Video game developer and publisher, Electronic Arts (ERTS) reported fourth quarter 2011 results, which inched past the Zacks Consensus. The better-than-expected results were driven by strong top-line growth in the quarter.
Operating Performance
Electronic Arts reported non-GAAP earnings (excluding one-time items of 31 cents per share but including stock-based compensation) of 14 cents per share, significantly up from a loss of 6 cents per share in the prior-year quarter. However, this failed to meet management guidance range of 15 cents to 25 cents per share.
The year-over-year growth was attributable to significant upside in revenue and margins in the quarter.
Net income on a non-GAAP basis was $45.0 million compared with a loss of $20.0 million in the year-ago quarter.
Gross profit on a non-GAAP basis increased 21.2% year over year to $670.0 million. Gross margin expanded 220 basis points (bps), due to higher revenue growth in the Digital segment.
Total operating expenses increased 6.4% year over year to $597.0 million in the quarter. Operating expense, as percentage of revenue, increased significantly from 45.1% in the prior-year quarter to 56.1% in the reported quarter.
The year-over-year growth in operating expense was primarily credited to higher marketing & sales expense (up 460 bps as a percentage of sales and 13.5% year over year on a dollar basis), general & administrative (up 70 bps, despite decreasing 5.1% year over year on a dollar basis) and research & development expenses (up 610 bps and 5.5% year over year on a dollar basis).
Despite higher operating expenses in the quarter, the operating income went up to $73.0 million from a loss of $8.0 million in the prior-year quarter, primarily based on strong revenue growth.
Revenue
Revenues, excluding negative deferred revenue of $95.0 million, increased 17.1% year over year to $995.0 million, but failed to beat the Zacks Consensus Estimate of $1.04 billion. Reported revenue, however, was ahead of management’s guided range of $850.0 million to $950.0 million.
Strong revenue growth was primarily driven by improved performance of the Digital segment and catalogue performance in the quarter. Strong performance from FIFA 11, Need For Speed Hot Pursuit, Battlefield: Bad Company 2, and Dragon Age propelled catalogue growth, which was 17.0% of fourth quarter revenue.
Sales from Publishing (69.0% of the total revenue) increased 5.1% year over year, while revenues from Distribution (4.1% of the total revenue) were flat on a year-over-year basis in the quarter.
Digital revenues (26.9% of the total revenue) shot up 71.8% year over year to $268.0 million in the quarter, primarily driven by growth in mobile and other handheld revenues and downloadable content (DLC).
DLC and free-to-play micro transaction content was $113 million in the fourth quarter, up almost 200% year over year.
Mobile and other handheld digital revenue grew at or above the market rate and were up 25% year over year, driven by strong growth in smartphone related revenue, which more than offset a reduction in feature phone related revenue.
Full game downloads were $34.0 million, up 21% year over year. Revenue from subscriptions, digital advertising and other surged 50% year over year to $51 million.
At quarter end, core registered users were 112 million, significantly up from 61 million reported in the year-ago quarter.
Moreover, robust growth from titles played on Apple Inc.’s (AAPL) iPhone and iPad spurred the revenue climb (up 100.0% year over year). In the quarter, 15 Electronic Arts’ paid games featured in the top 25 paid games on the iPhone during the Easter weekend.
Revenue from the Playfish social gaming site soared approximately 100.0% year over year in the fourth quarter.
Region-wise, North American sales were up 4.0% year over year. Europe increased 36.0%, while Asia achieved a growth of 7.0% in the reported quarter.
Electronic Arts was the #1 publisher in the western world for the quarter, with 19% share in North America and 20% share in Europe (up 3.0%). The company was the leading publisher in the western world in high-definition consoles and PC games.
Balance Sheet
In the fourth quarter of 2011, cash from operations was $253.0 million compared with $349.0 million in the prior quarter. Electronic Arts ended the quarter with cash, short-term investments and marketable securities of $2.08 billion as compared with $1.86 billion at the end of December 31, 2010. The company has no long-term debt.
Outlook
For the first quarter of 2012, Electronic Arts expects revenue on a non-GAAP basis to be in the range of $460.0 million to $500.0 million.
Loss per share on a non-GAAP basis is expected to be in the range of 49 cents to 44 cents. The Zacks Consensus Estimate is currently pegged at a loss of 41 cents for the quarter.
The company also provided fiscal year 2012 revenue and earnings guidance. Revenue on a non-GAAP basis is projected to be in the range of $3.75 billion to $3.95 billion. Electronic Arts expects $250.0 million of revenue in 2012 on the back of two potential league lockouts (NFL and NBA) in the EA Sports business.
Earnings on a non-GAAP basis are expected to be in the range of 70 cents to 90 cents per share for fiscal 2012. Management expects earnings in the first half of the fiscal year to be down versus last year.
Management believes that 2012 will be a strong year, driven by quality title releases and robust growth in the Digital business. However, we remain cautious on Electronic Arts revenue growth for fiscal 2012, due to the back-end loaded guidance and uncertainty related to the release of Star Wars: The Old Republic.
Electronic Arts forecasts Publishing and other revenue of between $2.50 billion and $2.65 billion for fiscal 2012. Distribution revenue is expected to be approximately $200.0 million and Digital revenue in the range of $1.05 billion to $1.1 billion for fiscal 2012.
For fiscal 2012, non-GAAP gross profit margin is expected to be approximately 62% to 63.0%. Operating expense is expected to be slightly higher compared with fiscal 2011. Management expects to incur approximately 49% of operating expenses in the first half of 2012 and the remaining in the second half.
We believe higher marketing expenses related to the launch of Battlefield 3, a direct competitor to Activision Blizzard Inc.’s (ATVI) Call of Duty franchisee, may hurt profitability going forward.
The company anticipates its top 20 titles for fiscal year 2011 to generate roughly 77.0% of total packaged-goods revenue as compared with 76.0% in fiscal 2010.
Electronic Arts expects to release 22 titles for fiscal 2012, with 4 titles scheduled for the first quarter.
Electronic Arts, on a GAAP basis, expects operating cash flow in the range of $250.0 million to $300.0 million for fiscal 2012.
Our Take
Electronic Arts remains focused on delivering quality titles, which we believe will drive significant top-line growth going forward. The company’s impressive product pipeline guarantees market share gains over the long term.
Moreover, Electronic Arts’ increasing exposure to online social gaming and mobile applications and growing contribution from the Digital business will likely drive revenue over the long term.
However, we believe that cut-throat competition within the video game industry will make it difficult for any single company to gain significant market share in 2011. Electronic Arts continues to face strong competition from Activision and Take-Two Interactive Software Inc. (TTWO), which may hurt profitability going forward.
Moreover, in the social gaming market Electronic Arts faces increasing competition from social networking companies, such as Zynga.
Zynga has become one of the fastest-growing technology companies by using Facebook Inc.’s social network to distribute games. The company is a dominant player in this sector with more than 210 million monthly active users. Six of the 10 most popular apps on Facebook belong to Zynga, led by “FarmVille” with 57.6 million users. We believe Electronic Arts’ existing tie-up with Facebook will improve its position in the social gaming market going forward.
We remain Neutral on Electronic Arts on a long-term basis (6-12 months).
Currently, Electronic Arts has a Zacks #5 Rank, which implies a Strong Sell rating over the short term.
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