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Electronic Arts Inc. (ERTS)

F2Q08 Earnings Call

November 1, 2007 5:00 pm ET

Executives

Tricia Gugler - Director, Investor Relations

John S. Riccitiello - Chief Executive Officer, Director

Warren C. Jenson - Chief Financial Officer, Executive VicePresident, Chief Administrative Officer

Analysts

Edward Urban - Bear Stearns

John Taylor - Arcadia

Doug Creutz - Cowen & Company

Benjamin Schachter - UBS

Brent Thill - Citigroup

Mike Hickey - Janco Partners

Heath Terry - Credit Suisse

Justin Post - Merrill Lynch

Rick Kaiser - Sanford Bernstein

Tony Gikas - Piper Jaffray

Arvind Bhatia - Stern Agee Leach

Operator

Good day, everyone, and welcome to the Electronic Artssecond quarter fiscal year 2008 earnings conference call. Today’s call is beingrecorded. For opening remarks and introductions, I would like to turn the callover to Ms. Tricia Gugler, Director of Investor Relations. Please go ahead.

Tricia Gugler

Welcome to our second quarter fiscal 2008 earnings call.Today on the call we have John Riccitiello, Chief Executive Officer and Warren Jenson, Chief Financial andAdministrative Officer.

Before we begin, I would like to remind you that may findcopies of our SEC filings, our earnings release, and a replay of the webcast onour website at investor.ea.com. Shortly after the call, we will post a copy ofour prepared remarks on our website.

Throughout this call, we’ll present both GAAP and non-GAAPfinancial measures. Non-GAAP measures exclude charges and related income taxeffects associated with the impact of the change in deferred net revenuerelated to packaged goods of digital content, acquired in-process technology,amortization of intangibles, certain litigation expenses, restructuringcharges, and stock-based compensation.

In addition, the company’s non-GAAP results exclude theimpact of certain one-time income tax adjustments. Our earnings releaseprovides a reconciliation of our GAAP to non-GAAP measures. In addition, weinclude a detailed GAAP to non-GAAP reconciliation on our website.

Information regarding our use of non-GAAP measures alongwith a schedule demonstrating how we calculate return on invested capital willbe included with a copy of today’s prepared remarks we post on our website.

These non-GAAP measures are not intended to be considered inisolation from, a substitute for, or superior to our GAAP results and weencourage all investors to consider all measures before making an investmentdecision.

All comparisons made in the course of this call are againstthe same period for the prior year unless otherwise stated. All references tocurrent generation systems include the Xbox 360, the PlayStation 3, and theWii. We are now referring to the PS2, Xbox and Game Cube as legacy systems.

We also included a summary of our financial guidance withour prepared remarks, as well as our trailing 12-month platform shares and asupplemental schedule on our website.

During the course of this call, we may make forward-lookingstatements regarding future events and the future financial performance of thecompany. We caution you that actual result may differ materially. We refer youto our most recent Form 10-K and 10-Q for a discussion of risk factors thatcould cause our actual results to differ materially from those discussed today.

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

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

John S. Riccitiello

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

Our label base structure is now largely in place. Employeesare essentially in the right seats and our system migration is underway. PeterMoore, Nancy Smith, Frank Gibeau and Kathy Vrabeck are in command of fourlabels that can now run faster and smarter. They and their teams are acutelyfocused on product quality and innovation, driving segment share and improvingour cost structure.

We are in the process of completing our acquisition of BioWareand Pandemic and I want to congratulate the BioWare team on Mass Effect. Theearly reviews look great. We look forward to having them join us in January.

And we are in the midst of building our strategic andfinancial plans for FY09 and beyond. As the teams build out their plans, theyare focusing on the four long-term priorities we discussed on the last call.

First, increase our segment shares. Although there is muchwork to do, we have already begun to execute. Our long-term relationship withHasbro will bring incredible casual and family-oriented franchises to ourlineup, like Monopoly, Littlest Pet Shop, Tonka and Nerf.

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

Our pipeline of wholly-owned IP is robust. We’ve beeninvesting in new IP, some of which has begun to ship this year, and we’ve madeprogress on the Nintendo platforms. This has been a priority for the company.

While it would be a battle for the year, we are now pleasedto report that we are the number one third party publisher on the Wii in bothNorth America and Europe year-to-date. Still work to do, but we’re on it.

These strategic actions will help us grow share in FY09 andbeyond.

Second, expand into digital revenue streams; we areextremely focused on driving our digital revenue streams, including wireless,advertising, subscriptions, digital downloads, microtransactions, and ourAsia-based online business. These segments will grow at a faster rate than thetraditional packaged goods business and will be a significant part of ourlong-term growth and margin story.

Third, smart growth through acquisitions; as I mentioned, werecently announced our acquisition of BioWare and Pandemic. We expect this dealto generate significant returns for the company over the long-term. Goingforward, we will continue to pursue the right acquisitions to further build ourbusiness.

And fourth, leverage our P&L through cost efficiency andproductivity. Let me update you on some recent actions. Today we announced arestructuring which includes headcount reductions and facility closures. Thiswas a difficult decision because it impacts the careers of some very talentedpeople. Some of the talent will be assigned to new projects. Permanentfull-time employees that leave the company will be offered severance andout-placement assistance.

While these actions are small in relation to our worldwideemployee 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 andleveraging our P&L through cost efficiency and productivity.

I recognize that we have a lot to do, but we are makingprogress. I look forward to sharing more with you on our next call and at ouranalyst meeting in Redwood Shores that we have scheduled for February 12, 2008.

