3
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ______ to_____
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1450 Fashion Island Boulevard
San Mateo, California 94404
(Address of principal executive offices) (Zip Code)
(415) 571-7171
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock July 27, 1996
--------------------- -------------
$0.01 par value per share 53,136,162
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
June 30, 1996 and March 31, 1996 3
Consolidated Statements of Income for
the Three Months Ended June 30, 1996 and 1995 4
Consolidated Statements of Cash Flows for
the Three Months Ended June 30, 1996 and 1995 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II - Other Information
Item 1. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
2
<PAGE>
<TABLE>
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<CAPTION>
ASSETS
June 30, March 31,
1996 1996
--------- ---------
(unaudited)
<S> <C> <C>
Current assets:
Cash and short-term investments $ 149,798 $ 147,983
Marketable securities 41,915 37,869
Receivables, less allowances of $23,729 and $27,569, respectively 52,281 73,075
Inventories 13,628 14,704
Prepaid royalties 16,446 14,519
Other current assets 11,105 12,188
--------- ---------
Total current assets 285,173 300,338
Property and equipment, net 72,424 70,062
Prepaid royalties 9,279 11,030
Long-term investments 24,200 24,200
Investments in affiliates 16,327 15,952
Other assets 2,566 2,637
--------- ---------
$ 409,969 $ 424,219
========= =========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 26,020 $ 37,019
Accrued liabilities 51,276 63,606
--------- ---------
Total current liabilities 77,296 100,625
Minority interest in consolidated joint venture 1,094 1,277
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares -- --
Common stock, $0.01 par value. Authorized 70,000,000 shares;
issued and outstanding 53,114,396 and 52,741,572, respectively 531 527
Paid-in capital 114,502 108,078
Retained earnings 199,558 199,523
Unrealized appreciation of investments 18,961 16,266
Translation adjustment (1,973) (2,077)
--------- ---------
Total stockholders' equity 331,579 322,317
--------- ---------
$ 409,969 $ 424,219
========= =========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended
June 30,
1996 1995
-------- --------
Net revenues 80,627 $ 80,523
Cost of goods sold 39,467 42,801
-------- --------
Gross profit 41,160 37,722
-------- --------
Operating expenses:
Marketing and sales 13,965 11,690
General and administrative 8,166 6,181
Research and development 25,329 19,883
-------- --------
Total operating expenses 47,460 37,754
-------- --------
Operating loss (6,300) (32)
Interest and other income, net 6,116 1,143
-------- --------
Income (loss) before provision for income
taxes and minority interest (184) 1,111
Provision (benefit) for income taxes (59) 356
-------- --------
Income (loss) before minority interest (125) 755
Minority interest in consolidated
joint venture 160 45
-------- --------
Net income $ 35 $ 800
======== ========
Net income per share: $ 0.00 $ 0.02
======== ========
Number of shares used in computation 54,930 53,287
======== ========
See accompanying notes to consolidated financial statements.
4
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Three Months
Ended June 30,
---------------------
1996 1995
--------- ---------
Operating activities:
Net income $ 35 $ 800
Adjustments to reconcile net income to net
cash used in operating activities:
Minority interest in consolidated joint venture (160) (45)
Depreciation and amortization 4,480 3,253
(Gain) loss on sale of fixed assets (56) 64
Gain on sale of marketable securities (4,702) --
Change in assets and liabilities:
Receivables 20,794 (4,138)
Inventories 1,076 374
Prepaid royalties (176) (4,824)
Other assets 1,046 (4,746)
Accounts payable (10,999) 1,991
Accrued liabilities (13,796) (23,297)
Deferred income taxes 24 (539)
--------- ---------
Net cash used in operating activities (2,434) (31,107)
--------- ---------
Investing activities:
Proceeds from sales of furniture and equipment 145 83
Proceeds from sales of marketable securities 4,989 --
Capital expenditures (7,019) (30,647)
Investment in affiliates (375) (7,228)
Change in short-term investments, net (10,420) 7,800
Adjustment for effects of poolings in prior period -- (88)
--------- ---------
Net cash used in investing activities (12,680) (30,080)
--------- ---------
Financing activities:
Proceeds from issuance of common stock 5,283 3,508
Tax benefit from exercise of stock options 1,145 1,276
--------- ---------
Net cash provided by financing activities 6,428 4,784
--------- ---------
Translation adjustment 104 363
Minority interest on translation adjustment (23) 60
--------- ---------
Decrease in cash and cash equivalents (8,605) (55,980)
Beginning cash and cash equivalents 105,628 143,421
--------- ---------
Ending cash and cash equivalents 97,023 87,441
Short-term investments 52,775 22,900
--------- ---------
Ending cash and short-term investments $ 149,798 $ 110,341
========= =========
Supplemental cash flow information:
Cash paid during the year for income taxes $ 605 $ 8,130
========= =========
Non-cash investing activities:
Unrealized gain (loss) on investments $ 4,137 $ (826)
========= =========
See accompanying notes to consolidated financial statements.
