What drove EA's revenue growth in fiscal 1998?

Revenue growth of 35% was driven mainly by PlayStation product sales, which nearly doubled to $380.3 million, along with increased affiliated label distribution (up 92% to $185.9 million), N64 cartridge sales ($56.7 million), and PC-CD sales ($231.0 million, up 7%). These gains were partially offset by declines in 16-bit cartridge revenue and Saturn sales.

Why did gross margins decline, and is this likely to continue?

Cost of goods sold rose to 52.9% of revenue from 48.9%, due to a greater share of lower-margin affiliated label and N64 products, a smaller share of higher-margin PC-CD sales, and higher celebrity and manufacturing royalties. Management indicated that margins may remain at or decline from fiscal 1998 levels, since N64 products carry lower margins and the affiliated label share may continue to grow.

How much of the net income growth came from one-time items?

The $12.6 million gain on the sale of Creative Wonders was a non-recurring benefit, while the $10.8 million in Maxis merger costs and $1.5 million in-process technology charge were non-recurring expenses that partly offset it. The net effect of these items was modest relative to $72.6 million in net income, though the gain alone is worth about $0.13 per diluted share before tax, and operating income growth reflects core business performance.

What are the main risks to EA's business going forward?

The main risks include dependence on Sony and Nintendo for hardware platforms, which control manufacturing and set royalties; the hits-driven nature of the business and high advertising costs; product development delays, such as those affecting Populous 3 and SimCity 3000; intense competition for shelf space and creative talent; and currency exposure, since 43% of revenue is international. Additionally, the company faces a Year 2000 compliance risk whose cost has not yet been determined.

EA 10-K FY1998 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed June 26, 1998. Cited figures are marked; the original filing is the authoritative source.

Electronic Arts (EA) reported a strong fiscal 1998 (year ended March 31, 1998), with net revenues rising 35% to $908.9 million^a from $673.0 million and net income up 41% to $72.6 million, or $1.19 per diluted share.

Growth was driven primarily by Sony's PlayStation, which accounted for about 42% of revenue ($380.3 million^b, up from $187.5 million), along with strong affiliated label (AL) distribution sales and the first meaningful N64 contributions. Gross margin, however, compressed to 47.1% from 51.1% as lower-margin AL and N64 products grew as a share of the mix, and management explicitly warned that margins may remain at or decline from current levels. Operating income rose 33% to $83.4 million, but the reported profit was flattered by a $12.6 million gain on the sale of the Creative Wonders joint venture, and was partly offset by $10.8 million in Maxis merger costs and a $1.5 million in-process technology charge.

Operating margin was essentially flat at 9.2% versus 9.3% a year earlier, so the earnings growth came mainly from scale rather than improved profitability. The balance sheet is solid, with cash and short-term investments of $374.6 million^c, working capital of $408.1 million, and operating cash flow of $79.0 million, though receivables grew faster than sales. Investors should weigh EA's heavy dependence on a few platforms and franchises, particularly the PlayStation, against the risks of product delays, hardware-controlled manufacturing, and a hits-driven business.

The company is also shifting its portfolio toward PC-CD and N64 titles, with Saturn and 16-bit sales expected to decline sharply, and it announced new joint ventures with Square. The company pays no dividends and plans to reinvest its cash, so shareholder returns depend on continued share price appreciation.

02—Key points

Key Highlights

Net revenues grew 35.0% to $908.9 million, led by PlayStation sales that rose 103% to $380.3 million (42% of revenue).
Net income increased 41.4% to $72.6 million; diluted EPS was $1.19 versus $0.86 in fiscal 1997.
Gross margin fell to 47.1% from 51.1%, reflecting a shift toward lower-margin affiliated label and N64 products, and management expects margins may stay flat or decline.
Operating income rose 32.9% to $83.4 million, but operating margin was roughly flat at 9.2%; results included a $12.6 million gain on the Creative Wonders sale, offset by $10.8 million in Maxis merger costs and a $1.5 million in-process R&D charge.
Strong liquidity: $374.6 million in cash and short-term investments, $408.1 million in working capital, and $79.0 million in operating cash flow.
Concentration risk remains high: PlayStation supplies 42% of revenue and Sony controls manufacturing, while Saturn and 16-bit sales are expected to decline significantly and no new titles are planned for those platforms in fiscal 1999.
International revenue rose 30% to $389.4 million (43% of total), and the company announced joint ventures with Square Co. in North America and Japan.

03—Questions

Frequently Asked Questions

What drove EA's revenue growth in fiscal 1998?
Revenue growth of 35% was driven mainly by PlayStation product sales, which nearly doubled to $380.3 million, along with increased affiliated label distribution (up 92% to $185.9 million), N64 cartridge sales ($56.7 million), and PC-CD sales ($231.0 million, up 7%). These gains were partially offset by declines in 16-bit cartridge revenue and Saturn sales.
Why did gross margins decline, and is this likely to continue?
Cost of goods sold rose to 52.9% of revenue from 48.9%, due to a greater share of lower-margin affiliated label and N64 products, a smaller share of higher-margin PC-CD sales, and higher celebrity and manufacturing royalties. Management indicated that margins may remain at or decline from fiscal 1998 levels, since N64 products carry lower margins and the affiliated label share may continue to grow.
How much of the net income growth came from one-time items?
The $12.6 million gain on the sale of Creative Wonders was a non-recurring benefit, while the $10.8 million in Maxis merger costs and $1.5 million in-process technology charge were non-recurring expenses that partly offset it. The net effect of these items was modest relative to $72.6 million in net income, though the gain alone is worth about $0.13 per diluted share before tax, and operating income growth reflects core business performance.
What are the main risks to EA's business going forward?
The main risks include dependence on Sony and Nintendo for hardware platforms, which control manufacturing and set royalties; the hits-driven nature of the business and high advertising costs; product development delays, such as those affecting Populous 3 and SimCity 3000; intense competition for shelf space and creative talent; and currency exposure, since 43% of revenue is international. Additionally, the company faces a Year 2000 compliance risk whose cost has not yet been determined.

04—Continue

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