EA Betters Estimates; Loss Widens

| About: Electronic Arts (EA)
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Video game developer and publisher, Electronic Arts (ERTS), better known as EA, reported second quarter 2012 results, which improved considerably from the Zacks Consensus Estimate of a loss of 15 cents per share.

EA’s non-GAAP loss (excluding one-time items but including stock-based compensation) of 8 cents per share was much wider than 3 cents per share reported in the prior-year quarter. This was, however, in line with the mid-point of management’s guided range of a loss of 13 cents to 3 cents.

The wider-than-expected loss in the quarter was primarily attributed to higher marketing expenses related to the launch of Battlefield 3 in the quarter. Moreover, number of title releases in the quarter was also low compared with the year-ago quarter (5 versus 7).

Operating Performance

Gross profit on a non-GAAP basis increased 17.0% year over year to $610.0 million. Gross margin remained flat on a year-over-year basis.

Total operating expenses increased 19.2% year over year to $628.0 million in the quarter. Operating expense, as percentage of revenue, increased 100 basis points (bps) year over year from 59.6% to 60.6% in the reported quarter.

The year-over-year growth in operating expense was primarily credited to higher marketing & sales expenses (up 28.3% year over year on a dollar basis), general & administrative (up 14.3% year over year on a dollar basis) and research & development expenses (up 14.8% year over year on a dollar basis).

Operating loss in the reported quarter was $18.0 million compared with a loss of $22.0 million in the prior-year quarter. Net loss on a non-GAAP basis was $26.0 million compared with a loss of $11.0 million in the year-ago quarter.


Revenues, including deferred revenue of $319.0 million, increased 17.0% year over year to $1.03 billion, way ahead of the Zacks Consensus Estimate of $731.0 million. Revenue also surpassed management’s guided range of $925.0 million to $975.0 million.

The beat was primarily driven by improved Digital and catalogue performance in the quarter. Strong performance of FIFA 12, NCAA Football 12, NHL 12, Madden NFL 12 and The Sims Social propelled growth in the second quarter. FIFA 12 sold nearly 8 million units while Madden NFL 12 sold more than 3 million units in the second quarter.

Sales from Publishing (76.0% of the total revenue) increased 14.0% year over year, while revenues from Distribution (3.0% of the total revenue) jumped 7.0% year over year. Digital revenues (21.0% of the total revenue) surged 30.0% year over year to $216.0 million in the quarter, primarily driven by growth in mobile and other handheld revenues and downloadable content (DLC).

DLC and free-to-play micro transaction content increased 33.0% year over year to $85.0 million in the second quarter. Mobile and other handheld digital revenue expanded 8.0% year over year to $55.0 million, driven by strong smart phone-related revenue. In the second quarter, smart phone-related non-GAAP revenue shot up 87% year over year, particularly driven by EA’s continued mobile leadership on Apple Inc.’s (NASDAQ:AAPL) iOS platform.

Full game downloads were $26.0 million, up 44.0% year over year. Revenue from subscriptions, digital advertising and others increased 52.0% year over year to $50.0 million.

At quarter end, core registered users were 140 million, significantly up from 80 million in the year-ago quarter. In social network gaming, EA has 101 million monthly active users. The Sims Social launched in August was the ranked #2 on Facebook. According to AppData, the game has over 8 million daily active users (DAU) and nearly 40 million monthly active users (MAU).

Region wise, North American sales increased 3.0% year over year. Sales from Europe also increased 31.0%, while Asia achieved a growth of 65.0% in the reported quarter. EA emerged as the #1 publisher in the western world with 25.0% segment share in the quarter.

Balance Sheet/Cash Flow

In the second quarter of 2012, cash used from operations were $211.0 million compared with $274.0 million in the prior quarter. EA ended the quarter with cash, short-term investments and marketable securities of $1.50 billion compared with $1.85 billion at the end of June 30, 2011.

In the quarter, EA repurchased 4.7 million shares for $98 million. The company has $353 million remaining under its existing share repurchase authority.


For the third quarter of 2012, EA expects revenue on a non-GAAP basis in the range of $1.55 billion to $1.65 billion. For the third quarter of 2012, non-GAAP gross profit margin is expected to be approximately 67.0%. Operating expense is expected to be $650.0 million.

For the third quarter, earnings per share (EPS) on a non-GAAP basis are expected in the range of 85 cents to 95 cents. The Zacks Consensus Estimate is currently pegged at 78 cents for the quarter.

The company raised its 2012 revenue guidance and the lower end of the earnings guidance. Revenue on a non-GAAP basis is projected between $4.05 billion and $4.20 billion (previous guidance was $3.90 billion to $4.10 billion). Earnings on a non-GAAP basis are expected in the band of 75 cents to 90 cents (previous guidance 70 cents to 90 cents) per share for fiscal 2012.

EA forecasts Publishing and other revenue in the range of $2.65 billion to $2.75 billion (up from $2.55 billion and $2.70 billion) for fiscal 2012. Distribution revenue is expected to be approximately $250.0 million and Digital revenue in the range of $1.15 billion to $1.20 billion for fiscal 2012.

For fiscal 2012, non-GAAP gross profit margin is expected to be approximately 63.0%. Operating expense is estimated to be $2.20 billion.

EA expects to release 22 titles for fiscal 2012, with 6 titles scheduled for the third quarter.

EA on a GAAP basis expects operating cash flow in the range of $250.0 million to $300.0 million for fiscal 2012.

Our Take

Despite beating the Zacks Consensus Estimate, EA shares were down 3.27% in after hours trading. We believe this was particularly driven by a conservative EPS guidance. EA boasts a robust product pipeline for the upcoming holiday season, which is also traditionally the strongest quarter for the company. Battlefield 3 has already hit the stores and EA is scheduled to release the much-hyped Star Wars game in the latter half of this quarter.

However, we believe EA will face stiff competition from Activision Blizzard Inc. (NASDAQ:ATVI) in the upcoming holiday season sales. Activision is scheduled to release the latest installment of its top-selling franchisee Call of Duty in November this year. We also believe EA’s margins will remain under pressure in the upcoming quarters due to higher marketing costs related to the Star Wars franchise.

Nonetheless, we believe EA has a strong product pipeline for fiscal 2012 and beyond that will drive top-line growth going forward. We believe that high quality titles, impressive product line, increasing online exposure, social games and portfolio diversification guarantees market share gains over the long term.

We have a Neutral recommendation on Electronic Arts over the long term (for the next 6 to 12 months). Currently, Electronic Arts has a Zacks #3 Rank, which implies a Hold rating in the short term.