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

Warren C. Jenson

Thanks, John, and good afternoon, everyone. We are pleasedwith our Q2 financial performance. Both top and bottom line results were abovethe high end of our GAAP and non-GAAP guidance.

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

GAAP diluted loss per share was $0.62 versus earnings pershare of $0.07 a year ago. Non-GAAP diluted earnings per share were $0.27versus $0.21.

Q2, as usual, was a big sports quarter. FIFA ’08 had astrong international launch, selling 2.9 million copies in just one week. InEurope, all platforms experienced unit growth, with estimated sell-through up18% year over year. FIFA ’08, which launched in October in North America, isalso 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, revenuewas 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 legacyconsoles.

Tiger Woods PGA tour sold 1.6 million copies. NHL ’08 hitthe 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. My Sims hada successful debut, selling 1.2 million copies on the Wii and NDS, with over60% on the DS. This is a big win for us on the Nintendo platforms and a greatexample of what can be accomplished by focusing on innovation specifically forthese platforms.

Harry Potter and the Order of the Phoenixcontinues to do well, with close to 3 million copies sold since launch. Skate,with a meta critic rating of 85, had a strong opening, selling over 500,000copies on the 360 and PS3. Skate brought innovation and accessibility to theskateboarding genre and has given us a new franchise.

We also moved forward on several strategic fronts. Owned IP-- we are pleased with the reception of our three new owned IPs, Skate, MySims, and Boogie. New platforms -- this quarter, we launched nine SKUs on theWii and NDS with My Sims and Boogie only available on these platforms. Wegenerated $130 million in revenue ex deferral on the Nintendo systems.

Online revenue was $42 million, up 58% year over year. Weare continuing to make progress on all online initiatives. In September, welaunched the new EA online store, which should make it even easier forconsumers to buy our content directly.

And finally, we announced our proposed acquisition of BioWareand Pandemic. This acquisition does a few things for us strategically, helpsfill out the gap we have in the RPG, action and adventure genres, brings highquality talent, builds on our presence in the MMO space, and expands our portfolioof owned IP.

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

For the next few minutes, I’ll focus my remarks in twoareas. First, I’ll review our Q2 financial results; second, I’ll go over ouroutlook and guidance, and then following my comments, John and I will open thecall to your questions.

Revenue ex deferral was $936 million, up 19% from a yearago. Excluding the impact of foreign exchange, revenue increased 16% year overyear. Revenue was driven by Madden NFL, FIFA ’08, NCAA Football ’08, TigerWoods PGA Tour ’08, and My Sims, 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 ayear 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 ofthe top 10 games in North America and four of the top 10 in the U.K. Although the mobilebusiness is up year over year, we are reducing our full year estimate forfiscal 2008. We now expect the mobile business to generate $155 million inrevenue versus our previous estimate of $175 million.

We have temporarily lost some momentum, given aweaker-than-expected North America segment and a few execution issues. Thatsaid, we have every confidence that the team is doing the right things to growthis business.

Handheld revenue ex deferral was $94 million, up 9%. NDS wasour best performing handheld platform, with revenue of $47 million, over 3Xthat of last year, driven by My Sims and Harry Potter. Revenue ex deferral fromboth the PSP and GBA were down year over year.

PC revenue ex deferral was $116 million, up 35%, driven bythe Sims and Medal of Honor franchises. We had eight of the top 20 titles inNorth America and we estimate 10 of the top 20 in Europe.

Co-pub and distribution revenue was $32 million, down $7million. Internet, licensing, advertising and other revenue was $39 million, up63% primarily due to growth in Club Pogo and in-game advertising.

Club Pogo was driven by a 15% year-over-year increase insubscribers and an increase in the annual subscription fee. In-game advertisingwas $5 million in the quarter.

Geographically, North America revenue ex deferral was $525million, up $13 million or 3%. The increase in current gen consoles,subscriptions, advertising and the NDS, offset the declines from legacyconsoles and the PSP. Legacy systems declined 50% year over year.

International revenue ex deferral was $411 million, up $139million, 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 millionor 53%, driven by the strong launch of FIFA ’08 and My Sims. Excluding a $21million benefit from foreign exchange, Europe revenue ex deferral would haveincreased 44%.

Legacy systems declined 11% year over year. In addition, NDSand PC each had growth of $25 million year over year.

Asia revenue ex deferral was $36 million, up $9 million or33%.

Moving on to the rest of the income statement, GAAP grossprofit 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 aresult of the revenue deferral.

Non-GAAP gross profit was $549 million, up 21%. Non-GAAPgross margin was 58.7% versus 57.8%, up 90 basis points primarily due to a highermix of owned IP.

OpEx, sales and marketing expense excluding stock-based compwas $159 million, up $55 million primarily due to higher advertising spend tosupport our Q2 releases, including new IP launches. For the year, we continueto expect sales and marketing to decline 1% to 2% as a percentage of non-GAAPrevenue.

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

R&D excluding stock-based comp was $237 million, up $18million or 8%. For the year, excluding the impact of BioWare and Pandemicacquisition, we expect R&D to increase in the low single digits year overyear. 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 dilutedearnings per share of $0.07 a year ago. Non-GAAP diluted earnings per sharewere $0.27 versus $0.21 a year ago. The $0.89 difference between GAAP loss pershare 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 millionversus $571 million for the comparable period. The decline was primarily as aresult of lower non-GAAP net income and the timing of our sales. We expect ourcash flow for the full fiscal year to rebound and exceed the $397 million fromthe prior year.

