are tracking to be very high quality and just as importantly, on time. EA Games is performing well.

John S. Riccitiello

Thanks, Frank. In summary, EA had a strong quarter. Our title slate for the second half is on track, and we’re taking the right steps now to set ourselves up for the future. We remain cautious in our outlook over the next few quarters. We’re making the tough but right calls on costs, enabling us to invest in our hits and digital growth. We’re delivering products that reviewers and consumers alike recognize for their quality. I am proud of our teams. They are executing well.

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

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Heath Terry with Friedman Billings Ramsay.

Heath Terry - Friedman Billings Ramsay

John, and then this goes I guess is more directed to John Shepard -- John, you’ve made some comments back in October when the Playfish acquisition was first being rumored that really kind of compared the social gaming landscape as it stands now versus the mobile landscape back when you guys bought [Jamdat]. I was wondering if you could maybe flush that out and give us a sense of how you expect this space to evolve relative to what we saw in mobile over the last few years.

John Schappert

Sure, Heath. You know, what I said was I think when you look at the social gaming space, I think you see a lot of new IP and original IP and not a lot of established brands. I think you haven’t seen brands kind of make their way into that space yet and it was very reminiscent of when we acquired [Jamdat] and what was great about that was they were able to take their own original IP, continue working on that but then capitalize on EA's IP and when you look at their performance now, seven of the top 10 games on Verizon on iPhone you can see a bunch of EA IP in there. You see Madden, you see FIFA, you see Command and Conquer. And I think when you look at social gaming, we are very happy with the original IP that Playfish is bringing to bear. We are also excited, and so are they, at the large portfolio of IP that EA owns that they are going to be able to capitalize on in that space as well.

Operator

Our next question is from Justin Post with Banc of America Merrill Lynch.

Justin Post - Banc of America Merrill Lynch

Thank you. Just overall, John, your strategy when you started was really to kind of build up the title pipeline and really build out a bunch of titles, and kind of going back from that strategy a little bit and just focusing on what you consider the hits and the best opportunities, just to get that margin level up from the 7% to 10% currently, do you think you still need to have some titles selling north of 2 million to 3 million units, some new titles and do you think that’s achievable as you look out to next year or do you have some real opportunities to maybe surprise people and come up with some titles that really drive the top line in margins next year?

John S. Riccitiello

Well first off, just for clarity’s sake, I don’t think we ever talked about increasing the number of titles at EA, even going back to my first -- drawing on my first earnings call. We talked about driving quality. What we felt was lacking at that point was titles that had the potential to deliver 5 million units or better and we didn’t feel that we had the strength, particularly in the EA Games label where some of our IP had become a little stale and where we didn’t really have the pipeline of new intellectual properties. I am happy to say that Frank and his teams have really addressed that. When you think about intellectual property franchises like Battlefield, Need for Speed, what we have with Mass Effect, Dragon Age, et cetera. I think we have really got a strong portfolio of titles that can deliver probably not annually for all of them but for several of them and put us where we need to be in terms of margin structure and that was exactly what we talked about and I would say that we are sort of halfway through the process of realizing that outcome.

You know, in terms of guidance on F11 titles, I would say that I am very pleased with the slate we have coming together for F11 but we are going to reserve time on the February call to talk more about the specific titles.

I will point you though at least to the near term to the first quarter of calendar 10 and in the games label alone, we’ve got Army of Two: 40th Day, we have Dante’s Inferno, we have Mass Effect 2, which promises to be a blockbuster, and Battlefield Bad Company 2 which as Frank had mentioned in his commentary I think has every right to see itself as a rival to the number one FPS game that one of our competitors is releasing next week. So we are feeling really good about it.

Justin Post - Banc of America Merrill Lynch

Thank you.

Operator

Our next question is from Brian Pitz with UBS.

Brian Pitz - UBS

John, we all know that sales of Nintendo consoles, especially the new ones, have been weak but there is currently an installed base of over 50 million consoles out there. Can you talk about what you can do to actually reinvigorate sales among this installed base? Thanks.

