Here’s the entire text of the prepared remarks from Electronic Arts’ (ticker: ERTS) Q2 2006 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Tricia Gugler, Director, Investor Relations
Warren Jenson, Chief Financial and Adminstrative Officer
Larry Probst, Chairman and Chief Executive Officer
Frank Gibeau, Executive Vice President, General Manager, North American Publishing
Gary Cooper, Banc of America
Brian Pitz, Morgan Stanley
Glen Reid, Bear Stearns
Justin Post, Merrill Lynch
Anthony Gikas, Piper Jaffray
Edward Williams, Harris Nesbitt
Evan Wilson, Pacific Crest Securities
Shawn Milne, Friedman, Billings, Ramsey Group
Jeetil Patel, Deutsche Bank
Heath Terry, Credit Suisse First Boston
Arvind Bhatia, Southwest Securities
Mike Hickey, Janco Partners
Colin Sebastian, Thomas Weisel
Mike Wallace, UBS
Chris Frost (ph), Analyst
Good day, everyone, welcome to the Electronic Arts Second-Quarter Fiscal Year 2006 Earnings Conference Call. Today's call is being recorded. For opening remarks and introductions I would like to turn the call over to Miss Tricia Gugler, Director of Investor Relations. Please go ahead.
Tricia Gugler, Director, Investor Relations
Good afternoon and welcome to our second-quarter fiscal 2006 earnings call. Today on call we have Larry Probst, Chairman and Chief Executive Officer, Warren Jenson, Chief Financial and Administrative Officer and Frank Gibeau, Executive Vice President and General Manager of North American Publishing. Before we begin I would like to remind you that you may find copies of our SEC filings, our earnings release, and a replay of our webcast on our web site at investor.ea.com. Shortly after the call, we will post a copy of Warren's remarks on our web site. Throughout the call, we will present both GAAP and non-GAAP financial results. Non-GAAP results exclude charges associated with restructuring, asset impairment, other temporary impairment of investment and affiliates, apart in process technology, amortization of intangibles, employee stock-based compensation, and certain non-recurring litigation expenses and their related tax effects. In addition, the Company's non-GAAP results exclude the impact of tax adjustments. A supplemental schedule to our earnings release provides the reconciliation of non-GAAP to GAAP measures. In addition, a supplemental schedule demonstrating how we calculate ROIC will be included on our web site. All non-GAAP measures are provided as a complement to our GAAP results and we encourage investors to consider all measures before making a decision. All comparisons made in the course of this call are against the same period of the prior year unless otherwise stated. We have included our trailing 12-month platform shares in our 2005 estimated market outlook in a supplemental schedule that will be posted on our web site.
During the course of this call, we may make forward-looking statements regarding future events and the future financial performance of the company. We caution you that actual events and results may differ materially. We refer you to our most recent form 10-K and 10-Q for a discussion of risk factors that could cause our actual results to differ materially from those discussed today. We make these statements as of November 1, 2005 and disclaim any duty to update them. Now, I would like to turn the call over to Warren.
Warren Jenson, Chief Financial and Administrative Officer
Thanks, Tricia. Good afternoon, everyone, and thanks for joining us. Our second-quarter results were solid, netting the ins and outs of title moves, particularly FIFA in Europe, we extended the top end of our revenue guidance and soundly came ahead on the bottom line. Sports, is off to a great start. Our North American segment share is a record 75%, up 7 points from this time last year. Of the top ten sports titles, we have nine on the PS2 and eight on the Xbox. Madden NFL '06 took only three weeks to become the number one console title for the year in North America. Through the end of the quarter, we sold an excess of 4 million copies. With 12 weeks of retail data, we estimate sell-through is up in the high-teens year-over-year. NCAA Football 2006 has sold over a million and a half copies, and we estimate sell-through is up over 15%. FIFA ‘06 launched very strongly. So far we estimate our sell-through is pacing more than 30% ahead of last year, FIFA was at the top of the charts in Europe for three consecutive weeks. The competition is heating up, but we are very pleased with our performance and like our prospects. NBA Live 2006, while only a week's worth of industry numbers are formally in, we estimate that we are outselling our nearest competitor by a factor of 5. NBA Live has now surpassed the billion-dollar lifetime sales mark becoming EA’s fifth billion-dollar franchise. Burnout Revenge sold more than 1.8 million copies and joins Battlefield 2 as the top ten rated title for the year. Year-to-date, our overall quality rating as measured by Metacritic leads all major third-party publishers, roughly 50% of our titles have been rated 80 or higher, double the industry average of 24%.
On the PSP, we were the number one publisher in North America with a 27% segment share and four top ten titles. In Europe, we estimate that our segment share was approximately 16% and that we were the number one third-party publisher. Now while we are pleased with our overall title performance in the quarter to be balanced, we have also seen some recent softness at retail in North America. On mobile phones, we continue to build our foundation. We have recently entered into a distribution agreement with Vodafone to deliver games in Europe, Egypt, Australia, South Africa and New Zealand.