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

Now on to the balance sheet. Cash and short-term investmentswere $2.2 billion, flat to last quarter. Marketable equity securities were $716million, up $56 million sequentially, due to the overall market appreciation inour investments.

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

Reserves against outstanding receivables totaled $185million, up $13 million from a year ago. Reserve levels were 14% as apercentage of trailing six month net revenue ex deferral, consistent with lastyear. As a percentage of trailing ninemonth net revenue ex deferral, reserves were 9%, also consistent with the prioryear.

Inventory was $103 million, up $36 million from last year.Other than NBA Live, FIFA, and MaddenNFL, no one title represented more than $5 million of net exposure. Thisquarter, in addition to building inventory for the FIFA launch in NorthAmerica, we also manufactured inventory for the October release of NBA Live‘08.

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

Now our outlook; first, on the industry. We expect thatsoftware sales in North America and Europe will be up 15% to 20% for thecalendar year. We have increased ourrange based on the strength of the Nintendo platforms. In addition, the recentactions by Sony and Microsoft should fuel demand for the PS3 and Xbox 360.

Second, we have a strong lineup for the holidays. We’recoming to market with a balance of perennial blockbusters and new IP. In addition, we have a strong line up for theNintendo platforms. We have over 10 titles this holiday, including NBA Live‘08, Half Life 2: Orange Box, Hellgate London, NCAA March Madness ‘08, Need forSpeed Pro Street, TheSimpsons, Sim City 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 fivetitles for the NDS and four for the PSP; and on the PS2, we expect to shipseven 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 restructuringthat will result in facility closures and staff reductions of approximately 350people across the studio, publishing and corporate divisions.

In the U.K., we are consolidating our operations which willresult 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 ourfiscal third quarter. This will significantly impact our 2008 GAAP EPS. Weexpect these actions to result in an annual operating cost savings ofapproximately $25 million to $30 million.

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

This guidance reflects the strength of our year-to-dateperformance, favorable foreign exchange rates, and the expected strength of ourlineup, 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 mobilebusiness. Keep in mind that Army of Two and Warhammer are higher marginproducts.

Also, please remember that foreign exchange upside does notautomatically fall to the bottom line. Our local currency COGS and operatingexpenses naturally offset much of the benefit.

Finally, we want to highlight that we have several titleslaunching in Q4. There is always development risk. Should one or more of these titlesmove out of the fiscal year, this would further impact our guidance.

Now the numbers. Let me again remind everyone that a one-pagesummary of our financial guidance will be included with the call script on ourwebsite. Hopefully this will assist you to build your GAAP and non-GAAP models.Our estimates include the projected impact of the BioWare and Pandemicacquisition.

First, our GAAP guidance. For the full year, we expect: revenueto be between $3.35 billion and $3.65 billion, which is a $150 million increaseto 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 infiscal ‘09.

Now, our non-GAAP guidance. For the full year, we expect: revenueex deferral to be between $3.8 billion and $4.0 billion, which is a $150million increase to our previous range; non-GAAP diluted earnings per share tobe between $0.85 and $1.15; non-GAAP gross margin to be 57% to 59%; dilutedshare count to be 322 million.

In addition, one point on headcount; in fiscal 2008, we planto end the year with roughly 8,300 people -- a 5% increase excluding Pandemic andBioWare. This is down five percentagepoints from our original operating plan. It’s also important to note that allof the increase is occurring in lower cost regions of the world, including Shanghai,India, Romania, Montreal and Spain. Weexpect our headcount in higher cost regions of the world to be downyear-over-year.

Overall, we expect our non-GAAP EPS to be roughly $2.06 to $2.45better than our GAAP results. The estimated break-down of these adjustments isas follows: change in deferred revenuerelated to packaged goods and digital content to be between $0.86 and $1.10; acquisition-relatedcharges 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; amortizationof intangible assets, roughly $0.15; restructuring charges related to thereorganization and establishment of an international publishing headquarters inGeneva, approximately $0.01; the difference between diluted and basic sharecount, approximately $0.02 of a loss.

For the quarter ending December 31st, first our GAAPguidance. 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 andearnings per share of $0.12; gross margin to be between 47% and 50%; basicshare count to be 314 million; and diluted share count to be 323 million.

Now our non-GAAP guidance. For the quarter, we expect: revenueex deferral to be between $1.625 billion and $1.8 billion; non-GAAP dilutedearnings per share to be between $0.75 and $0.95; non-GAAP gross margin to bebetween 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 break-down of theseadjustments is as follows: change in deferred revenue related to our packagedgoods and digital content to be between $0.54 and $0.74; charges related to thereorganization plan we announced today of approximately $0.17 to $0.19; stock-basedcompensation, 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 SKUscompared to 41 ayear ago. To date, we have shipped: NBA Live 08 on six platforms; The Simpsonson six platforms; Playground on the Wiiand NDS; The Sims 2 Castaway on four platforms.

In addition, we plan to ship: Need for Speed Pro Street on sixplatforms; NCAA March Madness ‘08 on three; Sim City Societies on the PC; SmartyPants on the Wii; The Sims 2 Teen Style Stuff on the PC; Boogie on the PS2 andNDS; Madden NFL 08 Espanol onthe 360 and PS2; Medal of Honor Airborne on the PS3; Medal of Honor Heroes 2 onthe Wii and NDS. The Wii SKU will be available for the Nintendo Zapper.

