EA Beats, Reaffirms Guidance - Analyst Blog

Electronic Arts (ERTS) reported second quarter 2011 results and reaffirmed its fiscal 2011 guidance. Loss per share narrowed down to 2 cents as compared with a guidance of 10 cents to 15 cents, primarily driven by strict cost control and higher gross margins.

Loss per share, which includes stock-based compensation but excludes one time items, was well above the estimated loss of 26 cents projected by Zacks.

Operating Performance

Gross margin increased to 59.0% in the quarter as compared with 48.0% in the prior-year quarter, driven by a greater percentage of higher-margin digital revenues and Electronic Arts' owned catalog titles. Operating margin, including stock based compensation, was 4.0% in the quarter as compared with 2.0% in the prior-year quarter.

Electronic Arts remains on track to reduce annualized operating expenses by $100.0 million in fiscal 2011, attributable to a better leveraged product portfolio, efficient marketing, global sourcing and shared technologies.

During the quarter, Electronic Arts announced a plan to restructure licensing and developer agreements, primarily aimed at improving long-term profitability of its packaged goods portfolio. Electronic Arts expects to incur a one-time charge of $180.0 million in the second half of 2011.

Revenue Details

Revenues on a non-GAAP basis decreased 23.0% year over year to $884.0 million, well above the Zacks Consensus Estimate of $648.0 million and guidance range of $775.0 million to $825.0 million.

The year-over-year weakness was primarily due to lower distribution revenues and fewer title releases, partially offset by strong growth in digital revenues. Electronic Arts released seven titles in the second quarter of 2011 as compared with nine in the prior-year quarter.

Sales from publishing (78.0% of total revenue) fell 11.0% year over year while revenues from Distribution (3.3% of total revenue) decreased 88.0% in the quarter. This was partially offset by strong growth in Digital revenues (Wireless, Internet-derived and advertising).

Digital revenues (18.7% of total revenue) spiked up 20.0% year over year to $166.0 million in the quarter, primarily driven by increases in PC digital distribution and downloadable content.

At second quarter 2011 end, core registered users were 80 million, significantly up from 41 million reported the year-ago quarter.

Moreover, robust growth from titles played on Apple Inc.'s (AAPL) iPhone and iPad also drove further revenue growth. In the quarter, Electronic Arts was the number one publisher across all platforms in Apple's application store.

By geographical region, North American sales fell 27.0% year over year, Europe decreased 16.0% and Asia plunged 38.0% in the second quarter of 2011.

The company noted that its share in the high definition consoles market increased 25.0% at the end of the second quarter of 2011 and Electronic Arts retained its number one publisher position. Electronic Arts also achieved significant market share gains in North America and Europe and its market share increased 23.0% during the quarter.

In the reported quarter, six Electronic Arts games FIFA 11, Madden NFL 11, NCAA Football 11, NHL 11, Battlefield: Bad Company 2 and FIFA 10 were among the 20 top selling games in the North American and European markets.

FIFA 11 was the number one title in Europe in the second quarter. The recently released Medal of Honor sold 2 million units in just two weeks in October.

Balance Sheet

In the second quarter of 2011, cash used in operations was $134.0 million as compared with $148.0 million in the prior quarter. Electronic Arts ended the quarter with cash, short-term investments and marketable securities of $1.66 billion as compared with $1.73 billion at the end of June 30, 2010 and no long-term debt.

Post second quarter 2011, Electronic Arts acquired Chillingo, a leading publisher of iPhone and iPad games for $17.0 million upfront, with up to another $12.0 million to be paid over the next three years.

Outlook

For the third quarter of 2011, Electronic Arts expects revenues on a non-GAAP basis to be in the range of $1.375 billion to $1.5 billion. Earnings per share on a non-GAAP basis are expected to be in the range of 50 cents to 60 cents.

For the fourth quarter of 2011, Electronic Arts expects revenues on a non-GAAP basis to be in the range of $850.0 million to $975.0 million. Earnings per share on a non-GAAP basis are expected to be in the range of 13 cents to 23 cents.

The company reiterated its fiscal year 2011 revenue and earnings guidance. Accordingly, revenues on a non-GAAP basis are projected to be in the range of $3.65 billion to $3.90 billion. Earnings on a non-GAAP basis are expected to be in the range of 50 cents to 70 cents per share.

Electronic Arts believes that 2011 will be a strong year, driven by quality titles and robust growth in the digital business. Management stated that the digital segment worldwide is growing in the range of 25.0% to 30.0% year over year on an annualized basis.

The company continues to expect that the top 20 titles for fiscal year 2011 will generate approximately 77.0% of total packaged goods revenue.

Electronic Arts expects to release 35 titles (previous guidance 36) for fiscal year 2011, with 14 titles in the third quarter and 8 titles in the fourth quarter. Electronic Arts cancelled the release of NBA ELITE 11, which was scheduled for release in the third quarter. This is expected to have a negative impact of 5 cents on fiscal 2011 results.

Our Take

We maintain a Neutral rating on Electronic Arts on a long-term basis (6-12 months), primarily due to better-than-expected second quarter results, a strong product pipeline and a debt free balance sheet.

Our positive outlook is tempered by sluggish video game industry trends, negative cash flow, cancellation and rescheduling of major titles and increasing competition from Activision Blizzard Inc. (ATVI) and Take-Two Interactive (TTWO) that will hurt profitability over the long term.

Currently, Electronic Arts has a Zacks #3 Rank, which implies a Hold rating on a short-term basis (1-3 months).

 
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