5
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements are unaudited and reflect all adjustments
(consisting only of normal recurring accruals) that, in the opinion of
management, are necessary for a fair presentation of the results for the interim
period. The results of operations for the current interim period are not
necessarily indicative of results to be expected for the current year or any
other period.
These consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended March 31, 1996 as filed with the
Securities and Exchange Commission on July 1, 1996.
Note 2. Cash and Investments
Cash equivalents consist of highly liquid investments with maturities of three
months or less at the date of purchase. Short-term investments include
securities with maturities greater than three months and less than one year,
except for certain investments with stated maturities greater than one year.
The Company accounts for investments under Statement of Financial Accounting
Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities, ("SFAS 115"). SFAS 115 requires that investments in equity and debt
securities be classified and accounted for in one of three categories. The
Company has classified short-term investments as "available-for-sale" and has
stated applicable investments at fair value which approximates cost. The cost of
securities sold is based upon the specific identification method.
Cash and short-term investments at June 30, 1996 and March 31, 1996 consisted of
(in thousands):
June 30, 1996 March 31, 1996
------------- --------------
Cash and cash equivalents $ 97,023 $105,628
Short-term investments 52,775 42,355
-------- --------
$149,798 $147,983
======== ========
Note 3. Marketable Securities
Marketable securities consist of equity securities. The Company has accounted
for investments in equity securities as "available-for-sale" and has stated
applicable investments at fair value with net unrealized gains (losses) reported
as a separate component of stockholders' equity.
At June 30, 1996, marketable securities included the Company's approximate 10.5%
ownership interest (2,813,668 shares) in The 3DO Company ("3DO"). For the
quarter ended June 30, 1996, the Company sold 422,000 shares of 3DO stock and
realized a gain before taxes of $4,702,000. See THE 3DO COMPANY, below.
6
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 4. Software Development Costs
To date, the Company has not capitalized any software development costs in
accordance with Statement of Financial Accounting Standard (SFAS) No. 86 since
the impact to the financial statements for all periods presented has been
immaterial.
Note 5. Inventories
Inventories are stated at the lower of average cost or market. Inventories at
June 30, 1996 and March 31, 1996 consisted of (in thousands):
June 30, 1996 March 31, 1996
------------- --------------
Raw materials and work in process $ 4,029 $ 2,160
Finished goods 9,599 12,544
------- -------
$13,628 $14,704
======= =======
Note 6. Accrued Liabilities
Accrued liabilities at June 30, 1996 and March 31, 1996 consisted of (in
thousands):
June 30, 1996 March 31, 1996
------------- --------------
Accrued expenses $13,701 $18,203
Accrued royalties 9,578 16,889
Accrued compensation and benefits 9,825 11,480
Accrued income taxes 9,851 10,477
Deferred income taxes 7,344 5,878
Deferred revenue 977 679
------- -------
$51,276 $63,606
======= =======
7
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
<TABLE>
Note 7: Operations by Geographic Areas
The Company operates in one industry segment. Information about the Company's
operations in North America, Europe, South Asia Pacific and Japan for the three
months ended June 30, 1996 and 1995 is presented below (in thousands).
<CAPTION>
North South Asia
America Europe Pacific Japan Eliminations Total
------- ------ ------- ----- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Three months ended June 30, 1996
Net revenues from
unaffiliated customers $ 38,154 $ 30,322 $ 4,862 $ 7,289 $ -- $ 80,627
Intersegment net revenues 7,046 739 -- 11 (7,796) --
--------- --------- --------- --------- --------- ---------
Total net revenues $ 45,200 $ 31,061 $ 4,862 $ 7,300 $ (7,796) $ 80,627
========= ========= ========= ========= ========= =========
Operating income (loss) $ (9,133) $ 2,369 $ 924 $ (460) $ -- $ (6,300)
Identifiable assets $ 300,349 $ 89,401 $ 8,940 $ 11,279 $ -- $ 409,969
Three months ended June 30, 1995
Net revenues from
unaffiliated customers $ 47,203 $ 22,312 $ 3,287 $ 7,721 $ -- $ 80,523
Intersegment net revenues 6,921 1,398 -- -- (8,319) --
--------- --------- --------- --------- --------- ---------
Total net revenues $ 54,124 $ 23,710 $ 3,287 $ 7,721 $ (8,319) $ 80,523
========= ========= ========= ========= ========= =========
Operating income (loss) $ (5,307) $ 4,929 $ 610 $ (264) $ -- $ (32)
Identifiable assets $ 263,125 $ 45,037 $ 5,872 $ 10,947 $ -- $ 324,981
</TABLE>
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Quarterly Report on Form 10-Q and in particular Management's Discussion and
Analysis of Financial Condition and Results of Operations contains forward
looking statements regarding future events or the future financial performance
of the Company that involve certain risks and uncertainties discussed in
"Factors Affecting Future Performance" below at pages 18 to 23, as well as in
the Company's Annual Report on Form 10-K for the fiscal year ended March 31,
1996 as filed with the Securities and Exchange Commission on July 1, 1996.
