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Electronic Arts Warns

Troy Wolverton

Electronic Arts (ERTS Quote) warned Tuesday that its sales and earnings in the holiday quarter -- the most important of the year for the video game industry -- will be "well below" its own previous outlook and the Street's expectations.

Company officials declined to give new earnings or revenue targets, but CFO Warren Jenson suggested on a conference call that sales could fall as much as the "mid-teens" percentage-wise in the quarter, compared with last year. Worse yet, Jenson said the company expects its troubles to continue into next year, affecting its fourth fiscal quarter, which ends in March.

"The demand curve has shifted abruptly," Jenson said on the call, adding, "We have no reason to believe this abrupt shift in demand will reverse itself."

Investors frowned on the announcement, as EA shares fell $1.96, or 3.7%, to $51.15 in after-hours exchanges following a trading halt.

In the holiday period last year, the company earned $375.1 million, or $1.18 a share, on $1.43 billion in sales. A hypothetical 15% drop would imply sales of $1.22 billion in the current period.

In contrast, analysts polled by Thomson First Call were expecting the video game software publisher to earn $1.17 a share on $1.47 billion in sales in its fiscal third quarter. EA had previously predicted that it would 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 to $1.575 billion in the holiday quarter.

EA is still optimistic about the long-term future of the video game business, Jenson and company CEO Larry Probst said on the call. But in the meantime, the company is suffering from a number of issues related to the industry's transition to a new generation of game hardware, they said.

Notably, the installed base of users for Microsoft's (MSFT Quote) new Xbox 360 console is likely to be lower than EA had expected it to be by the end of the holiday quarter, Probst said. So, too, is the user base in North America and Europe for Sony's (SNE Quote) PlayStation Portable handheld system, he said.

Meanwhile, Sony is likely to sell fewer PlayStation 2's this holiday season than expected, Probst said, adding that sales of that older console would have been helped by a price cut.

Additionally, the software lineup is notably weaker this holiday season than last, Probst said. The industry doesn't have anything to match hits such as Microsoft's Halo 2, Take-Two Interactive's (TTWO Quote) Grand Theft Auto: San Andreas from last year, he said.

Taken together, those issues could lead to a double-digit sales decline for the industry this holiday quarter, Jenson said. For the year, the company now expects video-game software sales to fall between 5% to 10% in North America. Previously, the company had predicted that sales would range from flat to up 5%.

"We're still very bullish about upside potential of next-generation platforms," Probst said. "A combination of things occurred this quarter that caused it to be below expectations."

Tuesday's announcement shouldn't have come as much of a surprise to investors. EA officials have been cautioning investors since early November that holiday results could be weak. Indeed, the company's previous holiday quarter guidance was already well below analysts estimates at the time; at that point, Wall Street was calling for $1.42 a share in earnings in the quarter.

EA has kept up the mantra since then. Less than two weeks ago, for instance, Jenson said that although sales in North America had picked up around Thanksgiving, they were weak before and after then in both that continent and in Europe, the company's two biggest markets.

And EA's not alone in seeing poor sales. Activision (ATVI Quote), one of EA's leading rivals, issued its own earnings warning last week. Last month, GameStop (GME Quote), the leading video game retailer, slashed its sales guidance for the holiday quarter. Meanwhile, industry research firm NPD Group estimated that retail sales of video game software in the U.S. fell 18% in November, marking the third straight month of disappointing sales.

Indeed, investors seemed to take EA's news as a bad sign for its rivals as well. In recent after-hours exchanges, Activision shares were off 28 cents, or 2%, to $12.75; THQ (THQI Quote) shares were off 84 cents, or 4%, to $21.67; and Take-Two Interactive's (TTWO Quote) were off 51 cents, or 3%, to $16.92.

The industry's troubles come amid a transition to a new generation of video game technology. Last month, Microsoft released the Xbox 360, the first of three new game consoles expected on the market in the next year.

Previous transitions have caused similar upheaval for the video-game software publishers. Typically during such periods, companies see sales of older-generation games slow long before they can be replaced by sales of games for the new systems. At the same time, publishers' costs typically soar as they invest in developing games for the new consoles.

EA's stock closed regular trading Tuesday up 86 cents, or 1.7%, to $53.11.