EA Partners has already launched Half-Life 2: Orange Box forthe PC which is off to an excellent start; Hellgate London for the PC,including the collector’s edition just shipped yesterday; in addition, weexpect to ship Rock Band, North America only on the Xbox 360, PS3 and PS2;Crysis and Crysis Collector’s Edition on the PC; Orcs and Elves on the NDS.

EA Mobile plans to launch 11 games on cellular handsets:Sims, DJ, Need for Speed Pro Street, Blastdown, Sim City Societies, HarryPotter Classes, NBA Live ’08, Pictionary multi-player, ESPN Darts, Dakar ’08,Orcs and Elves 2 and FIFA ’08.

In summary, let me conclude with a few thoughts. First, weare making good progress on the reorganization, label strategies and operatingplans, 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-termtrajectory; and third, we are looking forward to the holidays and the back partof the year. We’ve got some great titles on the way.

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

Question-and-AnswerSession

Operator

(Operator Instructions) And we’ll take our first questionfrom Edward Urban with Bear Stearns.

Edward Urban - BearStearns

Thanks. Good afternoon. I was wondering if you could talkabout what you are seeing currently with the development of PS3 SKUs and if youthink there is an inflection point in hardware, what you are looking for inthat regard?

And then also, I was just wondering if you could update uson the development of the Spielberg Wii title, and is that still anticipatedfor fiscal ’08?

John S. Riccitiello

In terms of an inflection for PS3, what we would be lookingfor more than anything is increased hardware sell-through, which is going to bepricing driven and title driven. And frankly, I think I would rather give youan answer to that question with more specificity after the Thanksgiving holidaywhere we see where the hardware picks up.

But as we’ve said many times in the past, we remainsupremely confident that this is a three-horse race and it’s going to end upwith 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 you is I am seeing aninflection point but it is not a sharp corner. It is one that we are going tobe watching carefully between our Christmas quarter and the first quarter ofnext year.

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

Edward Urban - BearStearns

Okay, great. Thanks.

Operator

We’ll take our next question from John Taylor with ArcadiaInvestments.

John Taylor - Arcadia

I was wondering if you might be able to give us a ranking orsome kind of priority of some of the factors that are reflected in yourincreased confidence. I guess a couple of things I might throw out there -- areyou seeing next gen grow faster than you thought? Is it Nintendo driven? Is itco-publishing business or is it maybe a lesser erosion rate on the legacysystems? Maybe give us a sense of where those things are coming in relative toyour expectation. Thank.

John S. Riccitiello

A lot of different things there. That could be a novelrather than a short answer. Industry in general I would say is performingrelatively in line with our expectations but a little bit strong, and as Warrenmentioned in his opening remarks, we trace most of that optimism for sectorgrowth to Nintendo.

If you ask me about some of the legacy systems, a little bitof better performance, particularly out of secondary markets on the PS2 inEurope is also helping out, so the PS2 continues to be strong in Eastern Europeand a few other markets. So that’s sort of holding on for that. A little bit better performance there andyou’ll see if you rank or stack rank the platform sales in Europe, the PS2still remains very strong and a higher percentage of total business there thanit does in North America.

In terms of our business, I think the higher confidencecomes out of a couple of things. One, it is three months later and many of thetitles that we were looking at alpha software are in the box and on the shelfand highly rated. So just getting the experience under the belt makes us feelgood. And in particular, what we’ve seen on a couple of the EAP partnerstitles, they’ve been very, very strong.

So we are pleased with the way The Simpsons finished. We arevery pleased with the way titles are getting out in terms of Orange Box and afew others from EAP and we are highly confident in Rock Band.

So in terms of tenor or sense of confidence, I think it is alot easier to talk about the Christmas quarter now than it was three monthsago.

John Taylor - Arcadia

So a quick follow-up on that; when you are looking atsell-through of sports titles and maybe how the order book is looking for Needfor Speed, are those coming in pretty much where you thought they would, eitherin aggregate or highlighting any of the major platforms?

John S. Riccitiello

In terms of the sports titles, there’s a couple of differentstories going on here. One of them is FIFA, which has a strong centering onboth legacy platforms and both the Microsoft and Sony next-gen platforms, isdoing particularly well in Europe. It had a very, very strong introduction sowe feel strong about FIFA. I frankly thing that’s attributable to the fact thatwe just built a better product. It’s highly innovative, both in player controlsand the AI. It feels like a good win for us.

When I look at the bulk of our sports titles though, I thinkin North America, it is not getting the growth this year that we would haveotherwise liked. I think it is relatively straightforward to understand what’shappened. Part is that we are comparing to an extremely strong prior calendaryear that 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 platform, a higherpercentage than we had anticipated at the start of the year.

We under-represent ourselves on Nintendo. Even though we arethe number one third-party on the platform so far this calendar year, ourmarket shares on Nintendo are lower than they are on Sony or Microsoftplatforms. That has an impact.

And as I believe we discussed on the last call, to a degreewe shot ourselves in the foot on PS2 pricing on NCAA and Madden. We were alittle 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 havebeen six-and-three-quarters years, so we pulled up a bit short.

In terms of Need for Speed, frankly you are kind of pushingme into a world of crystal balling because we haven’t shipped the title yet. Ican tell you that the title looks fantastic. It is one that we are mostconfident in. The preorders are strong but I would rather give you an estimateif I even had a week of information. I don’t have that yet, so it’s part of thebundle of things that are aggregators in our Q3 forecast that Warrenoutlined.

John Taylor - Arcadia

Okay, great. Thank you.