In addition, during the quarter, our games did well. For September, we have four top 20 titles on Verizon mobile handsets, Madden 2D, Poppit, Madden 3D and Need for Speed Underground 2. In the UK, FIFA is already the number one title on the Vodafone platform. We are also pleased this quarter to have announced a groundbreaking partnership with Steven Spielberg for the creation of three new intellectual properties. In summary, we think we are off to a solid start for the year.
For next few minutes, I will focus my remarks in two areas. First, I will review our Q2 financial results. Second, I will go over our outlook and financial guidance. Following my comments, Larry, Frank, and I will open the call to your questions.
Q2 performance. Net revenue was $675 million down 6% from a year ago driven by lower PC, console and co-publishing related revenues. Partially offset by a significant increase in revenues for mobile platforms. Remember that last year, we launched Sims 2 on the PC. This quarter we released 37 SKUs in the quarter, of which seven were associated with mobile platforms. Last year, we launched 33 SKUs, two of which were mobility based. Six titles went platinum in the quarter versus four a year ago. Madden NFL ‘06, NCAA Football, Burnout Revenge, FIFA 06, NBA Live and The Sims 2 Nightlife.
As compared to our Q2 guidance, product shifts added approximately $30 million net to our top line and approximately $.05 as GAAP and non-GAAP EPS. Console revenue was $467 million down 5% year-over-year. While there were single-digit declines on both the PS2 and Xbox, the most significant decline was on the Game Cube. PC revenue was $91 million, down 35% due to the strong launch of The Sims 2 last year. This decline was partially offset by the continued strength of Battlefield 2. Mobility, revenues were up fivefold to $62 million. The increase was driven by the PSP and to a lesser extent the NDF. The European PSP launch was solid. In Europe; Burnout Legend and the Need for Speed Rivals charted in the top five games. Co-publishing and distribution revenue was $32 million, down $17 million year-over-year, driven by the reclassification of the Battlefield franchise to PC. Internet services, licensing and other was $23 million, flat to last year.
As of today, Club POGO paying subscribers have reached 1 million, up 75% from a year ago. Geographically, North America revenue was $443 million down $30 million or 6% year-over-year. All console platforms in the PC were down in the quarter while overall mobile revenues were up significantly. Essentially the improvements in mobile did not completely offset the prior year strength of Def Jam Fight for NY and The Sims 2. Europe revenue was $191 million down $19 million or 9%. The decrease was driven principally by lower PC and co-publishing related revenue which was partially offset by sales on the PSP and PS2. Console revenues for the quarter were flat year-over-year given this year's launch of FIFA. Asia revenue was up 24% year-over-year, driven primarily by the PSP and PS2. Changes in foreign currency rates had no significant impact on our top line in the quarter. With that said, we continue to expect currency movements to negatively impact the back half of the year.
Moving on to the rest of the income statement. Gross profit in the quarter was $391 million, down 9%. Gross margin was $ 57.9% versus $60.3 a year ago. The decline was driven by higher licensing royalty rates and a higher mix of royalty-based titles. These negatives were partially offset by lower development royalties. Last year we accrued for royalties on Burnout. This year we own the IP.
Marketing and sales. Marketing and sales expense was $107 million flat to last year. G&A. G&A was $52 million, up $10 million year-over-year and relatively flat with last quarter. The year-over-year increase was primarily driven by increased headcount, a slight increase in litigation cost, and slightly higher bad debt expense. While this increase is significant, we continue to expect G&A for the full year to be up in the mid single-digit range.
R&D. R&D was $182 million, flat to last quarter, and up $25 million from a year ago. The increase was driven primarily by higher staffing levels, resulting from the development of next generation tools, technologies, and titles. This increase was partially offset by lower third-party development advances in the quarter. R&D related headcount was up 39% to roughly 4700. Acquisitions account for approximately 12 points of this increase. Please remember that we are investing ahead of next generation revenue. We record the expense today, but the revenue comes later. Diluted earnings per share, was $0.16 versus $0.31 a year ago. Non-GAAP diluted EPS was $0.15 versus$0.31. Our effective tax rate was 15% versus 29%. Our Q2 rate includes a $9 million favorable net tax adjustment. This amount was excluded from our non-GAAP result.
Our trailing 12-month operating cash flow was $592 million versus $664 million for the comparable period. We have now completed our $750 million share repurchase program, buying a total of 13.4 million shares. Our diluted share count was $314 million versus $316 million a year ago.
