Electronic Arts Inc. (EA) reported earnings of 25 cents per share in the second quarter of fiscal 2014, comprehensively beating the Zacks Consensus Estimate by 23 cents. Earnings were much better than the year-ago quarter earnings of a penny.
Earnings include stock-based compensation but exclude acquisition-related expenses, amortization of debt discount, change in deferred net revenue, college football settlement expenses, gain on strategic investments, restructuring and other and related tax effect.
Revenues (including change in deferred revenues) decreased 3.7% from the year-ago quarter to $1.04 billion but were much better than the Zacks Consensus Estimate of $976.0 million. Revenues were also higher than management’s guidance of $975.0 million.
The year-over-year decline in revenues was primarily attributed to sluggish sales of some EA Sports published titles such as NCAA Football 14, Madden NFL 25 and NHL 14. However, this was partially offset by another strong performance from the digital segment.
Digital revenues jumped 11.0% year over year to $348.0 million (33.5% of revenues) in the quarter. EA’s publishing and other segment (64.4%of revenues) revenues declined 10.0% from the year-ago quarter to $670.0 million. Distribution revenues remained flat on a year-over-year basis at $22.0 million.
The improvement in digital revenues was fueled by a 11.0% increase in extra content and free-to-play segment. Revenues were positively impacted by strong sales of FIFA Ultimate Team, Star Wars: The Old Republic and FIFA Online 3.
Mobile business’ revenues improved 30.0% from the year-ago quarter in which games such as The Simpsons: Tapped Out, The Sims FreePlay and Real Racing 3 were the main contributors. During the quarter, the company released Plants vs. Zombies 2, which also contributed to growth.
Moreover, buoyed by the robust performance of SimCity and deferral of SimCity first quarter revenues, last quarter full game downloads recorded 42.0% year-over-year growth. However, advertising and other digital revenues declined 16.0% from the year-ago quarter.
Region-wise, North American sales (42.0% of revenues) decreased 14.0% year over year to $439.0 million while international revenues (58.0% of revenues) increased 5.0% from the year-ago quarter to $601.0 million.
EA’s gross margin (excluding acquisition-related expenses and change in deferred net revenues) expanded 150 basis points (bps) year over year to 61.6% in the second quarter. The solid margin expansion was primarily led by robust digital revenues and reduction in online support cost.
Operating expenses (before acquisition-related contingent consideration, amortization of intangibles, restructuring and other but including stock based compensation) as a percentage of revenues declined 250 bps from the year-ago quarter.
The year-over-year decline was primarily attributed to lower marketing & sales expense and research & development expense, which decreased 450 bps and 110 bps, respectively. General & administrative expense increased 310 bps from the year-ago quarter.
A higher gross margin base and lower-than-expected increase in operating expenses helped operating margin (including stock based compensation expense but excluding one-time items) to expand to 10.1% from 2.2% in the year-ago quarter.
Net income (including stock based compensation) was $69.0 million compared with $5.5 million in the year-ago quarter.
Balance Sheet and Cash Flow
EA exited the quarter with $1.42 billion in cash, short-term investments compared with $1.41 billion in the previous quarter. Cash used in operating activities were $6.0 million.
For the third quarter of fiscal 2014, EA expects to generate non-GAAP revenues of approximately $1.65 billion. The company expects non-GAAP earnings to be $1.22 per share.
Non-GAAP operating expense is expected to be $600.0 million, impacted by phasing of operating expenses from previous quarters. In the third quarter, EA is expected to release four major titles, including Battlefield 4 and Need for Speed.
For FY14, EA expects to generate non-GAAP revenues of approximately $4.0 billion. The company upped its earnings guidance to $1.25 from the earlier outlook of $1.20 per share.
Management continues to expect gross margins of 66.0% while operating expenses are projected to be approximately $2.10 billion (down from $2.15 billion).
We believe that EA’s strong digital portfolio and continuing growth in the free-to-play and online segment will drive top-line growth, going forward. Additionally, the company is gaining traction in the tablet and smartphone market, though games released on Apple’s (AAPL) iOS and Google’s (GOOG) platforms are commendable.
We believe that the upcoming launch of new console systems will boost EA’s overall top-line growth in the near term. Moreover, the company’s efforts to optimize costs through overhead reductions will be beneficial.
However, we believe that the company faces a number of headwinds that include significant competition from other game makers such as Activision (ATVI).
Currently, EA has a Zacks Rank #4 (Sell).