New Game in Electronic Arts' Lineup: "Financial Crisis?"
Electronic Arts, home to some of the most popular PC games of all time, including the blockbuster Sims, Madden football, and Rock Band franchises, reported a loss of $1.08 billion for fiscal 2009 ended March, hurt by weaker-than-expected holiday sales and an admitted failure to score enough big sellers on the most popular game console system, Nintendo's Wii.
The video game publisher can weather the current downturn in consumer spending, as it sits on more than $2.1 billion in cash, according to its annual regulatory filing with the SEC. Curiously, as Wall Street analysts argue amongst themselves about the merits of EA driving growth by staying with roads-well-traveled-reliance on churning out sequels to pre-existing hits and producing big, expensive Hollywood-style games (think the oft delayed Harry Potter and the Half-Blood Prince), not one analyst bothered to voice any concerns on information buried deep in the body of the regulatory filing -- the fact that the video game maker almost defaulted on real-estate loan covenants!
EA leases certain of its current facilities, furniture, and equipment under non-cancellable operating lease agreements that it records as off-balance sheet commitments. In Feb. 1995, the company entered into a build-to-suit lease for its headquarters in Redwood City, Calif. This facility comprises a total of approximately 350,000 square feet and provides space for sales, marketing, administration and research and development functions. The lease expires in Jan. 2039.
On Feb. 2, 2009, the lease was amended to modify the Fixed Charge Coverage Ratio, the Quick Ratio and the Consolidated EBIDTA definitions used in the covenants. In the event that the company had not entered into this amendment, which covered the quarter ended December 31, 2008, as well as future quarters, EA would have been unable to meet the Fixed Charge Coverage Ratio for the December quarter -- default!
In December 2000, the company also entered into a second build-to-suit lease to expand the Redwood City headquarters facilities by an additional 310,000 square feet. Development of the adjacent property was completed in June 2002. Similar to the 1995 lease, had the company not modified the Fixed Charge Coverage Ratio, it would have been in non-compliance of that lease, too.
The two lease agreements are with KeyBank National Association. The following table sets forth the amended financial covenants as of February 2, 2009 (all of which EA is currently in compliance with as of March 31, 2009):
Even scarier is the rise of free games. As presciently opined by Dean Takahashi last month in VentureBeat: What happens when the user decides that free is best? This is the same problem that newspapers, movies, music, and other producers of content are facing as the Internet undercuts the traditional barriers that have kept prices high.
As EA grapples with a weak consumer spending environment and the changing dynamics of interactive entertainment, fissures are opening up on the balance sheet: cash generated from operations plummeted 96 percent to $12 million and shareholder equity fell 28 percent to $3.1 billion. Nonetheless, chief executive John Riccitiello remains cautiously optimistic on the sales outlook for 2010, telling analysts on the earnings call that a strong lineup of titles on EA's core platforms (PS3, Xbox 360, and Nintendo Wii), including The Sims 3, Tiger Woods PGA Tour 10, and Harry Potter should drive sales and profitability.
In my opinion, however, EA's wireless digital-service initiatives will define the financial health of the company in the years ahead. The digital business is currently scaled at over $400 million and it is growing north of 20 percent. Although wireless sales will contribute only about 10 percent of anticipated revenue of $3.7 billion to $3.85 billion in fiscal 2010, EA remains committed to being the number one publisher in wireless in North America and Europe combined, said Riccitiello.
EA's global publishing footprint has long been a strategic advantage for the company. Setting the investment stage in wireless and making their games more accessible to a broader audience, including social networking (such as Pogo on Twitter!) will, in my opinion, strengthen further its balance sheet in coming years, too. Or, as Oliver Wendell Holmes said: "it is not so much where we stand, as in what direction we are going."