Operator

We’ll now go to Doug Creutz with Cowen & Company.

Doug Creutz - Cowen& Company

You took up your estimate for industry software growth forthe year. I’m wondering if you could tell me, given how strong Nintendo firstparty software has been and also if you throw away the performance of Halo, howmuch of that bump was due to incremental first party growth versus third partygrowth? Thanks.

John S. Riccitiello

I don’t think we’ve aggregated this in the way you asked thequestion, but I will tell you that you are spot on. By and large, Nintendo has57% of both of their platforms, which is a much higher ratio than eitherMicrosoft or Nintendo, where frankly traditionally the leading platform has hadin the marketplace. So Nintendo is clearly getting a good chunk of the growthin the industry.

Lot’s of pundits would like to point out that absentNintendo, the industry is actually slightly down. I think that’s a bit of afalse analogy because virtually any industry is down when you strip out theimpact of the market-leading growth engine, so I think that’s a little bitcircular.

I don’t know if I’m answering your question exactly otherthan to say that because Nintendo has a high share on their own platform, andthey are a key reason why we’ve upgrade the industry sector software growthguidance for the year, that Nintendo is a key beneficiary of that.

The surprising note I think for most anybody that’s beentracking EA for the last couple of years is that EA is showing up as the numberone third party on the Nintendo Wii. I frankly do not even believe I would haveforecast that on the basis of what I was seeing when I came in in April, sobetter performance there, which bodes well for the future. A lot of folks havebeen wondering if EA could make up for lost ground there and while we arenowhere near out of the woods or achieving the goals we would like to beachieving on the platform, and we are not yet achieving what we would like toon the NDS, it’s positive trends on market share.

Doug Creutz - Cowen& Company

Okay, thanks.

Operator

Our next question comes from Ben Schachter with UBSSecurities.

Benjamin Schachter -UBS

John, you were quoted in some media reports talking aboutsome potential experiments and changing pricing structure I think at a lectureyou gave at Berkeley. I was wondering if you could perhaps summarize some ofthose comments.

And then perhaps related to that, could you discuss a bitmore about your strategy, what you see going forward in China, what you arelearning over there?

John S. Riccitiello

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 wasvery 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 onwith microtransactions, a nickel, a dime, a quarter for one aspect of game playor another.

Now, what’s exciting about that is that EA is general -- isachieving on its FIFA franchise a great deal more revenue and a great deal moremargin per user than we did on a similar product in packaged goods. Thequestion is whether the uptake in the western markets is going to be as good asthe uptake in Korea.

And that’s something we can’t know yet, and because ourbusiness model is so robust and the stakeholders all have a vested interest inNorth America in the current model, meaning us with $59 pricing, first partywith a royalty structure, retailers with their share of $59 pricing, andoftentimes license partners like the [leagues], the transition will not takeplace overnight.

I think we all waited for about a decade to get the firstinspiration of convergence that we’ve been hearing about for such a long time.

So what we are doing now is we are very aggressivelyexperimenting in Asia with what we call mid-session games and what that’sallowing us to do is test this exact model. We have several titles slated forfiscal ’08 and ’09 in Korea, China and a couple other markets in Asia, and weare also looking to test some of these on non-core titles in the Westernmarket.

In terms of China and what we are learning over there, Ithink in a simple term, we are learning it’s slow. We are working through a lotof issues. We have a great partner in The9. We are rapidly moving through theprocess of engineering and launching FIFA Online on an MSG model with The9 in China,and there’s titles, several titles, slated to follow on.

It’s actually progressing to scale and to the timescale thatwe had originally anticipated. From a personal level, this stuff just takestime and it frustrates me a little bit but the good thing is we’ve got a greatpartner and it seems to be working.

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

Benjamin Schachter -UBS

Thank you.

Operator

We’ll now go to Brent Thill with Citigroup.

Brent Thill -Citigroup

Thanks. Regarding Rock Band, can you just give us a sense ofyour level of comfort addressing the demand environment over the holidayseason?

John S. Riccitiello

If I were you, on the 19th of November, I would get in lineoutside your favorite retailer because we’ve got one hot product, it’s $169band-in-a-box. It’s going to -- we’ve got a lot of inventory coming and myexpectation is that it will sell through. So just remember November 19th, youare going to be waiting in line, unless you’ve got a buddy that works at one ofour retailers, you’re not going to have it at Christmas.

But seriously, it’s going to be a hit title. We are going tobe following it through with a subsequent launch in Europe at the end of our Q4and we expect it to be similarly strong there.

This is definitely not a sprint. We are not going to be ableto put enough inventory to meet demand in North America and Europe thiscalendar year or this fiscal, and we expect this to sell through both thebalance of FY08 and through FY09, with songs coming every week, [inaudible]SKUs, all sorts of stuff and we could not be more pleased with our partner inMTV. The muscle they bring to this, the intelligence they bring to it, thedrive, the marketing, the cross-selling -- these guys are doing a great job to-- the way we work together on the operating side to pull off something thatwas almost impossible, which was to get this inventory on this timeline in themarketplace with a product this good. It feels great.

Brent Thill -Citigroup

Thanks, John.

Operator

Our next question will come from Mike Hickey with JancoPartners.

Mike Hickey - JancoPartners

Thanks for taking my questions. If you could please justupdate us on three titles: Spore, Sims 3, and Warhammer, and if you could givea little bit of details as to the delay of Warhammer. We’ve heard that there’sjob cuts already. That’s probably part of your reorg or restructure, whateveryou call it, but if you could give us some insight there, that would be great.