Actual events or the actual future results of the Company may differ materially
from any forward looking statement due to such risks and uncertainties.
Net Revenues June 30, June 30,
1996 1995 % change
Consolidated Net Revenues --------------------------------------
Three Months Ended $80,627,000 $80,523,000 0.1%
International Net Revenues
Three Months Ended $42,473,000 $33,320,000 27.5%
as a percentage of net revenues 52.7% 41.4%
North America Net Revenues
Three Months Ended $38,154,000 $47,203,000 (19.2%)
as a percentage of net revenues 47.3% 58.6%
The Company derives revenues from shipments of EA Studio Compact Disk ("CD")
personal computer products ("PC CD") and floppy-disk personal computer products
(primarily entertainment software), EA Studio CD products for dedicated
entertainment systems ("CD-Videogame"), EA Studio cartridge products, licensing
of EA Studio products, distribution of EA Studio products through hardware
companies ("OEMs") and shipments of Affiliated Label ("AL") CD and Floppy-Disk
products that are created by third parties.
Overall, North American net revenues decreased 19.2% for the three months ended
June 30, 1996 compared to the same period last year primarily due to decreased
Affiliated Label sales resulting from the initial distribution of PC products to
key accounts on behalf of third party publishers which occurred in the prior
year. The mix of North American sales reflected the transition from the mature
16-bit cartridge market to the 32-bit personal computer CD ROM and dedicated
entertainment systems, including the Sony PlayStation and Sega Saturn. Total
North American PC CD and CD-Videogame revenue increased $12,863,000 or 99.5% to
$25,786,000 for the three months ended June 30, 1996 in comparison to the same
period in the prior year, while 16-bit net revenues decreased $12,394,000 or
72.0% to $4,814,000.
9
<PAGE>
International net revenues increased 27.5% for the three months ended June 30,
1996 compared to the same period last year. The increase was primarily due to a
35.9% increase in European net revenues consisting of higher sales of Sony
PlayStation, PC CD and AL products offset by a decrease in Sega 16-bit cartridge
products. Total net revenues in Europe were $30,322,000 for the three months
ended June 30, 1996 compared to $22,312,000 in the same period last year.
European AL sales increased to $6,698,000 or 83% for the quarter ending June 30,
1996 due to the expansion of the distribution business in Germany and Spain.
The increase in European net revenues was offset by a decrease in net revenue of
$432,000 or 5.6% in Japan. Net revenues in Japan for the first fiscal quarter
1997 were $7,289,000 compared to $7,721,000 for the corresponding period in the
prior year. Revenues in the current fiscal quarter were comprised primarily of
sales from Sony PlayStation products compared to sales of 3DO and SNES products
in the prior year.
Sales in the South Asia Pacific region increased by 47.9% to $4,862,000 compared
to $3,287,000 in the prior year due to increased sales of Sony PlayStation and
PC CD titles and new sales offices in New Zealand and Singapore opened during
fiscal 1996. Though international revenues are expected to grow in fiscal 1997,
they may not grow at as high a rate as in prior years.
EA Studio Net Revenues:
32-bit Videogame Product Net Revenues
June 30, June 30,
1996 1995 % change
----------------------------------------
Three Months Ended $27,173,000 $5,874,000 362.6%
as a percentage of net revenues 33.7% 7.3%
The Company released seven 32-bit CD-Videogame products during the first quarter
of fiscal 1997 comprised of four for the Sony PlayStation, including Triple Play
97 and Fade to Black and three for the Sega Saturn, including The Need for Speed
and Road Rash. All 32-bit CD-Videogame revenues for the quarter ended June 30,
1996 were from sales of Sony PlayStation and Sega Saturn products compared to
100% of revenues for the quarter ended June 30, 1995 being derived from sales of
products for the 3DO Interactive Multiplayer. The Company has no planned
releases of 3DO games in fiscal 1997. The increase in sales is attributable to
the increased number of titles released and the greater installed base of 32-bit
consoles.
10
<PAGE>
Under the terms of a licensing agreement entered into with Sony Computer
Entertainment of America in July 1994 (the "Sony Agreement"), the Company is
authorized to develop and distribute CD based software products compatible with
the Sony PlayStation (the "PlayStation"). Pursuant to the Sony Agreement, the
Company engages Sony to supply PlayStation CDs for distribution by the Company.
Accordingly, the Company has limited ability to control its supply of
PlayStation CD products or the timing of their delivery. See HARDWARE COMPANIES,
below.
