Electronic Arts Misses, Shares Up - Analyst Blog

Electronic Arts Inc. (ERTS) reported third quarter 2011 results, which missed the Zacks Consensus Estimate of 47 cents. However, shares were up $1.58 (10.12%) in after-hours trading due to a strong growth outlook and the announcement of a share repurchase program.

Operating Performance

Electronic Arts reported non-GAAP earnings (excluding one-time items of $1.42 per share) of 45 cents, significantly up from 20 cents in the prior-year quarter and a loss of 3 cents in the previous quarter. However, this failed to meet management guidance of 50 cents to 60 cents.

The year-over-year growth was driven by strong operating income primarily attributable to lower operating expense in the quarter.

Net income was $150.0 million compared with $66.0 million in the year-ago quarter and a net loss of $10.0 million in the second quarter of 2011.

Gross profit on a non-GAAP basis increased 58.1% year over year and 19.2% sequentially to $827.0 million.

Marketing & sales expense increased 21.6% year over year and 46.2% sequentially to $253.0 million. However, this was partially offset by lower general & administrative (down 10.7% year over year and 2.6% sequentially) and research & development expenses (down 5.9% year over year and 1.4% sequentially).   

Operating income was $226.0 million, up from $112.0 million in the third quarter of 2010 and an operating loss of $4.0 million in the prior quarter.

Revenue

Revenues, including deferred revenue of $357.0 million, increased 4.8% year over year and 59.5% quarter over quarter to $1.41 billion. This was well above the Zacks Consensus Estimate of $1.05 billion and was within management's guidance range of $1.375 billion to $1.5 billion.

The year-over-year growth was primarily driven by strong Digital revenues in the quarter. Electronic Arts released fourteen titles in the third quarter of 2011.

Sales from Publishing (79.0% total revenue) increased 19.0% year over year while revenues from Distribution (6.0% of total revenue) decreased 66.0% in the quarter.

Digital revenues (15.0% of total revenue) spiked up 39.0% year over year to $211.0 million in the quarter, primarily driven by increases in PC digital distribution and downloadable content.

At quarter end, core registered users were 98 million, significantly up from 50 million reported in the year-ago quarter.

Moreover, robust growth from titles played on Apple Inc.'s (AAPL) iPhone and iPad spurred the revenue climb. In the quarter, Electronic Arts was the number one publisher across all platforms in Apple's application store and also on Microsoft Corp.'s (MSFT) Windows Phone 7.

Region-wise, North American sales fell 11.0% year over year. However, Europe increased 29.0% and Asia achieved a growth of 6.0% in the third quarter of 2011.

The company noted that its share in high definition consoles market was 22% in the calendar year 2010 with Electronic Arts retaining its number one publisher position. Electronic Arts also achieved significant market share gains in North America (14.0%) and Europe (17.0%) during the quarter.

In the calendar year 2010, Electronic Arts launched five games – FIFA 11, Medal of Honor, Madden NFL 11, Need for Speed Hot Pursuit and Battlefield: Bad Company 2 – each selling more than five million units.

In December, 2010, Electronic Arts released Mass Effect 2 for the PlayStation 3, which earned a rating of 95. Recently, Electronic Arts released Dead Space 2 with a 91 rating and sales approximating 2 million units.

Balance Sheet

In third quarter of 2011, cash from operations was $349.0 million as compared with a cash outflow of $134.0 million in the prior quarter.  Electronic Arts ended the quarter with cash, short-term investments and marketable securities of $1.86 billion as compared with $1.55 billion at the end of September 30, 2010. The company has no long-term debts.

Electronic Arts initiated a share repurchase program worth $600.0 million, to be completed over the next eighteen months.

Outlook

For fourth quarter 2011, Electronic Arts expects revenue on a non-GAAP basis to be in the range of $850.0 billion to $950.0 billion (previous guidance $850.0 million to $975.0 million).

Earnings per share on a non-GAAP basis are expected to be in the range of 15 cents to 25 cents (previous guidance 13 cents to 23 cents). The Zacks Consensus Estimate is currently pegged at 12 cents for the quarter.

For the fourth quarter, gross profit margin is expected to be in the range of 67.0% to 68.0% and operating expense in the range of $505.0 million to $520.0 million.

The company revised its fiscal year 2011 revenue and earnings guidance. Revenue on a non-GAAP basis is projected to be in the range of $3.682 billion to $3.782 billion (previous guidance $3.65 billion to $3.90 billion). Earnings on a non-GAAP basis are expected to be in the range of 60 cents to 70 cents (previous guidance 50 cents to 70 cents) per share for fiscal 2011.

Management believes that 2011 will be a strong year, driven by quality titles and robust growth in the Digital business.

Electronic Arts forecasts Publishing and other revenue of $2.73 billion to $2.83 billion for fiscal 2011. Distribution revenue is expected to be approximately $200.0 million and Digital revenue to be $750.0 million for the fiscal year 2011.

For fiscal 2011, non-GAAP gross profit margin is expected to be approximately 61%. Operating expense is expected to be approximately $2.0 billion.

The company anticipates its top 20 titles, for fiscal year 2011, to generate roughly 77.0% of total packaged-goods revenue as compared with 76.0% in fiscal 2010.

Electronic Arts expects to release 37 titles (previous guidance 35) for fiscal year 2011, with 10 titles scheduled for the final quarter.

Electronic Arts, on a GAAP basis, expects operating cash flow in the range of $250.0 million to $300.0 million for fiscal 2011.

For fiscal 2012, Electronic Arts forecasts double-digit earnings growth on a non-GAAP basis, driven by aggressive growth from the Digital segment.

Our Take

Electronic Arts remains focused on delivering quality titles, which we believe will drive significant top-line growth going forward. The company's impressive product pipeline would guarantee market-share gains over the long term.

Moreover, Electronic Arts' increasing exposure to online social gaming and mobile applications and growing contribution from the Digital business remain the primary long-term revenue drivers.

However, weakness in the overall packaged-goods sector, compounded by intense competition from Activision Blizzard Inc. (ATVI) and Take-Two Interactive Software Inc.(TTWO), will hurt profitability long term.

We remain Neutral on Electronic Arts on a long-term basis (6-12 months).

Currently, Electronic Arts has a Zacks #4 Rank, which implies a Sell rating over the short term.

 
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