EA Exceeds by a Dime

But the video game publisher's outlook is far below Wall Street's expectations.
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Updated from 5:12 p.m. EST

Second-quarter revenue and earnings slipped at

Electronic Arts

(ERTS)

, but the company far exceeded the Street's expectations.

However, after the bell Tuesday, the video game-software publisher gave an especially cautious outlook for the holiday season.

The company's guidance reflects the shifting of the release dates of some of its games, company CFO Warren Jenson said in an interview with

TheStreet.com

; EA moved up the release of its

FIFA Soccer

title to the second quarter from the third quarter, for example.

But the outlook also incorporates the company's caution about holiday spending in North America after the industry experienced soft spending in October, he said.

"There are a lot of good things in the market around our space. That speaks positively for the industry's prospects in the holiday season," Jenson said. But he dubbed the October results as a clear "cautionary note."

Investors seemed to find more positive than negative in EA's report. In recent after-hours exchanges, the company's stock was up 86 cents, or 1.5%, to $56.65.

In the quarter ended Sept. 30, EA earned $51 million, or 16 cents a share, on $675 million in sales. Those results compared unfavorably with the year-ago period when the company earned $97 million, or 31 cents a share, on $716 million in sales.

Excluding certain charges such as those for amortization and stock-based compensation, the company would have earned $46 million, or 15 cents a share.

The results blew through the Street's estimates and the company's own outlook. On a pro forma basis, analysts polled by Thomson First Call were expecting the company to post a profit of 4 cents a share for the just-completed quarter on $632 million in sales.

The company, meanwhile, had forecast a bottom line ranging from break-even to a profit of 5 cents a share on both a GAAP and non-GAAP basis on sales ranging from $600 million to $630 million.

But the company warned that it didn't expect similar outperformance in the current period. For the quarter ending Dec. 31, EA expects to post a profit of between $1.15 and $1.25 a share -- or between $1.18 to $1.28 a share sans charges -- on sales ranging from $1.475 billion and $1.575 billion.

That's far below Wall Street's expectations. Analysts predicted that the company would earn $1.42 a share on $1.63 billion in sales in the quarter.

In the same period last year, EA earned $375.1 million, or $1.18 a share, on $1.43 billion in sales.

Meanwhile, the company's full-year outlook also appears cautious, considering the magnitude of its earnings beat in the just-completed quarter. The company now expects to earn $1.40 to $1.55 a share in the full year -- or $1.45 to $1.60 a share, excluding charges -- on sales ranging from $3.25 billion to $3.4 billion.

For the full fiscal year, analysts are looking for earnings of $1.55 a share on $3.36 billion in sales. EA's previous guidance was for a profit of $1.45 to $1.60 a share on both a GAAP and pro forma basis on sales ranging from $3.3 billion to $3.4 billion.

Part of the reason for the company's better-than-expected result in the second quarter -- and for its worse-than-expected outlook for the third quarter -- was the shifting of various titles between the two periods.

In addition to bumping up the release date of

FIFA

, EA delayed the European release of its latest iterations of

NBA Live

and

Tiger Woods Golf

from the second quarter to the third, Jenson said.

The net result of all those shifts was a boon of $30 million to revenue and a boost of 5 cents a share to earnings in the second quarter, he said.

EA's overall year-over-year decline in sales was broad-based, company executives said. The company's North American sales fell 6% and its international sales 5%. And sales fell for games designed for all the major game platforms, including

Sony's

(SNE) - Get Report

PlayStation 2 and

Microsoft's

(MSFT) - Get Report

Xbox.

Most dramatic was the decline in sales of games for PCs and

Nintendo

GameCubes, which fell 35% and 29% from the second quarter last year, respectively. On a conference call, Jenson blamed the drop in sales of PC games, which fell to $91 million from $141 million, on the tough comparisons with last year.

The company's

Sims 2

title drove sales in the category last year, he said.

On a more positive note, sales of games for Sony's PlayStation Portable handheld system jumped from nil last year to $45 million this year. EA is the No. 1 publisher on the platform, Jenson said.

And the success of the PSP is one of the things that could benefit EA's holiday sales, company executives said.

But in the short term, the company is also battling rising expenses. The company's gross margin, for instance, slipped to 57.9% of sales from 60.3% of sales a year ago. Gross margin represents the difference between what a company charges customers for its products and services, and its direct costs of making and providing them.

The slippage in gross margin was related to higher royalty rates and a higher percentage of royalty-based titles in the just-completed quarter as compared with the year-prior one, said Jenson on the call.

In the past 12 months, EA has signed license deals with the National Football League, John Madden and

Disney's

(DIS) - Get Report

ESPN network, all of which weighed on its Madden NFL football title this year.

Similarly, the company reported a jump in operating expenses. General and administrative costs rose 24% to $52 million, while research and development costs spiked 16% to $182 million. As a percentage of sales, R&D costs rose to about 27% from 22% last year.

The rise in development costs is related to gearing up for the next-generation consoles that will start rolling out this month with the debut of Microsoft's 360, Jenson said. The company is investing in development tools and technology for the new platforms and in crafting next-generation titles, he said.

Additionally, the company's development staff has swelled more than 30% to 4,700 people he noted.

EA generally expenses its development costs as it incurs them. In contrast, most of the company's competitors account for those costs as capital expenses, amortizing them a little bit at a time over the expected life cycle of particular games.

EA's accounting method tends to weigh down earnings in transition years, such as this one, but helps boost earnings later in the cycle, Jenson said.

Despite posting a profit in the quarter, EA saw a net outflow of cash in the period. Its free cash flow -- which represents cash generated from operations minus capital expenditures -- was $11 million in the red.

Meanwhile, the company spent $372 million in the quarter repurchasing stock as part of a $750 million overall repurchase plan.

The company ended the quarter with $2.23 billion in cash and short-term investments compared with $2.57 billion at the end of the fiscal first quarter in June.

EA's shares closed regular trading off $1.09, or 2%, to $55.79.