In its second quarter results released October 29, Take-Two (TTWO) exceeded non-GAAP revenue estimates, generating $1.3 billion in sales, $400 million more than expected and a sizable increase from $280 million in the comparable quarter. Non-GAAP earnings per share also exceeded consensus expectations by $0.84 per share, with the company earning $2.49 during the second quarter.
Year-to-date, free cash flow totaled $120 million, but that figure simply does not tell the story. Because non-GAAP results include only sell-in numbers, the company hasn't received cash just yet. However, accounts receivable now exceeds $1 billion, equal to over 60% of the current market cap. The vast majority of that figure will be converted to cash that Take-Two can allocate going forward.
CEO Strauss Zelnick also made a bold claim, declaring:
"We're better positioned than ever to deliver returns for our shareholders and expect to be profitable on a non-GAAP basis in fiscal 2015 and every year for the foreseeable future."
The only negative during the quarter was that the non-GAAP revenue provided by the company considers sell-in (selling to retailers with the risk that the retailer will return unsold inventory). It is possible that the retail channel may be stuffed with inventory that won't sell ahead of a shift to the next generation of gaming consoles. Though this is a fair point, we think management made it clear that demand was robust heading into the holiday season. Additionally, we doubt the console refresh will prevent gamers from purchasing GTA V.
How about EA?
Electronic Arts (EA) is probably best known for its sports catalog, which includes Madden, FIFA, NHL Hockey, and NCAA Football. It also recorded results for its 2014 fiscal year second quarter. Non-GAAP net revenue was roughly flat compared to the year-ago period at $1 billion, but the performance still exceeded consensus expectations. Non-GAAP earnings per share more than doubled to $0.33, compared to the slight decline analysts had predicted.
EA's strong earnings didn't come from robust sales growth, but rather from more disciplined marketing spending, which declined by $55 million compared to the year ago period, and a $23 million reduction in research & development expenditures. There's nothing wrong with cutting unnecessary waste and becoming a leaner company, but all things equal, we'd rather see a firm drive earnings growth with additional revenue (Take-Two) rather than via cost cuts (Electronic Arts).
Both companies guided to strong 2014 fiscal years. In the case of Take-Two, the firm guided to full-year non-GAAP earnings per share range of $3.50-$3.75 compared to the Street's consensus of $2.80 per share. EA, on the other hand, guided to non-GAAP earnings per share of $1.25 versus a consensus estimate of $1.22.
Both Take-Two and EA posted solid second-quarter results, but we think Take-Two's quarter was better, mostly because of the revelation that the company anticipates being profitable from now on. Take-Two also noted a strong pipeline of future games, and it should be able to benefit from a console tailwind.
Still, the video game industry is inherently risky. We use a wide range of fair values to capture the boom-and-bust nature of the industry. We're not rushing to add exposure to this area in our actively-managed portfolios.