EA's Critical Juncture

Despite all the excitement surrounding the video game industry at the moment, you could argue that Electronic Arts (Nasdaq: ERTS  ) appears to have been left behind. Although the video game publisher beat expectations with its fourth-quarter results, it warned that fiscal 2008 won't be too inspiring. It also plans to delay Spore, one of the highly anticipated video game titles in its pipeline.

For its fourth quarter, Electronic Arts posted a net loss of $25 million, or $0.08 per share, compared to a loss of $16 million, or $0.05 per share, last year. Revenues decreased 4.4% to $613 million. Margins dipped across the board, and free cash flow decreased by 49% to $154 million. (For a full rundown of all the numbers, see our Fool By Numbers on Electronic Arts' fourth quarter.) The big issue bugging investors, of course, is the disappointing guidance EA gave for the coming year.

It's no wonder that investors are disappointed, since the next-generation consoles from Microsoft (Nasdaq: MSFT  ) , Nintendo, and Sony (NYSE: SNE  ) are all out. But the transition has apparently been a bit rocky, as consumers forgo buying video games until they get new consoles. There have also been rumblings that Electronic Arts was ill-prepared for the Wii's surprising popularity.

In the company's conference call, it was clear that new CEO John Riccitiello has taken the reins from predecessor Larry Probst. If the CEO transition was a challenge, it wasn't described as such on the call. Furthermore, Spore's delay seems surprising, although management emphasized that it'd rather have a high- quality product than poorer one rushed to market. That's the best long-term strategy, despite gamers and investors' disappointment in the short term.

When I covered a recent Wall Street conference featuring Electronic Arts, I felt that the company had a good grasp on some of the elements it needs to aim for in ensuring long-term growth. On the other hand, there has been much talk about its need for innovation, and it's clear that investors should watch its execution going forward. Although the company has plenty of good franchises, resting on those laurels isn't a good strategy. Furthermore, some of the new titles it has recently talked about sound like attempts to steal market share from popular titles from rival Activision (Nasdaq: ATVI  ) -- EA plans Rock Band (as compared to Activision's Guitar Hero) and Skate (as compared to Activision's Tony Hawk series).

Investors' current pessimism could very well be short-term angst. There's still opportunity here, given the expanding market for video games. At the same time, EA has a lot to prove at the moment. With its historical reputation as an industry leader, it's not too hard to imagine that it will rise to the challenges just fine. But those challenges won't simply vanish, and investors' negative response at the moment is hardly surprising.

Here's some related Foolishness on EA:

Electronic Arts, Activision, and Nintendo are Motley Fool Stock Advisor recommendations. Microsoft has been recommended by Motley Fool Inside Value.

Alyce Lomax does not own shares of any of the companies mentioned.


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