Under the terms of a licensing agreement entered into with Sega Enterprises,
Ltd. in January 1995 (the "Sega Saturn Agreement"), the Company is authorized to
develop and distribute CD based software products compatible with the Sega
Saturn. Pursuant to the Sega Saturn Agreement, the Company engages various third
party manufacturers approved by Sega to supply its Saturn CDs for distribution.
Accordingly, the Company has limited ability to control its supply of Saturn CD
products or the timing of their delivery. See HARDWARE COMPANIES, below.
Personal Computer-based CD Product Net Revenues
June 30, June 30,
1996 1995 % change
--------------------------------------
Three Months Ended $27,064,000 $21,082,000 28.4%
as a percentage of net revenues 33.6% 26.1%
The Company released five new PC CD titles in the first quarter of the current
fiscal year, four for the IBM personal computer and compatibles including AH-64D
Longbow and Space Hulk: Vengeance of the Blood Angels, and Wing Commander IV for
the Macintosh, compared to three for the same period last year. As mentioned
above and elsewhere in this report, the increase in both absolute dollars and as
a percentage of total net revenues reflects the market transition from 16-bit
cartridge systems to CD platforms, including both personal computers and
CD-Videogames, and the Company's strategy to focus its development efforts on CD
based products. Though PC CD revenues are expected to grow in fiscal 1997, they
may not grow at as high a rate as in prior years.
11
<PAGE>
16-bit Videogame Product Net Revenues June 30, June 30,
1996 1995 % change
--------------------------------------
Three Months Ended $8,154,000 $26,716,000 (69.5%)
as a percent of net revenues 10.2% 33.2%
The Company released one new 16-bit videogame, Triple Play Gold for the Sega
Genesis, during the first quarter of fiscal 1997. Sega Genesis ("Genesis")
cartridge sales were $6,974,000 for the three months ended June 30, 1996
compared to $20,224,000 for the same period in the prior year. Super Nintendo
Entertainment System ("SNES") sales were $1,180,000 for the three months ended
June 30, 1996 compared to $6,492,000 for the same period last year.
The Company's net revenues derived from 16-bit videogames declined 69.5% during
the first quarter of fiscal 1997 compared to the same period in the prior year.
Since the 16-bit videogame market has matured, sales of the related software
have significantly declined and are expected to significantly decline further in
fiscal 1997. Additionally, as the 16-bit cartridge market has become more
"hits-driven", the Company will continue to ship fewer cartridge products in
fiscal 1997 than in fiscal 1996 and expects to release a higher percentage of
these products in the December quarter.
Under the terms of a licensing agreement entered into with Sega Enterprises,
Ltd., ("Sega") in July 1992, as amended ("the 16-bit Sega Agreement"), the
Company is authorized to develop ROM-cartridge software products compatible with
the Genesis system through December 1997 and to distribute those cartridges
through June 1998. Genesis cartridges are manufactured by the Company in Puerto
Rico and by a third party manufacturer under terms of the 16-bit Sega Agreement.
A shortage of components, or other factors outside the control of the Company
could impair the Company's ability to manufacture, or have manufactured an
adequate supply of its products.
12
<PAGE>
Under the terms of its licensing agreement with Nintendo, the Company engages
Nintendo to manufacture its SNES cartridges for distribution. The Company has
little ability to control its supply of cartridges or the timing of their
delivery. A shortage of microchips, or other factors outside the control of the
Company could impair the Company's ability to obtain an adequate supply of
cartridges. In connection with the Company's purchases of Nintendo cartridges to
be distributed in North America, Nintendo requires that the Company provide it
irrevocable letters of credit prior to Nintendo's acceptance of purchase orders
from the Company. For purchases of Nintendo cartridges for distribution in Japan
and Europe, Nintendo requires the Company to make cash deposits. Furthermore,
Nintendo maintains a policy of not accepting returns. Because of these and other
factors, the carrying of an inventory of cartridges entails significant
investment and risk. See HARDWARE COMPANIES, below.
License/OEM Net Revenues
June 30, June 30,
1996 1995 % change
--------------------------------------
Three Months Ended $4,980,000 $6,092,000 (18.3%)
as a percentage of net revenues 6.2% 7.6%
The decrease in license/OEM net revenues for the three months ended June 30,
1996 compared to the same period last year was primarily a result of a decrease
in the distribution of its products through OEM's in the United States.
Affiliated Label Net Revenues
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $13,107,000 $17,780,000 (26.3%)
as a percentage of net revenues 16.2% 22.1%
The decrease in Affiliated Label net revenues for the three months ended June
30, 1996 compared to the prior year period reflects the initial distribution of
PC products to key accounts on behalf of other third party publishers which
occurred in the first quarter of the prior year in North America partially
offset by the expansion of the distribution business in Europe.