And then on the PS3, certainly the installed base hasincreased, a more relevant market for you, but also it seems like the attachrate appears to be lagging. If you look how Sony is positioning the product tothe market this holiday with the Spider-man Blu-Ray, I mean, it looks like it’sa low-priced, and always has been, I guess, Blu-Ray player. But do you feelthat the attach rate will continue to lag, in particular the 360? And how doesthat impact your forecast going forward?

John S. Riccitiello

Let me take the last one last, the Blu-Ray issue last. Idon’t know if you recall, but they launched the PlayStation 2 with a DVD drivewith a movie at the time. It was The Matrix and it proved to a very smartstrategy for increasing the installed base and helped propel them to amarket-leading position. They are doing the exact same thing. It appears to bea smart strategy. I would applaud what they are doing.

Attach rates are not something you measure in a period of acouple of weeks. Attach rates are something you measure in two, three andfour-year timeframes. We are going to be paying very close attention to attachrates, particularly in Q3 and then in Q1 and Q2, calendar Q1 and Q2 of calendar’08.

The reason is we are now starting to see titles thatdemonstrate the power of this platform. One in particular that I draw yourattention to is one we are shipping in January, which is Burnout, coming out ofour U.K. studios.

I don’t want to jinx it by telling you how highly rated Ithink it is going to be but it is going to be a very highly rated and verysuccessful title. It’s the kind of thing that you’d say hey, Ma, come in theliving room, look what my TV can do, I didn’t know it was possible. That kindof stuff is what drives attach rates and unfortunately, Sony hasn’t had enoughof that until now.

And starting this Q and then in January and following withthings like GTA and Killzone and Metal Gear Solid, you’re going to see it flushout. 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 itout of the fiscal year in April of this year. The title continues to progressvery well. We are confident in the decision we made. Above all, for a titlelike this and for everything we do, we need to stand for quality and that was adecision for quality.

Relative to Sims 3, I appreciate you asking the question. Wehaven’t put any information out on the title yet and we will certainly give youa private call when we do. Jokes aside, we’ll let you know when we make theannouncement.

In terms of Warhammer, count on the first half of our fiscalyear. Frankly, this is a pretty straightforward situation and I want toemphasize to the team in Mythic, no, we are not having you be part of ourrestructuring. Just because you asked the question, I’m sure there is somebodythere listening. That is not the plan. We are investing in the growth of thatstudio, 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 franklythe talent and inspiration of the team to invest behind quality, we’re going togive a little bit more time, a little bit more money, and we think we are goingto have a little bit more of a hit on our hands. So, simple.

And you’re safe, Mark.

Operator

Our next question will be from Heath Terry with CreditSuisse.

Heath Terry - CreditSuisse

Great. Thank you. I was wondering if you could just talk tous a little bit about what your, in a little more detail about what youroutlook for the Wii market is. We are obviously seeing a ton of Wii productcoming into the market in the holiday season. Attach ratios on the system havebeen relatively low and really outside of that and then Zelda, we’ve yet to seea real successful title on the platform.

As you are planning for the future, particularly given thelow, seemingly low barrier, low cost to creating a Wii game and theproliferation or product, how are you thinking about your development for thesystem versus the others? And where would you say you are kind of weighting thethree platforms as you are putting new product into development today?

John S. Riccitiello

Let me tell you that we are very excited about the Wii. Iwill admit that there is a massive number of titles coming forward. My sense isit’s got a pretty wide range of quality, and I’ll touch on that in a second.But ours is an industry that’s never been about the number of titles. In agiven year, our industry sees 3,000, 4,000, 5,000 releases and no on in thisroom, including myself, can name more than 100.

So it’s not really about the large numbers; it’s about thetitles that matter and so far, other than Nintendo, there have been preciousfew titles produced for the Wii that matter. One of the titles that does matterand it’s doing extremely well is My Sense, but that’s an example of somebody,in this case, us, our Sims team, building a game that’s tailored for theplatform and the audience and is well-crafted and the numbers are solid. Weneed to do more of that type of thing to take advantage of the platform andthat’s just precisely what we are doing.

We’ve made progress in sports this year with our familymode, yet again something tailored for the platform. To be honest with you, ona 10-point scale of how tailored is it, it’s two on a 10-point scale. So we’vegot eight points to go, but it’s better than not tailored at all and we willmake further progress in the coming year.

And then you’ve heard about titles that we’ve announced, newintellectual properties like Playground and our Spielberg partnership titlecoming out in Q4 that are specifically tailored for the platform.

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

Heath Terry - CreditSuisse

Thank you.

Operator

Our next question will come from Justin Post with MerrillLynch.

Justin Post - MerrillLynch

A couple of questions. Warren, can you first reconcile theEPS guidance? How much is the acquisition costing you and given that you hadupside this quarter, just maybe you can quantify the Warhammer effect?

And then secondly, John, long-term R&D is obviously ahuge part of the street cycle peak EPS numbers. Where are you with R&Dafter this cut and can you give us any thoughts on your efficiencies and whatyou think you can still do next year as far as getting efficiencies? Thank you.

Warren C. Jenson

I’ll go ahead then and take the first part of the question.As announced here a couple of weeks ago with the VGH acquisition, theacquisition impact is $0.05, and we did obviously over-perform in Q2.