John S. Riccitiello

To be honest with you, I think the Wii platform has been a little weaker than we had certainly anticipated. And there is no lack of frustration to be doing that at precisely the time where we have the strongest third-party share.

I think driving revenues up on that platform from where we already are, which is up substantially from where we were a year ago, we are reaching out to Nintendo to find ways to partner to push third-party software harder. I frankly think they need more beats in the year than they get out of a first-party slate to be able to have the Wii software platform perform as well as they would like and we are building the products that are I think the most highly rated on the platform and at this point in time, generating the most revenue of any third party platform.

I would point out, by the way, the 50 million number of course includes Asia or Japan and I don’t think any of the western companies are likely to participate much at all on the Wii platform in Japan, so the addressable market we see is just a little bit below 40 million but that is still an important opportunity.

Brian Pitz - UBS

Just as a follow-up, is there anything specifically that you would change in your marketing strategy to maybe address this market that has changed a little bit versus your previous expectations?

John S. Riccitiello

Well, one of the things I think we have learned is when we really tackled it, exclusive major league marketing, we can create a gargantuan debt as we have with EA Sports Active. I would say one of the things we have been disappointed with on the other hand is I would personally tell you that I think the Wii entry this year on Madden is very, very strong but absent Wii, Madden is actually up as a franchise year over year. Wii is where we are missing it and so I really do think that the opportunity exists to find different ways to partner with first party in this case to sort of help establish in the minds of the consumer legitimacy of some of these other brands when they are going out multi-platform because very, very few multi-platform titles are succeeding on the Wii so far and collectively, Electronic Arts and Nintendo need to tackle that.

I will also point out that being the market leader on the Xbox 360 and the market leader on the PS3, a relative shift in that direction isn’t exactly a bad day for us.

Operator

Our next question is from Sean MacGowan with Needham & Company.

Sean MacGowan - Needham & Company

Thank you. I was wondering if you could be a little bit more specific about where, what areas we would see the reduction in titles -- are you pushing that genre wise or particular types of games?

John S. Riccitiello

We sort of thought about how we would answer that question on the call and we were going to tell you about the just over a dozen unannounced titles we were cutting but that seemed to be challenging in the way of communication because we haven’t previously communicated to you which they were.

I think the better way to look at it would be that Electronic Arts has a core slate of games label and sports franchises that we will iterate on a either annual or bi-annual basis. And I think you know what those major titles are -- all of them are selling or have sold in their most recent edition 2 million units or more. After that, we’ve got The Sims and Hasbro, and frankly anything that doesn’t measure up to looking like it can pencil out to be in very high profit contributor and high unit seller got cut from our title slate from this point going forward.

So it is really, in a way, if you could array our title slate up knowing what we did about what we would have otherwise brought to market, we cut the bottom third of it.

Operator

Our next question is from Eric Handler with MKM Partners.

Eric Handler - MKM Partners

I’m just trying to reconcile the guidance. Your guidance range of $4.2 billion to $4 billion compares to last quarter’s expectation of $4.3 billion, yet your -- the low end of your guidance of $0.70 would suggest that margins could contract significantly. Where would that come from?

Eric F. Brown

The important point to keep in mind here is that we believe we are going to pick up at least $100 million of additional revenue this year compared to the assumptions that we started out with. I mean, this is a function of the U.S. dollar getting weaker and weaker and so the way to think about this is that the high-end of our guidance at 4.4 is equivalent to the 4.3 that we previously stated and 4.2 at the low end is effectively 4.1 starting from that base line. We have a lot of non-U.S. dollar denominated operating expenses, in Canadian dollar, Europe, GBP, and so although we are getting the up-lift of say $100 million in FX at the top line, there is no flow through to bottom line EPS. So net, the takeaway on the bottom end of the range is working off the original $4.3 billion subtract up to $200 million of revenue on an equivalent basis and that is what produces the $0.70.