13
<PAGE>
Other Revenues
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $149,000 $2,979,000 (95.0%)
as a percentage of net revenues 0.1% 3.7%
Other revenues for the three months ended June 30, 1996 consisted primarily of
sales of floppy-disk based PC titles. For the quarter ended June 30,1995, other
revenues included sales of products for Gameboy, the Sega 32X platform and
floppy-disk PC titles. The Company released one title for the Sega 32X during
the first quarter of fiscal 1996. The Company does not plan to release any new
titles for hand-held equipment, the Sega CD or on floppy-disks in fiscal 1997
and accordingly, revenues for these platforms are not expected to be
significant.
Cost of Goods Sold
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $39,467,000 $42,801,000 (7.8%)
as a percentage of net revenues 49.0% 53.1%
The decrease in costs of goods sold as a percentage of net revenues, for the
three months ended June 30, 1996 compared to the same period last year was
primarily due to the increase in sales of higher margin PC CD and CD Videogame
titles compared to lower margin 16-bit cartridge products. The higher margins
were partially offset by higher production costs for multimedia releases, higher
professional, celebrity and manufacturing royalties as well as lower margins on
Affiliated Label products.
Marketing and Sales
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $13,965,000 $11,690,000 19.5%
as a percentage of net revenues 17.3% 14.5%
The increase in marketing and sales expenses was primarily attributable to
expansion of the Company's worldwide distribution business and increased
headcount worldwide. The increase reflects new sales and distribution offices in
the International market, including New Zealand, Singapore, Sweden and South
Africa.
14
<PAGE>
General and Administrative
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $8,166,000 $6,181,000 32.1%
as a percentage of net revenues 10.1% 7.7%
The increase in general and administrative expenses resulted primarily from an
increase in payroll and occupancy costs due to the opening of additional
international offices.
Research and Development
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $25,329,000 $19,883,000 27.4%
as a percentage of net revenues 31.4% 24.7%
The increase in research and development expenses was primarily due to
additional headcount relating to increased in-house development capacity, in
anticipation of a higher number of product releases in fiscal 1997 in comparison
to the prior year, and higher average development costs for CD-based products
than for cartridge products. Additionally, for the three months ended June 30,
1996, reserves against artists advances and depreciation of computer equipment
increased compared to the prior year.
Operating Loss
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $(6,300,000) $(32,000) N/M
as a percentage of net revenues (7.8%) (0.0%)
Operating loss increased for the three months ended June 30, 1996 compared to
the same period last year due to an increase in operating expenses partially
offset by an increase in gross profit margins, as noted above.
Interest and Other Income, Net
June 30 June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $6,116,000 $1,143,000 435.1%
as a percentage of net revenues 7.6% 1.4%
Interest and other income, net, increased for the three months ended June 30,
1996 compared to the same period last year primarily due to the gain on sale of
marketable securities of $4,702,000 and increased interest income as compared to
the same quarter in the prior year.
15
<PAGE>
Income Taxes
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $(59,000) $356,000 N/M
effective tax rate 32.1% 32.0%
The Company's effective tax rate for the three months ended June 30, 1996 was
comparable to the same period last year.
Minority Interest in Consolidated Joint Venture
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $160,000 $45,000 255.6%
as a percentage of net revenue 0.2% 0.1%
EAV is sixty-five percent owned by the Company and thirty-five percent owned by
Victor Entertainment Industries, Inc. ("VEI"), (formerly Victor Musical
Industries, Inc.) a wholly owned subsidiary of Victor Company of Japan, Limited.
The minority interest represents VEI's 35% interest in EAV. Minority interest
for the three months ended June 30, 1996 reflects higher reported losses for EAV
compared to the same period in the prior year.
Net Income
June 30, June 30,
1996 1995 % change
-------------------------------------
Three Months Ended $35,000 $800,000 (95.6%)
as a percentage of net revenue 0.0% 1.0%
The decrease in net income as compared to the prior year period was primarily
related to slightly higher revenues, other income and gross profit margins
offset by higher operating expenses.
16
<PAGE>
Liquidity and Capital Resources
As of June 30, 1996, the Company's working capital was $207,877,000 compared to
$199,713,000 at March 31, 1996. Cash and short term investments increased by
approximately $1,815,000 during the quarter as the Company used $2,434,000 of
cash in operations offset by proceeds from the sale of marketable securities and
the exercise of stock options.
Reserves for bad debts and sales returns decreased from $27,569,000 at March 31,
1996 to $23,729,000 at June 30, 1996. Reserves have been charged for returns of
product and price protection credits issued for products sold in prior periods.
Management believes these reserves are adequate based on historical experience
and its current estimate of potential returns and allowances.
Inventory levels at June 30, 1996 decreased slightly compared to March 31, 1996
due to seasonal decreases in inventory levels in Europe.
In connection with the Company's purchases of Sony products to be distributed in
Japan, Sony of Japan requires cash deposits totaling one-third of purchase
orders. At June 30, 1996, EAV had $60,000 of outstanding cash deposits to Sony.
