Fool on Call: A Hail Mary for EA?

If you've played Madden football, you know the situation: Fourth down, 60 yards to the goal line, and you're down by four, with just seven seconds on the clock. Only a Hail Mary will do.

As my colleague Alyce Lomax explained after examining the latest numbers, Electronic Arts (Nasdaq: ERTS  ) doesn't exactly need divine intervention at this point, but it may be getting close. In its most recent figures, the video game maker showed signs of fumble-itis, dropping the ball most dramatically in its outlook for the remainder of fiscal 2007.

This is where "Fool on Call" can take a snap and get a more detailed look at the situation on the field. Using the company's latest quarterly earnings conference call, we'll focus on what to expect from Electronic Arts over the short term.

Not exactly a changing of the guard, but ...
Just a quarter ago, in its previous quarterly earnings conference call, management was touting its market-chomping dominance. It's singing a different tune now. Can so much really have changed in just a single quarter? It's possible, but the cautious tone is more likely a reflection of new CEO John Riccitiello.

In his prepared remarks, Riccitiello called EA his "dream job." But just because coaching for a Notre Dame is a dream position, that doesn't mean the coach can't talk down its team and talk up the opponent, as former head coach Lou Holtz often did.

Very early in the call, management revealed that EA had 24 platinum titles for the year, down from 27 in the comparable period. Furthermore, the company's market share in North America and Europe slipped to 20%, down two to three percentage points year over year.

Even in the midst of a rough patch, it's tough to feel pity for a team that handily dominates its league. EA's latest figures hardly warrant a pity party, especially when you consider the sustained dominance this brand has enjoyed over the years. But EA's not looking for sympathy -- just keeping it real, offering a sobering view of an intensely competitive video game landscape that includes Activision (Nasdaq: ATVI  ) , Take-Two (Nasdaq: TTWO  ) , and Konami (NYSE: KNM  ) .

As the company shifts from FY 2007 to FY 2008, I was glad to see management stick with its industry growth forecast of 13% to 18% for European and North American software sales. That said, I still would've liked to see this range narrowed a bit. The five-point spread suggests there's still a lot of uncertainty in the market, particularly regarding supply issues for Sony's (NYSE: SNE  ) PlayStation 3.

In her analysis of EA, Alyce mentioned that company will likely push back its release of the much-anticipated SPORE until next fiscal year. During the question-and-answer session, Riccitiello indicated that right now the title is on the "bubble," to be released toward the end of Q4. However, it may yet be released in early fiscal 2009. Whenever it is released, it should be good; Riccitiello stated that in his early reviews, the title has looked "fantastic."

Even with SPORE out of the picture, EA has a substantial lineup in the coming quarters, packed with such game-breakers as Madden NFL, NCAA Football, NBA Live and others. That said, it does appear the first quarter will be a bit shortchanged. CFO Warren Jenson states, "While we love our lineup, it really starts to kick in with the launch of Harry Potter in late June." Timing issues should squeeze first-quarter performance, but the second quarter will likely benefit; EA expects "much improved" performance then.

It's also noteworthy that the bulk of titles shipping in fiscal 2008 will be for the Sony PS3 and the Microsoft (Nasdaq: MSFT  ) Xbox 360. Both systems are expected to receive about twice as many games as the Nintendo (OTC: NTDOY.PK) Wii. We know from previous calls that EA underestimated the Wii's ability to capture consumer attention. In this call, the company divulged that it's ramping R&D to catch up to underestimated demand for this innovative gaming system.

One analyst noted that if you exclude stock options, expected R&D expenditures for the year will almost double their 2004 levels. The analyst wondered whether the company could curb those rising costs. Riccitiello responded that the investments are necessary in order to be in "better position" with Wii. He adds, "Those are investments that are going to pay out beginning in 2008, moving into 2009 and fiscal 2010."

Shifting away from pure console gaming, the year's greatest growth will come from EA's mobile division and online segment, which are expected to increase revenues by roughly 23% and 40%, respectively. The big news on the online front is the upcoming release of FIFA Online in the Chinese and Japanese markets.

My only concern here is whether EA is doing enough to attack the Chinese market. As evidenced by CDC's latest performance, online gaming is currently experiencing extraordinary growth in China. Having listened in on recent calls for EA, I sense little urgency on EA's part to pursue this important market. Then again, the company may simply be reluctant to show its hand.

Riccitiello did indicate at the close of the call that the company is well-positioned to generate revenue from wherever the industry develops. Over the next three years, however, the console business will be the most important, "with an increasing share driven to new revenue models, in particular in Asia," Riccitiello added. I appreciate that mention, but I'd like to see more detail and emphasis placed on this region in future calls.

EA's strong finish
EA expects a slow start in fiscal 2008's first quarter, but the pace should pick up substantially in the second, and even more so into the third and fourth. If the current R&D spending is any indication -- and I think it is -- that acceleration should continue next year as the company brings on more Wii titles. Its strong sports lineup should fit particularly well with the motion-driven console system. In light of this forecast, prospective investors should have time to do further due diligence on the company over the next couple of months, before business starts to pick back up.

As for EA itself, the boost to R&D indicates increased urgency for the company -- a welcome sight, in my opinion. Management realizes that it dropped the ball on the Wii front, and it's intent on getting it back.

In short, EA doesn't need a Hail Mary pass just yet.

Electronic Arts, Nintendo, and Activision were selected by Motley Fool Stock Advisor. Microsoft is an Motley Fool Inside Value selection. Get in on the investing game with a free 30-day trial of either newsletter.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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