Electronic Arts Inc. (EA - Analyst Report) reported earnings (including stock based compensation but excluding all one-time items) of 62 cents per share in the second quarter of fiscal 2015, beating the Zacks Consensus Estimate of 43 cents. The bottom line also improved from earnings of 22 cents reported in the year-ago quarter.

Revenues

Non-GAAP revenues surged 17.3% from the year-ago quarter to $1.22 billion, which convincingly beat the Zacks Consensus Estimate of $990 million. Revenues were also much higher than management’s guidance of $1.14 billion.

The strong performance was led by FIFA 15, Madden 15, and The Sims 4. In addition to these key titles, catalog titles, including FIFA 14, Battlefield 4 and Plants vs. Zombies Garden Warfare, continued to perform well.

Digital revenues (37.1% of total revenue) jumped to $453 million in the second quarter from $348 million reported in the year-ago quarter. Mobile generated $115 million of revenues, up 11% on a year-over-year basis. Extra content and free to play contributed revenues of $153 million, up 20% on a year-over-year basis. Full game PC and console downloads generated $94 million in revenues, up 71% over the prior year period.

EA’s Packaging goods and other segment (62.9% of total revenue) revenues increased to $767 million from $692 million reported in the year-ago quarter.

North America contributed 60.3% of total revenue in the reported quarter while the remnant 39.7% was contributed by International revenues.

During the quarter, Hockey Ultimate Team registered year-over-year growth of 113%; FIFA Ultimate Team grew 61% while Madden Ultimate Team grew over 277% year over year.

In the last quarter, gamers logged more than 1.9 billion hours of game play on consoles and PCs. Monthly active users for EA’s mobile titles averaged over 155 million in the second quarter. EA’s mobile sports games averaged more than 40 million monthly active users in the second quarter, which was up 250% on a year-over-year basis.

Margins

EA’s non-GAAP gross margin expanded 440 basis points (bps) year over year to 66% in the second quarter. The solid margin expansion was primarily led by robust revenue growth in digital business, both full games download and extra content, as well as the Sims4 launch.

Operating expenses (before acquisition-related contingent consideration, amortization of intangibles, restructuring and other but including stock-based compensation), as a percentage of revenues, declined from 51.3% in the year-ago quarter to 44.2% in the reported quarter.

The year-over-year decline was primarily due to lower marketing & sales expense (down 80 bps), lower research & development expense (down 580 bps) and lower general & administrative expense (down 490 bps).

A higher gross margin base and lower-than-expected increase in operating expenses helped operating margin (including stock-based compensation expense but excluding one-time items) to expand to 22% from 10.1% in the year-ago quarter.

Net income (including stock-based compensation) was $200.5 million or 62 cents per share compared with $69.2 million or 22 cents per share in the year-ago quarter.
Earnings include stock-based compensation but exclude acquisition-related expenses, amortization of debt discount, change in deferred net revenue, gain on strategic investments, restructuring and other and related tax effect.

Electronic Arts Inc - Earnings Surprise | FindTheBest

Balance Sheet and Cash Flow

EA exited the quarter with $2.39 billion in cash and short-term investments compared with $2.32 billion in the previous quarter. Operating cash flow was $183 million in the reported quarter.

During the quarter, the company repurchased 2.6 million shares for $95 million. A $750.0 million stock repurchase plan was initiated by the company in May and is set to expire on May 31, 2016.

Outlook

For the third quarter of fiscal 2015, EA expects to generate non-GAAP revenues of approximately $1.275 billion, lower than th4e Zacks Consensus Estimate of $1.287 billion.

The company expects non-GAAP earnings of 90 cents per share for the third quarter while the Zacks Consensus Estimate for the same is pegged at 76 cents per share.

Non-GAAP gross margin is expected to be 70.5%. Non-GAAP operating expense is expected to be $515 million.

Management expects this quarter to benefit from the launches of NBA Live 15 and Dragon Age: Inquisition. The company is also hopeful about the two games that it is set to launch on mobile devices in the upcoming quarter namely SimCity BuildIt and Peggle Blast.

For fiscal 2015, EA expects to generate non-GAAP revenues of approximately $4.175 billion, higher than the Zacks Consensus estimate of $4.150 billion. The earlier revenue guidance for fiscal 2015 was $4.100 billion.

Non-GAAP earnings are expected to be $2.05 per share while the Zacks Consensus Estimate for the same is pegged at $1.58 per share.

Management continues to expect gross margin of 69%, while operating expenses are projected to be approximately $2.00 billion.

Digital revenue is forecast to be nearly $2.225 billion while Packaged goods & other revenue is expected to be $1.950 billion.

Operating cash flow is expected to be $850 million while free cash flow is expected to be $750 million.

Recommendation

Per Gartner, the worldwide video game marketplace is expected to reach $111 billion by 2015. Thus, a huge opportunity lies unexplored for gaming companies like Electronic Arts.

We believe that EA’s strong digital portfolio and continuing growth in the tablet and smartphone market are key growth catalysts. EA’s strong portfolio of games will continue to boost its market share on new consoles, going forward. Moreover, the company’s efforts to optimize costs through overhead reductions will be beneficial going forward.

However, the company faces a number of headwinds that include significant competition from other game makers such as Activision (ATVI - Snapshot Report), Glu Mobile Inc. (GLUU - Snapshot Report) and Take-Two Interactive (TTWO - Snapshot Report). Additionally, higher consumer spending on new consoles may cannibalize software sales in the near term.

Currently, EA has a Zacks Rank #3 (Hold).

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