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Low Bar Looms for EA

Electronic Arts cut expectations for Tuesday's report, but its outlook will set the industry's morale.

Investors will be tuning into

Electronic Arts'

(ERTS)

earnings report on Tuesday to find out whether a disappointing quarter was a one-time thing or a sign of more to come.

The video-game giant

warned in March that fourth-quarter earnings would come in below Wall Street's expectations and its own predictions. Many investors and analysts took the announcement as a sign that the game industry was starting to enter a down cycle ahead of the impending transition to new console hardware.

While EA's results for the past quarter are largely known, investors will be trying to glean on Tuesday how long the trough is likely to last and how the company will do in the interim.

"We're in a wait-and-see mode," says Peter Maher, an analyst with Bryn Mawr Trust, which is long EA. "How's ramp going? How are things shaping up? What are earnings going to look like a year from now?

"If management doesn't answer or address

those issues, we would be looking for clues around those types of things," adds Maher.

Among the items that Maher and other investors will be scrutinizing in EA's report are:

Sales of games for Sony's PlayStation Portable. Analysts and industry executives have been hoping the handheld-game system, which went on sale in late March, will help the industry better weather the console transition. EA has made a significant bet on the PSP, with six games already on the market or about to be released, including versions of its NFL Street football game and Tiger Woods golf title. The PSP has the potential to be a "near-term revenue booster" for EA, says Jason Maxwell, a buy-side analyst with TCW, which is long EA shares. "It's early on, but any early information we can get from that will be useful."

Development costs. Analysts expect the new consoles to start appearing as early as this fall. Costs for next-generation games are expected to double or triple to $10 million or more. Through its first three fiscal quarters, EA's development costs jumped 32% from a year earlier, rising to more than 18% of revenue from 15%. And company officials predict a continued to rise."There's been a little bit of uncertainty as to the level of that spending, what it's going to look like over next couple of quarters," said Maher.

New product announcements. From The Sims to Madden NFL football, EA has built up a stable of franchise games -- successful titles that it updates every year or so. Some in the industry believe that the best time to introduce new franchises is at the beginning of a console cycle, before old titles are updated for the new machines. Should EA be planning new major rollouts for the next consoles, the move could be an indicator of further development costs -- but also of potential long-term gains, analysts say."That has been their strength," says Bill DeRosa, managing partner at Anthem Asset Management, which has no position in EA shares.

The focus on the future follows some disappointments in the recent past from EA. In January, the company

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reported that sales in its holiday quarter fell year over year, and that it topped the Street's revenue expectations thanks largely to currency fluctuations. The company also offered a disappointing guidance for the fourth quarter. EA followed that up with a March warning that it wouldn't come close to meeting even that tepid outlook.

The March warning sent EA's stock tumbling. On the day of the warning, the company's stock was up about 8% for the year. Since then, EA's shares have fallen 21% and are now down 15% year to date.

The company now expects to post earnings of $1.70 to $1.72 a share before certain expenses -- on revenue ranging from $3.1 billion to $3.125 billion. That translates into a predicted quarterly profit of 5 cents to 7 cents a share on both a GAAP and pro forma basis on sales raging from $525 million to $550 million.

Analysts are now predicting the company will post a profit of 9 cents a share, excluding expenses, on $549.31 million in sales.

Indeed, with the rollout of new consoles typically meaning declining game sales, analysts aren't predicting that things will improve soon for EA. According to Thomson First Call, Wall Street analysts are predicting the company will earn $1.73 excluding items in its current fiscal year. That's only marginally better than the $1.71 analysts expect the company to post for its just completed year.

Still, even with the recent setbacks and the industry backdrop, investors largely seem to be betting on EA for the long haul. Despite the stock's slide, EA shares are still trading at about 31 times expected earnings for its just-completed fiscal year and about 30 times projected profit for the coming fiscal year. Both numbers are well above those of peers such as

Activision

(ATVI) - Get Report

and

THQ

(THQI)

, even though EA is a significantly larger company.

Indeed, many long-term investors consider all the worries about the console transition to be just noise. The game industry is still growing and will likely continue to do so in the next generation, they note.

"I think too much has been made about the console conversion. I think it's caused investors to be overly jittery," says Dan Ahrens, portfolio manager of Mutual.com's Vice Fund, which is long shares of EA and Activision. "EA's still in the dominant position. Based on that, what's not to like?"

While many analysts like Ahrens expect EA to rebound from its current troubles and maintain its dominance, some investors would like to have some reassurance. And they're hoping EA gives them some Tuesday.