On to the balance sheet. Cash, short-term investments, and marketables were $2.4 billion down 686 from March. The decrease relates primarily to the repurchase of our common stock. Gross accounts receivable were $465 million versus $502 million a year ago, a decrease of 7%. Reserves against outstanding receivables totaled $137 million, up 11% from a year ago. Reserve levels were 13% as a percentage of trailing six-month net revenue, up two points from last year. As a percentage of trailing nine-month net revenue reserves were 9%, also up 2 points. Inventory was $74 million, up $8 million from June, driven by the inventory build for the launch of FIFA 06. Other than FIFA no one title represented more than 4 million of net exposure.
Now on to our outlook. Before we get into the numbers, let me just stop and mention a few things. First, we are ready for the Xbox 360. We will be supporting the launch with five great titles including madden NFL, Need For Speed, FIFA road to the world cup, tiger and NBA live. By year end we plan to release three additional 360 SKUs, Fight Night Round 3, Battlefield Modern Combat, and Burnout Revenge. Currently we are actively developing over 35 SKUs for the Xbox 360, PS3 and Revolution. Second, we are ready for the holidays. Need for Speed Most Wanted and Harry Potter looks great and we expect will be solid hits. These titles will be bolstered by FIFA, The Sims 2 on console, Battlefield Modern Combat, and James Bond From Russia with Love to name a few. Our titles will be supported with marketing campaigns second to none in the industry. When you consider the absolute dollar amount we invest in marketing versus that of our competitors, the breadth and depth of our reach is unparalleled. Third, we have a strong lineup of new titles. In the second half of the year, we expect to launch several new first-time titles including Godfather, Black, Arena Football, NCAA Baseball and NFL Head Coach.
Owned intellectual properties. For the year, we expect revenues from owned IP will exceed $1.3 billion, an increase of 15% year-over-year. And finally, a final word of caution. Expect the unexpected. We are in transition. We could experience production or development snags or abrupt changes in pricing or demand. In addition, as I mentioned earlier in the call, we have seen some recent weakness in North America. I'll conclude my portion of today's call with our market outlook and financial guidance. Our overall market outlook is essentially unchanged. As Tricia mentioned you can find a detailed summary on our web site.
Now on to our financial guidance. The following forward-looking statements reflect our expectations as of November 1, 2005. Our actual results may be materially different and are affected by many factors such as consumer spending trends, the popular appeal of our products, development delays, current generation and next generation hardware availability, the seasonal and cyclical nature of our industry, the overall economy, competition, changes in foreign exchange rates, our effective tax rate, and other factors detailed in our earnings release and in our SEC filings.
Now to the numbers. For the full year, we expect revenue to be between $3.25 and $3.4 billion. GAAP diluted earnings per share to be between $1.40 and $1.55. Non-GAAP diluted earnings per share to be between $1.45 and $1.60. Please note that our GAAP results include up to a $.05 charge associated with the European reorganization and establishment of an international publishing headquarters in Geneva. We expect the charges to be split roughly evenly between our third and fourth quarters. For the quarter ending December 31, 2005, we expect revenue to be between $1.475 and $1.575 billion. GAAP diluted earnings per share to be between $1.15 and $1.25. Non-GAAP diluted earnings per share to be between $1.18 and $1.28. Specifically in the third quarter, we expect to ship 54 SKUs.
Our expected lineup for the third quarter includes Battlefield Modern Combat on console, Modern Combat Mass Expansion Pack on Xbox, Battlefield 2: Special Forces Expansion Pack for the PC, Black and White 2 on the PC, Burnout Legends on NDF, FIFA '06 in North America on four platforms, Half-life 2 on the Xbox, Harry Potter and the Goblet of Fire on seven platforms, James Bond From Russia with Love on three, Lord of the Rings Tactics on the PSP, Marvel Nemesis on two platforms, NBA Live '06 on the PSP, NCAA March Madness '06 on the PSP, Need for Speed Most Wanted on seven platforms, Need for Speed Most Wanted Collector's Edition on three platforms, The Sims 2 on console and hand-held, The Sims 2 Holiday Expansion Pack, Sims bundle for the PC, Total Club Manager '06 on the PC, SSX on Tour on four platforms. On the Xbox 360 we plan to launch five titles, Madden NFL '06 , NBA Live '06, Tiger '06, FIFA "06 Road to the World Cup, and Need for Speed Most Wanted. In addition, on mobile phones we plan to launch seven games. In North America and Europe, FIFA '06, NBA Live 06, Tiger Woods Golf, Need for Speed Most Wanted and Sims 2. In addition, we plan to launch POGO Harvest Mania and POGO Word Whomp in North America.
I will now conclude with a few closing thoughts. First, we are very fortunate to be in the middle of one of the most exciting global growth trends in entertainment today. Second, while there is plenty of risk and we certainly can and will make mistakes, we believe there is no company in a better position to take advantage of this opportunity than Electronic Arts. And third, rest assured, as the team and as a company, we are investing for sustained long-term leadership and we are intent on winning. With that, Larry, Frank and I will open the call to your questions.
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