John S. Riccitiello

And just to help expand on that a little bit, with that sort of jumping a little hard on the Nintendo platform bandwagon, the entirety of that decline for us would be in missing our expectations on those platforms while hitting our market share. Or put another way, I think we are pointing to the issue that the risk in our numbers in a downside bracket in our numbers at this point in time is more market performance. Our shares are at or above our going-in expectations and our costs are well-contained. We are hitting what we expected to hit and we are looking at the headwinds in the last couple of quarters and saying if we see in the next few what we have seen in the last couple, it’s going to cause us to miss on a couple of core platforms which will fall through to the bottom line.

Operator

Our next question is from Benjamin Schachter with Broadpoint Capital.

Benjamin Schachter - Broadpoint Capital

On the Playfish acquisition, can you talk a bit about the whole build versus buy and how you got to buying? And also, there has been a lot of discussion around the whole lead gen space related to that. I was wondering how much of that played into it and did that actually impact your offer at all? And then finally, just a housekeeping -- you didn’t mention Saboteur. Is that still coming this year? Thanks.

John S. Riccitiello

What was the last part?

Benjamin Schachter - Broadpoint Capital

Saboteur.

John S. Riccitiello

Right. I think we’ve got me, John, and Frank on this one. In terms of build versus buy, we think where Playfish and their team are with 60 million monthly active users growing at a -- frankly a staggering pace sort of in an interesting sort of way takes build versus buy off the table. They’ve got such a strong lead and it’s something we think when we look at it, the returns, IRRs, any number of measures, we are stronger with them than we are clean start on a build basis.

John might want to talk about the complexion and how we saw them differently from say the two leading competitors in terms of quality of revenues, quality of games, how we got to this particular selection.

John Schappert

I think the Playfish folks have set themselves apart in the space by delivering some of the best quality games in the social gaming space and we look at combining their high quality publishing model, development model with our great brands and we think they are going to be a great fit for EA Interactive, which already has success on the mobile platform and certainly with Pogo, so when we looked at the time it would take for us to kind of try to achieve the same success that they had, it would take a very long while, so good opportunity to be able to bring Playfish on board with EA.

I also wanted to note about revenues -- so there’s been a lot of talk about revenues in the social gaming and where they are coming from. Playfish has held a very, very high standard in terms of revenues and the majority -- in other words, almost 90% of their revenues come from non-offer based models, so direct to consumer transactions is how they make the bulk of their money, which also impressed us.

John S. Riccitiello

And with regard to your question on Saboteur, it is on track to hit ship date in Q3. We are very excited about this open world action game and introducing a new IP to the marketplace, so that’s on track.

Operator

Our next question is from Anthony Gikas with Piper Jaffray.

Anthony Gikas - Piper Jaffray

I was wondering if you could just share the current revenue run-rate of Playfish, maybe any valuation metrics and what the revenue expectations are in the next fiscal year since you’ve incorporated that into the plan now?

Eric F. Brown

In terms of rough numbers, as we look at Playfish’s forward revenue for F11, we think we are paying about 3X to 4X times revenue, that’s a rough number. We won't parse it any further than that. We do believe that in F11, Playfish will be EPS accretive on a non-GAAP basis, so that’s a positive contributor toward business overall.

Operator

Our next question is from Daniel Ernst with Hudson Square Research.

Daniel Ernst - Hudson Square Research

A combined question that involves mobile -- if you look at the growth in the mobile business, how much of that is coming from what I would call [Jamdat] classic versus core EA games like Need for Speed, Tiger and FIFA that have been really facilitated by the new larger screen devices like the iPhone?

And then with that question in mind, do you look back at the [Jamdat] acquisition and maybe some of the other ones, like Bioware, Pandemic, and Mythic, as you look at PlayStation, have you been able to secure a positive ROI on those prior deals as you looked at metrics for this new deal? Thanks.

John S. Riccitiello

Why don’t we parse that a couple of different ways -- John, do you want to tackle the mobile piece to start?

John Schappert

Sure. So on mobile, the bulk of the revenues from our mobile division, while they certainly have standard handset and iPhone revenues, the bulk of them come from standard handset devices and if you look at -- I cited seven of the top 10 iPhone games and eight of the top 10 on the Verizon deck, and when you kind of go through that list on iPhone, for instance, you see Madden, you see Need for Speed, you see the Sims 3 -- you see Scrabble Monopoly, which was part of our Hasbro license, and then Rockband is right at the top and we just launched Command and Conquer after this [inaudible] and it is doing very, very well.