I think you’ve also noted that there are a couple of thingschanging. In terms of negatively impacting our financial performance, there isa negative financial impact associated with Army of Two moving from Q3 to Q4for the fiscal year, but again as John mentioned, that was a decision forquality and for the title and we thought far better to sacrifice the short-termprofitability for the long-term health of that franchise.

The second aspect, negative financial impact, is Warhammermoving out of the fiscal year. Again, we think the right long-term deal but forthe 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 a strong foreigncurrency movement. We also have confidence in our titles and we have anexceptionally strong lineup for our EA Partners titles.

So net net, all of that sort of washed out, with the onlyoffset being the $0.05 of dilution coming from the VHG acquisition.

John S. Riccitiello

To your question about R&D leverage, the impact of theadjustment we just made with our facility closures, let me start by telling youthat I am not going to give you a specific answer to long-range guidance or theshape of our P&L in FY09. We will do that in a better way with long rangeviews at our February 12th analyst meeting.

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

But I think the broader story is that we fundamentallyshifted trajectory in terms of our headcount and costs and we intend tocontinue to shift trajectory in headcount and costs.

In round numbers, what we’ve been doing is moving thecomplexion of our workforce, so last year, we finished the year with between7,800 to 7,900 full-time heads. We currently have, we expect to finish thisyear between 8,200 and 8,300 heads.

But here’s the trick; we’ve added -- of the total add ofabout 400 heads, all 400 are in low cost locations in Eastern Europe, China,India, and other comparable locations, and so that’s what we get post thisadjustment, post this restructure. For the first time in several years, we arepancake flat on heads in western markets where it costs a lot to employ peopleand that’s the type of adjustment that I was referring to in recent calls whenpeople are 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 costas high as one might otherwise be projecting for the business.

Justin Post - MerrillLynch

Thank you.

Operator

Our next question will come from [Rick Kaiser] with SanfordBernstein.

Rick Kaiser - SanfordBernstein

Thanks for taking my question. Two quick things first;firstly with respect to advertising, did I correctly here you say that in-gameadvertising was $5 million in the quarter?

Warren C. Jenson

That is correct.

Rick Kaiser - SanfordBernstein

I’m just slightly surprised at how small that was. I thoughtwith Need for Speed, you did $5 million on just that one game, and here you’vehad a couple major releases in the quarter. Can you just help me understandthat?

Warren C. Jenson

I think it will build over time. At the end of the day, Needfor Speed is a big title. It’s coming again this holiday season and we’d expectthese numbers to build over time. To start for this quarter having $5 millionwe think is a success and as we move into the holidays and beyond, we hope tobuild from there.

Rick Kaiser - SanfordBernstein

Wouldn’t we be thinking that Madden could generate $5million in a quarter, given 4 million units?

Warren C. Jenson

I think you have to look at a couple of things when you talkabout in-game advertising. One is recognize where you have a licensed property,you are also going to have different splits as there are different people thatare involved. Microsoft has a piece, we have a piece, and the NFL has a pieces,so --

John S. Riccitiello

And there’s restrictions in terms of who the advertisers canbe. We are largely restricted to sponsors. That’s not the way it’s always goingto be. I really think when it comes to in-game advertising, the way to thinkabout it is it will be some day a great business. It is not today.

Most people involved in the business are investing spendingto establish position and it’s just currently not at all at scale. It’s awobbler at the moment with lots of long-term potential.

Warren C. Jenson

And just to give you a little more perspective, if you lookfor our entire fiscal year, I’d estimate that this number is going to besomewhere in the $25 million to $30 million number for us. But again, we’rejust getting started and take things from there.

Rick Kaiser - SanfordBernstein

What was the inventory sell-through, approximately? Is itstill around 30% like it was with Need for Speed, or do you have any colorthere?

John S. Riccitiello

That’s just not something we can get into.

Rick Kaiser - SanfordBernstein

Okay, fine, and just another really quick question, and thisis more longer term; you’ve talked a lot about production value or what it willtake 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 asense for, are we one to two years out on 360 and maybe four years before wehit that point in PS3? And then with respect to Nintendo, just how we shouldthink about when are the games really going to take full advantage of thedifferent platforms.

John S. Riccitiello

I think that’s a really hard thing to answer withoutanything sort of specific. Let me draw you back to the last generation. Ipersonally thought in 2001 and 2002 when I was looking at and buyingPlayStation 2 games, I was looking at what was close to optimal. And what I sawcoming out in 2003, 2004, 2005 frankly astonished me relative to how muchbetter those titles would get.

And what was happening as people were getting off of therelatively standard tools, they were writing specific code to the metal andmaking better software, particularly graphics, they were getting faster frame rates,they were getting smarter about lighting, animations got better. It was anastonishing pick-up in quality that I didn’t see coming at the beginning of thecycle.

Each of the current platforms have different strengths andweaknesses. So on the PS3, I think you are going to see, frankly start tofinish 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 aregetting better and learning more as we go, but it’s incredibly powerful.

When it comes to the Xbox 360, their sweet spot is theinterplay between online and traditional high-end game play and graphics, and Ithink we are actually getting some pretty good experiences. Halo is aparticularly good experience that was released by Microsoft a short while ago.

On the Wii, Nintendo’s mastered it better than anybody. Idon’t know if you’re -- if you’re like me, I find it pretty hard at this pointin time to even go through menus on the Wii because most of us haven’t done asgood a job as we could. A lot of the games have got menus that feel an awfullike menus on a PS3 or menus on the 360, which are designed for a differentinput device, a different type of controller. Simple things like that, I thinkit improved. As we get as good as Nintendo at these things, it will reallystart pushing out that platform.

