Strong Second-Quarter Results
Electronic Arts Inc. (ERTS) reported better-than-expected second-quarter results with a steep rise in net earnings and growth in revenue.
Net income, excluding non-recurring items of 6 cents per share increased 200% from the year-ago loss per share of 6 cents. Earnings also surpassed the Zacks Consensus Estimate of a loss of 6 cents. Effective cost management and a lower tax rate have driven earnings growth.
Due to the higher cost of sales, gross margin on a non-GAAP basis declined to 48% from 51% in the year-ago period. However, lower operating expenses in the quarter resulted in a better-than-expected operating margin, which improved to 2% from -3% in the year-ago period.
The company continues to experience a rise in the top-line. Total non-GAAP net revenue, adjusted for deferred revenue of $359 million related to certain online-enabled packaged goods and digital content, increased 1.7% year over year to $1.15 billion in the quarter. Revenue beat the Street expectation, and was driven by the launch of new game titles, which provided an edge to the company’s quarterly results.
Sales from Publishing (70% of total revenue) slipped 3%, offset by an increase of 26% in Distribution (30% of total revenue) in the quarter. By geography, North American sales declined 14% from the year-ago period, offset by a growth of 36% in Europe and 19% in Asia.
By products, packaged good software sales were impacted by weak consumer spending and as a result, declined 1% year over year. The company lowered its 2009 industry outlook for packaged good software sales. However, Wireless, Internet-derived and Advertising revenue increased 20% in the quarter.
The company generated operating cash flow of $6 million in the quarter versus $328 million of cash used in the previous quarter. Electronic Arts ended the quarter with cash, short-term investments and marketable securities of $2 billion and no long-term debt.
The gaming industry has been facing the brunt of the global meltdown, with sagging video game sales, lack of new game releases and intense price war among major gaming companies such as Sony Corp. (SNE), Nintendo and Microsoft Corp. (MSFT) who recently cut prices of the PS3, Wii and Xbox, respectively. Moreover, retailers remain cautious and consumer spending remains weak.
Although the upcoming holiday season could be weaker than normal, long-term we expect the video game market to get a boost from the recovery in spending. The traditional U.S. video game market is expected to continue growing, with software sales increasing to $19.5 billion in 2013 from $14.7 billion in 2008.
Cost Reduction
The company took decisive action to right-size the cost structure and lower operating expenses. Under the cost-cutting initiatives, the company will close down several facilities and reduce headcount by approximately 1,500 positions or about 17% of its workforce.
Management stated that 1,300 of these positions are included in a restructuring plan. The restructuring is expected to be completed by March 2010. The layoffs will result in an annual cost savings of at least $100 million and restructuring charges of $130 – $150 million.
In fiscal 2010, management plans to increase focus on titles with higher margins. The product portfolio will be narrowed, with fewer than 40 titles scheduled for release, down from around 60 published last year.
Guidance
Electronic Arts forecasted full-year 2010 earnings per share of 70 cents to $1, excluding one-time items. The company also expects to remain profitable in the next two quarters. Revenue, adjusted for deferrals is estimated to be $4.2 – $4.4 billion for fiscal 2010.
Acquisition of Playfish
Electronic Arts announced the acquisition of Playfish Ltd., a leading social games company, for $275 million in cash plus $25 million in equity and other considerations, seeking to expand into the growing social gaming sector and strengthen its focus on new gaming platforms by transitioning to digital and social gaming. Playfish has more than 150 million games installed on platforms such as Facebook, MySpace, News Corp (NWS), Google (GOOG) and Apple (AAPL).
Electronic Arts will subsequently pay $100 million more if the company meets undisclosed profit targets through 2011. Playfish will operate within EA Interactive, a division of EA focused on the web and wireless space.
The Playfish deal is expected to be neutral to adjusted non-GAAP earnings but increase net loss per share on a GAAP basis by 15 cents to 25 cents a share, due primarily to acquisition-related tax expenses, deferred revenue adjustments, additional stock-based compensation and amortization of intangible assets. The company believes Playfish will be accretive to its earnings in fiscal 2011.
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