On Verizon, you see similar titles -- you see Madden, you see Sims, you see Scrabble, you see Rockband. So I think our IP is playing very, very well on these platforms.

John S. Riccitiello

And I might let Frank speak quickly to the Bioware transaction. You asked about our M&A and I’ll give you a little bit more of an historical perspective after Frank [comments] on Bioware.

Frank D. Gibeau

So your question on [VGH] is a good one. Right now we are tracking right on the deal model that we put together for that transaction. The recent release of Dragon Age and with Mass Effect 2 and Star Wars right in front of us, it appears that we are going to hit our goals for what we signed up to in that acquisition.

John S. Riccitiello

So generally speaking, when we do M&A at Electronic Arts, and this goes back to this sort of mid-late 90s when I was working on these things under [Leonard Crowe], we had always set aggressive goals for IRR base that are typically in the high teens or 20s or higher and for being accretive and being probably more important than anything else strategically additive to the company, either through intellectual property, teams, or strategic leverage.

When we review our deals, which we do on a regular basis, I am happy to say that we are pretty darn pleased with our track record. I joined when the company was concluding Maxis. That’s been a home run for us. From there, major deals -- [Jamdat] without a doubt. We are very pleased with that transaction. It has made us the leader in the space and at this point in time it finally looks like a great deal, it is number one in the space. Dice brought us Battlefield and the underlying technology for a number of games. That’s been exceeding our expectations.

If we look -- you know, Frank had just touched on Bioware and Pandemic, it’s a little early to read. Criterion -- successful simply given the price on what we did with Burnout alone. At this point in time, Mythic, you specifically referenced that -- probably a little under our model [inaudible] that we first acquired them on the basis of but in general, I would say that we have a very high batting average for having these things work.

Operator

Our next question is from Jeetil Patel with Deutsche Bank.

Jeetil Patel - Deutsche Bank

You talked about 1500 positions on the restructuring -- I guess you talked about a third of your titles being eliminated, or at least in question, on development. Can you just give us a sense of what kind of annualized revenue that would represent? I guess kind of by our math, it looks like about $0.5 billion to $600 million. I guess it doesn’t seem like it -- it seems like enough of a headcount reduction to kind of -- given the -- a third of the lineup going away, or at least being put on hold. I guess can you elaborate a bit more about the restructuring and how much more there could be left to go, or kind of the revenue impact? Thanks.

John S. Riccitiello

I think you’ve actually got the math a little off but that’s a function of the fact that we haven’t given you enough detail to do it, so in general, we have titles that range from a staffing of four to staffing of 250. Generally speaking, and titles count, as it relates to headcount percentages isn’t really a valid way to do things. Most of the things we cut were small titles and/or titles that were at a different stage of development and/or not multi-platform massive [inaudible] [their full support] [inaudible] FIFA or Madden.

So I think we believe we are in exactly the right place. We think the cuts we have made are very, very aggressive. We’ve cut teams, we’ve cut corporate, we’ve cut overhead, we’ve cut publishing but not to the point of hampering ourselves. We think we are a strong company going forward and our goal from here is to grow profitably, or even more profitably.

Jeetil Patel - Deutsche Bank

I guess is there a general rule of thumb X million units or X hundred thousand units and below you are not doing and above a certain threshold you will do?

John S. Riccitiello

I think that’s hard to say right now because on the packaged good side, I think that we could give some rough guidance along that but we haven’t done so so far. But when you think about the cost of publishing a Flash game or putting something up on the Xbox Live arcade where the costs can be very, very modest, I don’t know that you want to apply a general rule of thumb.

What we have applied was a -- both an absolute [size] and a percentage profitability, again numbers we are not putting out today. We will probably describe more fully on our FY11 guidance call. But we are very keen at driving our margins up and doing so aggressively as we scale. So that is what was behind the thinking.

We also felt that we wanted to position ourselves better to drive our titles to the very tops of the charts. It’s nice to be number one. We’d like to be number one by a wider margin and to do so with fewer titles.

