EA's Loss Narrows in 1Q

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Video games developer and publisher, Electronic Arts Inc. (EA) reported first quarter 2013 non-GAAP loss of 41 cents per share, narrower than the Zacks Consensus Estimate of a loss of 51 cents. However, the reported loss was wider than a loss of 37 cents per share in the year-ago quarter.

Quarter Details

Revenues (including deferred revenue of $464.0 million) declined 6.0% year over year to $491.0 million, slightly short of management guidance of $500.0 million. The shortfall was primarily due to continued weak performance from the Publishing and Other (30% of total revenue) segment, which was down 25.0% year over year in the quarter to $146.0 million.

Distribution (4% of total revenue) was also significantly weak, with revenues plunging 83% from the year-ago quarter to $21.0 million. However, continued strong performance from the Digital segment partially offset these weak results. Digital revenue (66% of total revenue) jumped 55.0% year over year to $324.0 million in the first quarter. EA launched 7 digital titles in the reported quarter.

The growth in digital revenue was fuelled by a 34.0% year-over-year increase in revenue from mobile and other handheld devices. Smartphones and tablets revenue was up 86% year over year to $52.0 million. Subscriptions, advertising and other digital revenue grew 69% from the year-ago period, driven by Star Wars: The Old Republic.

Moreover, revenue from extra-content and free-to-play games was up 87% from the year-ago quarter, driven by strong performance from PopCap, Battlefield 3, Mass Effect 3 and The Sims Social. Free-to-Play (17% of total revenue) was particularly strong with year-over-year revenues increasing 156.0% in the reported quarter.

FIFA and Battlefield 3 premium were the two top performers in the quarter.FIFA Ultimate Team contributed more than $30.0 million of digital revenue in the first quarter. FIFA World Class Soccer and FIFA Online 2 generated more than $25.0 million in Asia in the reported quarter. Battlefield 3 Premium service, launched in June this year, sold approximately 1.3 million downloads over the last two months.

Region wise, North American sales (38% of total revenue) slumped 29% year over year to $185.0 million. Sales from Europe (53% of total revenue) climbed 17% year over year to $261.0 million. Asia (7% of total revenue) achieved a growth of 13% from the year-ago quarter to reach $45.0 million in the reported quarter.

On the operating line, gross profit (including stock-based compensation but excluding other one-time items) increased 5% year over year to $301.0 million. Gross margin increased 650 basis points (bps) from the prior-year quarter to 61.3% due to favorable product mix.

Operating loss (excluding stock-based compensation and other one time items) was $181.0 million as compared to a loss of $174.0 million in the year-ago quarter. Including stock-based compensation expense, operating loss was $220.0 million in the reported quarter.

EA reported net loss (excluding stock-based compensation and other one-time items) of $130.0 million or 41 cents per share as compared to a loss of $123.0 million or 37 cents in the year-ago quarter. Including stock-based compensation expense and excluding one-time items on a tax adjusted basis, net loss was $168.0 million or 53 cents per share in the reported quarter.

EA exited the quarter with $1.44 billion in cash, short-term investments and marketable securities, compared with $1.85 billion in the previous quarter. Cash outflow from operations was $244.0 million as compared with cash inflow of $287.0 million in the previous quarter.

Gaming & Partnership Details

EA announced a new two-tier pricing system for its massively popular multiplayer online game (:MMOG) Star Wars: The Old Republic, to be in effect from November this year. To rejuvenate its declining subscriber base (which went below one million in the reported quarter) EA is offering the first tier for a monthly subscription of $15.0. The second tier will be free-to-play with certain restrictions on content and features.

EA recently entered into a partnership with Seoul, South Korea-based Nexon to publish FIFA Online 3 in the country.

Outlook

For the second quarter 2013, EA expects non-GAAP revenues to be in the range of $1.05 billion to $1.10 billion. EA forecasts a profit for the upcoming quarter with earnings expected in the range of 7 cents to 12 cents on a non-GAAP basis. Operating expense is expected to be approximately $600.0 million for the quarter.

For fiscal 2013, management lowered its revenue guidance. EA now expects non-GAAP revenue to be in the range of $4.10 billion to $4.25 billion (down from $4.30 billion) due to unfavorable foreign exchange rate and weak performance of Star Wars. Digital is expected to grow more than 20%, while much stronger growth is expected from mobile and free-to-play, slightly offset by weak social and challenging conditions in the packaged goods segment.

EA forecasts operating expenses to be approximately $2.2 billion, $50 million lower than the prior guidance. Non-GAAP earnings are expected to be in the range of $1.05–$1.20 per share for fiscal 2013.

EA expects operating cash flow of at least $400.0 million and capital expenditure of $100.0 million. Hence, free cash flow is expected to be around $300.0 million for fiscal 2013. EA announced a new share buyback program to repurchase up to $500.0 million of its common stock.

Our Take

EA’s second quarter and full year outlook is optimistic in our view. This is particularly due to the robust product pipeline that includes some of the most popular franchises (Medal of Honor, Need For Speed) expected to be released in the second half of this fiscal. The upcoming release of Madden NFL 13 and FIFA 13 are expected to drive revenue growth in the second quarter.

EA’s strong digital portfolio and continuing growth in the free-to-play and online segment are expected to drive top-line growth over the long term. However, tough competition from Activision Blizzard Inc. (ATVI), Zynga Inc. (ZNGA) and Take-Two Interactive Software Inc. (TTWO) remains a concern over the long term.

Further, a soft video game industry outlook in the near term particularly due to weakness in retail sales, declining subscriber base of Star Wars, and lack of visibility around monetization and subscriber growth from the new pricing system keeps us cautious on the stock.

We remain Neutral over the long term (6-12 months). Currently, Electronic Arts has a Zacks #4 Rank, which implies a ‘Sell’ rating in the short term.

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