In lieu of letters of credit, EAV utilizes a line of credit to fund these
deposits and purchases of Sony products. At June 30, 1996, EAV had no amounts
outstanding on this line.
The Company's principal source of liquidity is $149,798,000 in cash and
short-term investments. Management believes the existing cash, cash equivalents,
short-term investments, marketable securities and cash generated from operations
will be sufficient to meet cash and investment requirements for the foreseeable
future.
17
<PAGE>
Factors Affecting Future Performance
The Industry and Competition. The interactive software business has historically
been a volatile and highly dynamic industry affected by changing technology,
limited hardware platform life cycles, hit products, competition, component
supplies, seasonality, consumer spending and other economic trends. The business
is also intensely competitive. A variety of companies offer products that
compete directly with one or more of the Company's products. These direct
competitors vary in size from very small companies to companies with financial,
managerial and technical resources comparable to or greater than those of the
Company. Typically, the Company's chief competitor on dedicated game platforms
is the hardware manufacturer/ licensor itself, to which the Company must pay
royalties, and in the case of Sony and Nintendo, manufacturing charges. For
example, Sony has aggressively launched sports product lines that directly
compete with the Company's sports products on the PlayStation. Additionally, new
entrants in the interactive entertainment and multimedia industries, such as
cable television, telephone and diversified media and entertainment companies,
and a proliferation of new technologies, such as on-line networks and the
Internet, are making market forecasting and prediction of financial results
increasingly difficult for the Company. For example, as the Company increases
its share of the PC CD market, the potential for competition with companies such
as Microsoft increases.
Products. Interactive entertainment software products typically have life spans
of only 3 to 12 months. In addition, the market is crowded with a large number
of titles competing for limited shelf space at retail. The Company's future
success will depend in large part on its ability to develop and introduce new
competitive products on a timely basis and to get those products distributed
widely at retail. To compete successfully, new products must adapt to new
hardware platforms and emerging industry standards, provide additional
functionality and be successfully distributed in numerous changing worldwide
markets. If the Company were unable, due to resource constraints or
technological or other reasons, to successfully develop and distribute such
products in a timely manner, this inability would have a material adverse effect
on its operating results and financial condition.
Development. Product development schedules, particularly for new hardware
platforms and high-end multimedia PC's are difficult to predict because they
involve creative processes, use of new development tools for new platforms and
the learning process associated with development for new technologies. CD-ROM
products frequently include more content and are more complex, time-consuming
and costly to develop than cartridge products and, accordingly, cause additional
development and scheduling risk. For example, in fiscal 1996, John Madden
Football 96 and NHL Hockey 96 for the Sony PlayStation did not ship at all due
to significant delays in development that made the delayed completion date
untimely for these products. In addition, Dungeon Keeper was originally
scheduled to ship in the first fiscal quarter of 1997 but it is now expected to
ship in the December quarter due to development delays. Because of the increased
cost of compact disk product development, write-offs of advance payments made to
outside artists for discontinued or unsuccessful products have increased and may
continue to increase.
18
<PAGE>
Manufacturing. Development risks for CD-ROM products can cause particular
difficulties in predicting quarterly results because brief manufacturing lead
times allow finalizing products and projected release dates late in a quarter.
Manufacturing lead times during the year for CD based products have been as
brief as one to three weeks; cartridge products more typically have had a six to
twelve week lead time for manufacture.
Platform Changes. A large portion of the Company's revenues are derived from the
sale of products designed to be played on proprietary videogame platforms such
as the Sony PlayStation, Sega Saturn, Super Nintendo Entertainment System and
Sega Genesis. The interdependent nature of the Company's business and that of
its hardware licensors brings significant risks to the Company's business. The
success of the Company's products is significantly affected by market acceptance
of the new videogame hardware systems and the life span of older hardware
platforms, and the Company's ability to accurately predict these factors with
respect to each platform. In many cases, the Company will have expended a large
amount of development and marketing resources on products designed for new
videogame systems (such as the new 32-bit systems) that have not yet achieved
large installed bases or continued product development for older hardware
platforms that may have shorter life cycles than the Company expected.
Conversely, if the Company does not choose to develop for a platform that
achieves significant market acceptance, or discontinues development for a
platform that has a longer life cycle than expected, the Company's revenue
growth may be adversely affected.
The Company believes that investment in products for the 32-bit market,
including both PC CD and CD-Videogame platforms, is strategically important and
the Company is therefore continuing its aggressive development activities for
32-bit platforms. Though Sony and Sega have announced price reductions of their
32-bit systems, the CD-Videogame market may grow at a slower than expected rate.
In addition, the Company's revenues and earnings are dependent on its ability to
meet its product release schedule and its failure to meet those schedules could
result in revenues and earnings below anticipated levels for the remainder of
fiscal 1997.