Jeetil Patel - Deutsche Bank

Last question, but just a housekeeping number, but how many titles this year in fiscal ’10?

John S. Riccitiello

We’ve had a little challenge on some of the definitions of what is in and out but I think in rough numbers, mid-60s would have been the way to think about last year and the way we A&R looking at it right now. Approximately 50 this year and something in the high 30s next year. So when you consolidate this thing, it’s about a 50% cut over two years.

Operator

Our next question is from Colin Sebastian with Lazard Capital.

Colin Sebastian - Lazard Capital

First of all, I guess John, I’m curious if you attribute any of the slowdown in the console side of the business this year as due to more time competition from platforms such as Facebook, the Facebook games, or do you view the opportunities with Playfish as largely incremental?

And then Eric, baked into your revised earnings assumptions, have you made any changes to the bonus accruals?

John Schappert

I guess I’ll take the first part of that. So with respect to some of the softness in the market and the social gaming maybe taking some of that, you know, I think that there is -- I think the economy is affecting the footfall at retail, which we are seeing, some of the softness there. I think people are still playing games or still buying games but they are being a little more selective. I think the nice thing about PlayStation and social gaming is it opens up other doors to a whole bunch of folks that aren’t specifically console gamers today and I think that’s the big win that we get there. You know, Facebook has over 300 million people and Playfish has had over 150 million installs of their software, with 60 million monthly active users. So I think the nice thing is we’ve got great packaged goods and console market share and lineup and now we’ve got a great new social gaming division, so you want to play games on the Xbox 360 or the Wii or the PS3, we’ve got the great games for you, number one publisher, independent publisher on all of those platforms. If you want to play games on the mobile phone, we’re there for you and now thanks to PlayStation, if you want to play games on the social networks, we are also there for you.

So I think it will be nice and accretive for us long-term.

Eric F. Brown

In regard to the second portion of your question, guidance and the inter-relationship about the bonus accrual, so at the high-end of the guidance, $4.4 billion of revenue dollar EPS we expect to [inaudible] from the bonus pool. At the low-end at 4.2 and $0.70 non-GAAP EPS, we’d fund half or maybe a bit less of the bonus pool, so there would be a sliding scale in between the two end points.

Colin Sebastian - Lazard Capital

Okay, thanks. That’s helpful.

Operator

Our next question is from Shawn Milne with Janney Montgomery Scott.

Shawn Milne - Janney Montgomery Scott

Thank you. I just wanted to follow-up on you talked about the run-rate of Playfish but if you look at the growth in your digital services business and you look out into next year, I mean, it seems like you are probably going to be on pace to be around $750 million in revenue. Can you give us a sense for where the margins are going to be tracking? I know you talked about a big investment over the last couple of years but any color on that would be helpful.

And then just secondly on the -- back to the guidance, you talked about at the lower end of the revenue, Eric, I mean, can you give us a sense for what kind of catalog sales you are expecting in the third quarter and specifically you gave out initial shipments on Need for Speed but I am assuming you’ve got that title down a fair amount year over year. Thanks.

John S. Riccitiello

There’s a lot of stuff there. Why don’t we try to figure out if we can still remember all the questions while we get through the first few -- vis-à-vis the digital streams for Electronic Arts, I am not going to confirm or deny your estimations for next year. I would tell you it is the most profitable part of our business right now and it is something we are very pleased with. I would also tell you that we have ambitions for discontinuity in the revenue growth stream for digital, thinking about launches of major MMOs, launches of products like Need for Speed Online, Battlefield Online, and a global western marketplace.

It’s something we’ve been investing in when we started the beginning of the fiscal year. There was a lot of frustration that -- in fiscal ’09 it was a net investment business and it wasn’t aggregating up to a profit. We explained to the people this year it would be strongly profitable. We turned a corner on all of our investments. Only some of them are fully coming to market this year and we’ve got strong ambitions for growth here.

