Video game developer and publisher Electronic Arts Inc. (EA - Analyst Report) earned a penny in the second quarter of 2013, better than the Zacks Consensus Estimate of a break-even. The reported earnings were much better than a loss of 8 cents per share in the year-ago quarter.
Revenues (including deferred revenue of $369.0 million) increased 4.0% year over year to $1.08 billion, which inched past the mid-point of management’s guided range of $1.05 billion to $1.10 billion.
The upside was primarily attributable to continued strong performance from the Digital segment. Digital revenue (29% of total revenue) jumped 45.0% year over year to $314.0 million in the second quarter.
The growth in digital revenue was fuelled by a 60.0% year-over-year increase in revenue from mobile and other handheld devices. Smartphones and tablets revenue was up 120% year over year to $66.0 million. Subscriptions, advertising and other digital revenue grew 48% from the year-ago period, driven by Star Wars: The Old Republic.
Moreover, revenue from extra-content and free-to-play games was up 34% from the year-ago quarter, driven by strong performance from Battlefield 3, Mass Effect 3 and SimCity Social.
The strong digital growth fully offset a continued weak performance from the Publishing and Other (69% of total revenue) segment, which was down 5.0% year over year in the quarter to $744.0 million. Distribution (2% of total revenue) was also significantly weak, with revenues plunging 29% from the year-ago quarter to $22.0 million.
Region wise, North American sales (46% of total revenue) increased 6% year over year to $508.0 million. Sales from Europe (57% of total revenue) remained flat on a year-over-year basis at $503.0 million. Asia (7% of total revenue) achieved a growth of 35% from the year-ago quarter to reach $69.0 million in the reported quarter.
Gross profit (including stock-based compensation but excluding other one-time items) increased 6% year over year to $649.0 million. Gross margin increased 100 basis points (“bps”) from the prior-year quarter to 60.0% due to favorable product mix.
Operating income (excluding stock-based compensation and other one-time items) was $68.0 million compared with $25.0 million in the year-ago quarter. Including stock-based compensation expense, operating income was $24.0 million in the reported quarter.
EA reported net income (excluding stock-based compensation and other one-time items) of $49.0 million or 15 cents per share compared with $17.0 million or 5 cents in the year-ago quarter.
EA exited the quarter with $1.22 billion in cash, short-term investments and marketable securities, compared with $1.44 billion in the previous quarter. Cash outflow from operations was $28.0 million compared with cash outflow of $211.0 million in the previous quarter. During the reported quarter, EA repurchased 8.4 million shares for $108.0 million.
For the third quarter 2013, EA expects non-GAAP revenues to be in the range of $1.25 billion to $1.35 billion. EA forecasts a profit for the upcoming quarter with earnings expected in the range of 50 cents to 60 cents per share on a non-GAAP basis. Operating expenses are expected to be less than $600.0 million for the forthcoming quarter.
For fiscal 2013, management lowered its revenue guidance. EA now expects non-GAAP revenue to be in the range of $4.05 billion to $4.20 billion (down from $4.10 to $4.20 billion) due to weaker-than-expected performance of Medal of Honor Warfighter.
EA forecasts operating expenses of approximately $2.2 billion. Non-GAAP earnings are expected to be in the range of $1.00 – $1.15 (down from $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’s lowered outlook disappoints us. This is particularly due to the robust product pipeline that includes some of the most popular franchises expected to be released in the upcoming holiday season. Moreover, 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, cancellation of NBA Live and weak customer response to Medal of Honor Warfighter will hurt top-line in the near term. Moreover, tough competition from Activision Blizzard Inc. (ATVI - Snapshot Report), Zynga Inc. (ZNGA - Snapshot Report) and Take-Two Interactive Software Inc. (TTWO - Snapshot Report) remains a concern going forward.
Further, a soft video game industry outlook in the near term particularly due to weakness in retail sales, and lack of visibility around monetization and subscriber growth from the new pricing system keeps us cautious on the stock.
We remain Neutral on the stock over the long term (6-12 months). Currently, Electronic Arts has a Zacks #3 Rank, which implies a Hold rating in the short term.