Hardware Companies. The Company's contracts with hardware licensors, which are
also some of the Company's chief competitors, often grant significant control to
the licensor over the manufacturing of the Company's products. This fact could,
in certain circumstances, leave the Company unable to get its products
manufactured and shipped to customers. In most events, control of the
manufacturing process by hardware companies increases both the manufacturing
lead times and the expense to the Company over the lead times and costs that the
Company can achieve independently. In both fiscal 1996 and to date in fiscal
1997, for example, the Company experienced delays in the manufacturing of Sony
PlayStation products which caused delays in shipping those products. The results
of future periods may be affected by similar delays. Finally, the Company's
contracts with its hardware licensors often require the Company to take
significant risks in holding or prepaying for its inventory of products.
19
<PAGE>
Revenue and Expenses. A substantial majority of the revenue of the Company in
any quarter typically results from orders received in that quarter and products
introduced in that quarter. The Company's expenses are based, in part, on
development of products to be released in the future. Certain overhead and
product development expenses do not vary directly in relation to revenues. As a
result, the Company's quarterly results of operations are difficult to predict,
and small delays in product deliveries may cause quarterly revenues, operating
results and net income to fall significantly below anticipated levels. The
Company typically receives orders shortly before shipments, making backlog an
unreliable indicator of quarterly results. A shortfall in shipments at the end
of any particular quarter may cause the results of that quarter to fall
significantly short of anticipated levels. In addition, due in part to the
volume of products introduced into the market and the short shelf life of most
products, there is increasing pressure from retailers to offer price protection
and accept returns of retailers' excess inventory.
Film and Videotape. The Company produces film and videotape to include in
certain products pursuant to agreements between certain of the Company's
subsidiaries with Screen Actors Guild (SAG), American Federation of Television
and Radio Actors (AFTRA) and British Actors Equity Association. However, the
costs of video production are significantly higher than for software production,
and for products which include a substantial amount of video such as certain
interactive movies, the costs of producing the video component is significantly
higher than the cost of developing the software component. For example, the film
component of Wing Commander IV cost approximately $8.0 million. Accordingly,
more units of such products must be sold to recoup the development and
production costs. While Wing Commander IV has sold sufficient units to recoup
the full costs of development, there can be no assurances that other products
including significant film or videotape components will be commercially
successful enough to recoup development costs. The Company expects to release
one product with significant video content during fiscal 1997. In addition, the
Company's agreements with SAG and AFTRA expire during the current calendar year,
and there can be no assurances that the Company will be able to renegotiate
favorable terms.
Employees. Competition for employees in the interactive software business is
intense and increasing as competition in the industry increases. In the last
fiscal year, recruiting of the Company's employees generally and its executive
officers in particular has been severe. Large software and media companies
frequently offer significantly larger cash compensation than does the Company,
placing pressure on the Company's base salary and cash bonus compensation. Small
start-up companies such as those proliferating in the on-line business offer
significant potential equity gains which are difficult for more mature companies
like the Company to match without significant shareholder dilution. In the last
eighteen (18) months, three of the Company's executive officers have resigned to
work with small start-up ventures, and virtually all of the executives are under
intense recruiting pressure. There can be no assurances that the Company will be
able to continue to attract and retain enough qualified employees in the future.
None of the Company's employees is subject to a collective bargaining agreement,
and the Company believes that its employee relations are excellent.
20
<PAGE>
Fluctuations in Stock Price. Due to analysts' expectations of continued growth
and other factors, any shortfall in earnings could have an immediate and
significant adverse effect on the trading price of the Company's common stock in
any given period. As a result of the factors discussed in this quarterly report
and other factors that may arise in the future, the market price of the
Company's common stock may be subject to significant fluctuations over a short
period of time. These fluctuations may be due to factors specific to the
Company, to changes in analysts' earnings estimates, or to factors affecting the
computer, software, entertainment, media or electronics industries or the
securities markets in general. For example, during fiscal year 1996, the price
per share of the Company's Common Stock ranged from $20.13 to $41.75 and in the
first quarter of fiscal 1997 ranged from $25.25 to $34.50.
Rapid Technological Change. The interactive software industry has recently
undergone another significant change due in part to the introduction or planned
introduction of new hardware platforms, as well as remote and electronic
delivery systems. The new generation of systems are based on 32-bit and 64-bit
microprocessors that incorporate dedicated graphics chipsets. Many of these
systems utilize CD-ROM drives. Sony and Sega each began distribution of their
next generation hardware systems (named the "PlayStation" and "Saturn",
respectively) in Japan during the quarter ended December 1994. Sega began
limited shipment of the Saturn in North America in May 1995 and Sony began
shipping the PlayStation in North America in September 1995. Nintendo shipped
the Nintendo 64 ("N64") in Japan in June 1996 and announced plans to begin
shipping the N64 in North America in the fall of 1996. In October 1995, 3DO
Company announced an agreement to license its next generation system, the M2 to
Matsushita Electric Industrial Co. Ltd. ("MEI").