Eric F. Brown

In regard to your question about guidance assumptions and catalog, as we look into the back half of the year, it’s important to recognize that -- we have one title, for example, Need for Speed Shift out six weeks earlier in the year and up 22 points in terms of its metacritic rating, so we will have the benefit of selling that throughout the second half of the year. We’ve had our best Q2 ever and so we have a better position in terms of catalog mode.

And we had a call out on our Q4 revenue and so Q4 last year was a bit more about catalog versus front line for us. Our fiscal Q4 is about front line. We mentioned four triple A front line titles coming from the games label in fiscal Q4 and so as a result, we have less dependency upon catalog in Q4 with that high quality slate of titles.

Operator

Our next question is from Doug Creutz with Cowen & Company.

Doug Creutz - Cowen & Company

You know, we are seeing it looks to me like some pretty aggressive discounting on price in the U.K. I wonder if you could talk about what you think is going on there and how that might be affecting your results.

And then also, if you look forward to the holidays here in the U.S., do you think that there is going to be some aggressive moves on price in the videogame space we’ve seen and some of the other consumer verticals like movies and books? Thanks.

John S. Riccitiello

We’ve seen channel discounting led by retailers both in North America and in Europe, as retailers really skirmish for market share. I think what you are referring to as some pretty aggressive stuff at grocery retail in the U.K. on FIFA. You know, programs like these that are often funded by retailers or are funded by retailers, you know, we watch with amusement because it can drive some short-term results. Our clear summary of where we are there was that did not sort of pull things into Q2 in any sort of way, you know, in a negative way in Q3.

And you can see major retailers, specifically those in the U.S., that work a lot with second sale or have some pretty aggressive programs out for some third-party titles that we compete with. You know, again, funded, they are seeking market share.

You know, beyond that, at least looking backwards, front line pricing in this industry has held better this cycle than last, held longer this cycle than last and as we go into the holiday, retailers will be competitive and I don’t think there is anything new there. So I don’t really see a shift from where we are today to where we have been in days or years gone by.

Doug Creutz - Cowen & Company

Thanks.

Mary Vegh

Operator, we have time for one more question.

Operator

Thank you, and our final question is from Atul Bagga with ThinkEquity.

Atul Bagga - ThinkEquity

Thank you for taking my call and congratulations on the Playfish deal. A couple of questions on the -- so clearly social gaming has been growing at a very fast pace. I wanted to understand what is your opinion, how long this fast growth can be maintained organically and with Playfish addition to EA, what kind of leverage, what kind of [inaudible] we can see in terms of growing top line using EA's IPs and what kind of IPs could be taken on the social gaming?

And a related question on that, do you guys have any concerns or rather how would you handle any concerns regarding diluting IPs when you are putting these games for free to play? Thank you.

John Schappert

Well, with respect to social gaming, lots of questions there on social gaming. We think that this segment is going to continue to grow exponentially for some time. We are very excited and bullish on the segment and we think not unlike our acquisition of [Jamdat], as we were excited about that segment and acquired [Jamdat], the market leader and have continued to grow them, and they are a very meaningful part of our business now and a big part of the growth.

We see the same thing happening in social gaming. With respect to franchises that are relevant, I am not going to name names, obviously, but again I will refer you back to looking at the top mobile games that we have and with that, I think Frank has some more color to add too.

Frank D. Gibeau

Yeah, I think your point about does the free to play version of an IP dilute the equity or the perception of quality and I think actually the way I look at it is it actually opens up an access point for people to come into the IP and experience it in new ways and potentially up-sell them to a more deep and larger product. We recently ran an experiment where we created a game called Dragon Age Journeys, which is a free-to-play web-based Flash game. That was a great entry way for people to understand and experience what Dragon Age was all about before it released. We generated a significant numbers of plays and very high levels of customer satisfaction and we actually went into the telemetry and looked and saw that people could unlock things in the web game and put it into the console game, so I think in general at EA, we see it as an opportunity to open up access to our IPs by putting that in free to play models as well as continuing to maintain the blockbuster model or a more connected means.

Mary Vegh

Okay, thanks, Atul. Thanks, everyone, for joining us today. This concludes our second quarter earnings call. We look forward to speaking with you again soon. Thank you.

Operator

That concludes our presentation. Thank you for your attendance.

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