EA Misses on Earnings in 4Q
Electronic Arts Inc. (EA) reported non-GAAP earnings per share of 55 cents in the fourth quarter of 2013, up significantly from 17 cents per share earned in the year-ago quarter. The year-over-year increase was primarily attributed to higher revenues and margin expansion.
However, including stock-based compensation, earnings came in at 41 cents, which lagged the Zacks Consensus Estimate of 51 cents per share.
Revenues
Non-GAAP revenues increased 6.4% year over year to $1.04 billion, primarily due to robust revenue growth from the digital segment. Reported revenue failed to beat management’s guided range of $1.025 billion to $1.125 billion and also missed the Zacks Consensus Estimate of $1.107 billion, primarily due to lower-than-expected sales of Crysis 3 and Dead Space 3.
Robust growth in EA’s Digital revenues (up 45.4% year over year) and Distribution (up 13.0% year over year) more than offset the 25.1% year-over-year decline in revenues from EA’s Publishing segment.
The growth in digital revenues were fueled by a 65% increase in full game downloads where SimCity played a crucial part. Moreover, extra content and free-to-play revenues increased 45.0% on a year-over-year basis primarily driven by FIFA Ultimate Team, Star Wars: The Old Republic and Bejeweled Blitz. EA’s mobile business also recorded 21.0% year-over-year jump in revenues. Additionally, advertising and other digital revenue also contributed to the 54% increase in revenues.
Region wise, North American sales (42.0% of total revenue) decreased 6% year over year to $437.0 million. Sales from Europe (54% of total revenue) increased 27.0% year over year to $557.0 million. Asia (4% of total revenue) plunged 36% from the year-ago quarter to reach $46.0 million in the reported quarter.
Margins
EA’s non-GAAP gross margin expanded 970 basis points year over year to 74.6% while gross profit increased 22.5% during the same period to $773 million. The solid margin expansion was primarily led by higher subscriptions from Battlefield 3 Premium and reduction in online support cost.
Operating expenses, as a percentage of revenue, declined to 51.9% in the fourth quarter from 56.7% in the year-ago quarter. Including stock-based compensation, the percentage decline was 490 basis points (bps).
These reductions in costs led to a substantial increase in operating income for EA. On a non-GAAP basis, EA’s operating income increased to $233.0 million up from $77 million in the year-ago quarter. Including stock-based compensation, operating income came in at $191.0 million versus $36.0 million in the year-ago quarter.
EA’s non-GAAP net income came in at $169 million which was up from $56 million while net margin came at 16.3% compared to 5.7% in the year-ago quarter. Including stock based compensation of $42 million, EA reported net income of $127 million.
Balance Sheet and Cash Flow
EA exited the quarter with $1.68 billion in cash, short-term investments and marketable securities compared with $1.43 billion in the previous quarter. Cash flow from operations was $233.0 million compared to $363.0 million in the previous quarter. During the reported quarter, EA repurchased 1 million shares for $13.0 million.
Outlook
For the first quarter of 2014, EA expects to generate non-GAAP revenues of approximately $450.0 million. EA expects non-GAAP loss per share to be 62 cents, wider than the Zacks Consensus Estimate of a loss of 46 cents. Non-GAAP operating expense is expected to be $530.0 million.
The company also provided fiscal 2014 guidance. EA expects to generate non-GAAP revenues of approximately $4.0 billion. Packaged goods revenue is expected to increase 7% year over year, driven by Battlefield 4 while digital revenues is expected to increase 4% year over year. The gross margin is expected to be 66% due to higher mix of packaged goods revenues. EA expects its non-GAAP earnings to be $1.20 per share, higher than the Zacks Consensus Estimate of 67 cents.
EA has planned to release 11 titles in 2014, which includes Battlefield 4 and the Sims 4. The company is expected to release 15 mobile titles for Apple’s (AAPL) iOS and Google’s (GOOG) Android platforms.
Recommendation
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. Moreover, the company’s efforts to optimize costs through overhead reductions will be beneficial going forward. The company’s licensing agreement with Walt Disney (DIS) to publish and market games based on Star Wars should also act in favor, as it will be gaining a new IP and a franchise.
However, we believe that EA faces a number of headwinds that include a soft video game industry performance, particularly due to weakness in retail sales amid an aging console system lifecycle. Competition from other game makers is also a headwind going forward.
Currently, EA has a Zacks Rank #4 (Sell).
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