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

And so I think -- think of it this way -- they are allprobably going to get better in steps throughout the cycle. I don’t thinkthere’s going to be a point in time where it feels like it is night and dayother than the PS3 about right now. So between some titles coming out late inthis quarter and the first half of next year, you are going to see the firstgames that I think start to show the promise of the PS3.

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

Rick Kaiser - SanfordBernstein

Great. Thank you very much.

Operator

Our next question will come from Tony Gikas with PiperJaffray.

Tony Gikas - PiperJaffray

Good afternoon. A couple of quick questions; John, maybe youcould just update us on your market share expectations? I think you talkedabout this a little bit on the last conference call, and when you expect tostart taking some meaningful share and where you might be at the end of thenext fiscal year? And then also, a quick update on the number of incrementalnew brands that you will be launching over the course of the next fiscal year?

John S. Riccitiello

Incremental new brands?

Tony Gikas - PiperJaffray

Right.

John S. Riccitiello

So first off, I’m actually pretty pleased to tell you thatthe dismal share performance that we had in calendar ’07, those quarters arelargely behind us. Sequentially, we picked up three market share points to 19 in Europe in the last quarter, 16moving to 19 and North America from 11 to 24. And we are expecting to dopositive pick-up from both those positions in quarter four, to finish the yearapproximately with 20% of the game business in Western Europe and North Americaconsolidated across all platforms.

So as a starting point, that is, I will admit, that is downtwo points from calendar year 2006. But the decline is in the past. We areholding our own in Q3 and Q4.

So would I rather be telling you that we have market sharegains this year? Absolutely. What we really had was a hole in the first half ofthe year and we are making up some of it in the second half of the year andcoming out strong at the end to finish with a net two points down.

The good thing is it gives us something to shoot for in2008.

Now, in terms of new brands next year, there’s a bunch, sowe’ve talked an awful lot about Spore, partly because I got addicted to it evenin 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’sgoing to help us on a number of platforms, including some that we’ve just beentalking about like the Wii and the DS, so we’ll pick up there and there’s alarge number of products in development there.

We have announced that we are working on a horror thrillercalled dead space. That will be in the marketplace.

There’s Warhammer which we are going to bring out MMO, andthen there is a bevy of things including Mercenaries 2 coming from VGH, ourbuy-ware pandemic partners. And there’s other titles coming there that we havenot yet announced and aren’t prepared to today.

If we had a long time, I could give you a whole lot more, butEA is definitely coming into the swing of things relative to new title andbrand launches.

Tony Gikas - PiperJaffray

Okay. Great job. Thanks.

John S. Riccitiello

One more question.

Operator

We’ll take our final question from Arvind Bhatia with SternAgee Leach.

Arvind Bhatia - SternAgee Leach

Thank you. I was wondering if you could talk a little bitmore about the Hasbro relationship. You mentioned you are excited about thatfor next year. What kind of margins should we expect in that? Are they anydifferent from your typical deal? And just some color on the scale of that.

John S. Riccitiello

This type of partnership is relatively unprecedented in thegame industry or the toy industry. Most typically what happens is a companylike Electronic Arts or Activision or THQ will work with a party on one or twoor three or five properties at most or multiple years around one property.

EA and Hasbro have joined together in what amounts to a verylarge scale joint venture. It is structured as a licensing partnership but thebusiness partnership is much deeper than that. We are working with each otherin ways that I think most wouldn’t imagine. We’ve spent -- in fact, our teamhere was recently at Hasbro headquarters with their President and Chief OperatingOfficer, Brian Goldner, going through line review for Hasbro and for EA andlooking for ways our products could intercept in the years to come, and findinga lot of good ways for that to happen.

So looking at it from that as a starting point, we are verybullish about the Hasbro intellectual parties and the ability to exploit themin a number of fronts. If I start with mobile, I think all of you know that ourcompetitors have a number of mobile properties at the top of the charts. Onmobile, they are not our properties. They are their properties, but they willsoon be our properties and we are very pleased about that.

In the casual space on PC, clear application of Hasbroproperties, whether it be Monopoly or Scrabble or Nerf, et cetera. We’ve gotsome surprising development against next generation consoles, which we haven’tyet announced, around -- actually, some things we haven’t yet announced butthey are going to be pretty interesting and exciting. I was about to give yousomething where you’d triangulate on it.

But it will be shortly announced, and we’ve also got a lotgoing on this one with what we believe we can do on platforms like the Wii andthe Xbox 360 Live Arcade.

So think of this being a core pillar for EA in the years tocome and a core pillar for Hasbro in the years to come and look for some prettyinteresting ways that our partnership will I think try and do something betterthan a straight license.

In terms of margins, we really haven’t divulged the detailsof the partnership but we are projecting it to be a highly profitable businessfor Electronic Arts in years to come.

Arvind Bhatia - SternAgee Leach

Aren’t they also doing some things, some toys based on whatyou are -- some of your properties?

John S. Riccitiello

I’m sorry, what was that?

Arvind Bhatia - SternAgee Leach

Are they also doing some toys and other things with yourassets?

John S. Riccitiello

We are working on a lot of things that are their toys thatare inspired by interactive activity, and I won’t go further than that. Andit’s a possibility that they will be making some things with some of ourproducts, and that’s contemplated in the partnership but not yet announced.

Warren C. Jenson

Excellent. Thanks, everyone, for joining us.

Operator

That does conclude today’s conference call. We do appreciateeverybody’s participation and have a good day.

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