Video game publishers are going through a well-publicized struggle with the transition pains associated with the new console cycle. Consumers are saving up for that next Sony (NYSE:SNE) PlayStation unit, so they aren't necessarily spending on current-generation software. With that as a general context, let's examine the annual data that Electronic Arts (NASDAQ:ERTS) released yesterday.
For the fourth quarter, sales increased 16% to $641 million. Operating income was $25 million, compared with nada for this metric in the previous year's quarter. There was a net loss of $16 million ($0.05 per diluted share) versus net income of $8 million ($0.02 per diluted share) last year.
For the full year, sales decreased 6% to just under $3 billion. Operating income was cut in half, coming in at $325 million. Net income also decreased precipitously, equaling $236 million ($0.75 per diluted share). That compares to $504 million ($1.59 per diluted share) for fiscal 2005.
Free cash flow also declined. For Q4, EA generated 30% less of the free green, at approximately $300 million. For fiscal 2006, the company minted about 7% less free money, at $473 million.
If you read through the release, you'll see that EA reports a more positive non-GAAP earnings scenario, after excluding costs associated with the acquisition of JAMDAT Mobile and company restructuring costs. No matter what, though, the publisher didn't have a happy year -- all you have to do is look at the declines in the top-line revenue and the free cash flow. You'll also notice that the operating margin for the year was 11%, as compared with 21% in fiscal 2005.
The main angle here is the aforementioned passing of the torch for the consoles. While this happens, EA may see declines in sales as consumers upgrade. It'll take some time, but the company's content library continues to grow. The headline, in fact, brings good tidings: "Over 30 titles in development for next generation titles." Considering that EA is a blue chip in this sector, you can bet that many of these titles will drive a lot of value. Indeed, the release bears out EA's status -- the company took 27 titles to platinum status in 2006 and 31 to that level in the previous year.
The company's outlook isn't great, unless you like little growth in revenues and declines in net income (maybe even a total net loss for fiscal 2007). But if you want to be exposed to the video game sector, you're going to find that patience is a virtue. Forget this coming holiday season -- it's probably the next two after that which will begin to bring on the joy for major publishers like EA, Activision (NASDAQ:ATVI), and THQ (NASDAQ:THQI).
In conclusion, I like EA's prospects. I trust its ability to develop and market a valuable pipeline of software. It's fighting a macro issue right now in the console transition, but that will eventually give way to better profit projections down the line. The major risk with EA is the increasing development budgets that all publishers must contend with. For now, I'm not panicking about that. Nevertheless, it's an issue that's currently under a lot of scrutiny, so individuals considering EA as an investment idea should keep it in mind.
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Fool contributor Steven Mallas owns none of the companies mentioned. The Fool has a disclosure policy.
