ERTS: Operating Leverage Under Fire By Jay Somaney RealMoney.com Contributor 5/14/2008 3:33 PM EDT

Electronic Arts (ERTS) reported numbers that blew away estimates on both the revenue front and on the bottom line as well.

The company reported fourth-quarter revenue of $919 million and earnings of 9cents per share vs. consensus of $835 million in revenue and breaking even on earnings. The gain was attributed to a one-time tax benefit, without which the company would have lost a nickel per share.

In addition, the company slashed earnings guidance down to a range of $1.30 to $1.70 per share ($1.50 at the midpoint) vs. consensus of $1.73 per share, and revenue was guided to a range of $4.9 billion to $5.15 billion vs. consensus of $4.59 billion. The fact that the company has guided nicely higher on revenue but has had to lower earnings guidance raises serious questions about its operating leverage going forward, which is the key reason the shares are down today.

Another key red flag is the fact that Electronic Arts is seeing better growth in its distribution business (i.e., taking other companies' products to market) than it is seeing in its own core software publishing business, which in turn is leading to more dependence on a lower-margin business. The company released the following key games in the fourth quarter:

• Burnout Paradise;
• Army of Two; and
• Rock Band catalog product

Electronic Arts is also planning to release at least 20 titles for the Wii platform and 15 for the NDS platform. Warhammer Online will also be released in the U.S., Asia and Europe this year along with FIFA Online in China and NBA Street Online in Taiwan. Spore is the key release for Electronic Arts this year and is due for a September debut.

I am surprised the shares are not down more today.

For Somaney's preview heading into the Electronic Arts conference call, please click here.

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At the time of publication, Somaney had no positions in the stocks mentioned, although positions may change at any time without notice.

Jay Somaney is a partner and fund manager with TSG Capital Partners, a hedge fund based in Plano, Texas, and founder of GlobalTechStocks.com, a subscription site that focuses on technology and Indian stocks (including ADRs), providing information, news and chatter. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Somaney appreciates your feedback; click here to send him an email.

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