What to Watch When Electronic Arts Reports Earnings

By John Ballard Markets Fool.com

IMAGE SOURCE: ELECTRONIC ARTS.

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Electronic Arts (NASDAQ: EA) will report its fiscal third-quarter earnings on Tuesday, Jan. 31, and the biggest trend to watch for is the continued growth of digital revenue as a percentage of total revenue.

Digital revenue growth

Continued growth in full-game downloads, mobile games, and extra content has helped EA grow digital revenue and expand its gross margin from 63% in fiscal 2013 to an expected 71% for fiscal 2017, which ends at the end of March. In fiscal 2016, EA's revenue totaled $4.6 billion, of which $2.5 billion -- 54% of the total -- was digital. Digital revenue is expected to be 57% of total revenue for fiscal 2017.

With almost every passing quarter, digital revenue should continue to grow relative to total revenue as more players download games directly to their consoles, and as management continues to invest in online subscription services, like EA Access and Origin Access, that allow players to download as many games as they want for a fee.

Battlefield and Titanfall

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Battlefield and Titanfall are two popular franchises that had new releases in October; they should be solid contributors to EA's fiscal third-quarter revenue. EA's strategy is to release a new version of these games every few years, and fill in the time between with extra content, such as maps and weapons, that players download to enhance the gaming experience. Since we won't see another Battlefield for at least a few years, quality downloadable content for players in the coming year will be very important to grow revenue.

EA's Battlefield 1 faced stiff competition from Activision Blizzard's Call of Duty: Infinite Warfare in the just-completed quarter. Activision already claimed victory by announcing that its new installment of the very popular Call of Duty franchise was the top-selling console game as of Dec. 15, but EA's first-person shooter wasn't too far behind. Battlefield 1's player base in the first week after launch was nearly double that of its predecessor title -- Battlefield 4 -- released in 2013, according to management.

While Battlefield 1 is expected to turn in solid sales numbers, it will be interesting how management characterizes results for Titanfall 2. Some analysts were concerned that releasing a new Battlefield and a new Titanfall game in the same month would cannibalize sales. This might have been a legitimate concern, as Titanfall 2 hasn't sold nearly as well as Battlefield 1, despite receiving good reviews.

EA Sports

In addition to first-person shooters, EA Sports' FIFA and Madden franchises are very important to holiday sales performance. FIFA 17 was released around the end of the previous quarter. The popular soccer game series in recent years has made up up 15% to 16% of EA's annual revenue. The new FIFA introduced a story mode called The Journey, which allows players to take control of a rising international soccer star. This new feature helped spurred FIFA 17 to outpace sales of FIFA 16 by 13% within the first month after release. Nearly two-thirds of all FIFA 17 players had engaged with The Journey, the company reported in early November. Expect the franchise to be a strong driver of fiscal third-quarter results.

As for EA's popular NFL franchise, players spent more time with Madden NFL 17 after its release in fiscal Q2 than any other version of the franchise in the last five years, according to management. Engagement with Madden's Ultimate Team card game increased 20% year over year.

The holiday quarter is a big quarter for the Madden franchise as it coincides with the end of the NFL regular season and the beginning of the playoffs, creating extra excitement for players to engage with the game.

The numbers

Madden, FIFA, and Battlefield are all expected to help EA reach $2.03 billion in total revenue for the third quarter compared to last year's $1.8 billion. Management has guided for a net loss of $53 million, or $0.17 per share, as the company invests in new franchises, as well as EA's development efforts with respect to digital content and subscription-based services.

Wall Street likes to focus on earnings per share, but the best way to measure the profitability of a video game business is its free cash flow -- expected to be $1.2 billion for the full year, thanks to expanding margins from growth in digital revenue. Management expects the holiday quarter to be the video game makers' biggest cash flow quarter ever.

One last thing

Last, but not least, the highly anticipated Mass Effect: Andromeda is expected to release in March. The sci-fi shooter will be a strong contributor to sales in the next few quarters, and possibly the game of the year for 2017. Management may provide color about what they are seeing in preorders, and their overall expectations for the game's sales.

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John Ballard owns shares of, and The Motley Fool owns shares of and recommends, Activision Blizzard. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.