As compact discs have emerged as the preferred medium for interactive
entertainment, education, and information software, the Company has continued
its investment in the development of CD-ROM tools and technologies and has more
than 50 titles in development for CD-ROM platforms, including the IBM PC and
compatibles, the Sony PlayStation and the Sega Saturn. Most of these products
will be convertible for use on multiple advanced hardware systems. As a result,
the Company's new product releases in its 1997 fiscal year will be primarily for
32-bit platforms, and to a lesser degree 16-bit videogame systems. However, the
transition from 16-bit cartridge-based game machines to the advanced systems
described above may continue to adversely affect the near term financial results
of the Company.
The 3DO Company. The Company currently owns approximately 10.5% of the common
stock of 3DO. There can be no assurance that 3DO as a company will be
successful. Because of the Company's equity stake in and historical association
with 3DO, a material adverse effect on the business or prospects of 3DO or a
substantial adverse change in the stock price of 3DO could have a material
adverse effect on the Company's stock price.
21
<PAGE>
Marketing and Distribution. As discussed above, the 16-bit videogame business
has become increasingly "hits" driven, requiring significantly greater
expenditures for advertising, particularly for television advertising. There can
be no assurance that the Company will continue to produce hit products or that
advertising expenditures will increase sales sufficiently to recoup the
advertising expenditures.
The Company has stock-balancing programs for its personal computer
products (whether provided on floppy-disk or CD-ROM) that, under certain
circumstances and up to a specified amount, allow for the exchange of personal
computer products by resellers. The Company also typically provides for price
protection for its personal computer and 16-bit and 32-bit videogame system
products that, under certain conditions, allows the reseller a price reduction
from the Company for unsold products. The Company maintains a policy of
exchanging products or giving credits, but does not give cash refunds. The risk
of price protection requirements is increasing as a result of the maturing and
the increasingly hit-based nature of the 16-bit video cartridge market.
Moreover, the risk of product returns may increase as new hardware platforms
become more popular or market factors force the Company to make changes in its
distribution system. The Company monitors and manages the volume of its sales to
retailers and distributors and their inventories as substantial overstocking in
the distribution channel can result in high returns or the requirement for
substantial price protection in subsequent periods. The Company believes that it
provides adequate reserves for returns and price protection which are based on
estimated future returns of products, taking into account promotional
activities, the timing of new product introductions, distributor and retailer
inventories of the Company's products and other factors, and that its current
reserves will be sufficient to meet return and price protection requirements for
the foreseeable future. However, there can be no assurance that actual returns
or price protection will not exceed the Company's reserves. See REVENUE AND
EXPENSES, above.
The distribution channels through which consumer software products are
sold have been characterized by change, including consolidations and financial
difficulties of certain distributors and retailers and the emergence of new
retailers such as general mass merchandisers. The development of remote and
electronic delivery systems will create further changes. The bankruptcy or other
business difficulties of a distributor or retailer could render Electronic Arts'
accounts receivable from such entity uncollectible, which could have an adverse
effect on the operating results and financial condition of the Company. In
addition, an increasing number of companies are competing for access to these
channels. Electronic Arts' arrangements with its distributors and retailers may
be terminated by either party at any time without cause. Distributors and
retailers often carry products that compete with those of the Company. Retailers
of Electronic Arts' products typically have a limited amount of shelf space and
promotional resources for which there is intense competition. There can be no
assurance that distributors and retailers will continue to purchase Electronic
Arts' products or provide Electronic Arts' products with adequate levels of
shelf space and promotional support.
22
<PAGE>
Seasonality. The Company's business is highly seasonal. The Company typically
experiences its highest revenues and profits in the calendar year-end holiday
season and a seasonal low in revenues and profits in the quarter ending in June.
The Company expects these seasonal trends to be magnified through the second
quarter of fiscal 1997 by general economic and industry factors, including the
continued transition from 16-bit cartridge-based game machines to the new 32-bit
systems, and the concentration of the Company's product releases in the second
half of the fiscal 1997.
Because of the foregoing factors, as well as other factors affecting
the Company's operating results and financial condition, past financial
performance should not be considered a reliable indicator of future performance,
and investors should not use historical trends to anticipate results or trends
in future periods.
23
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to pending claims. Management, after
review and consultation with counsel, considers that any
liability from the disposition of such lawsuits in the
aggregate would not have a material adverse effect upon the
consolidated financial position or results of operations of
the Company.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders, held on July
31, 1996, the stockholders elected the following individuals
for one-year terms to the Board of Directors: M. Richard
Asher, William J. Byron, Daniel H. Case III, Gary M. Kusin,
Timothy Mott and Lawrence F. Probst III. These individuals
have received a plurality of the votes eligible to vote,
voting either in person or by proxy.
In addition, the following matters were voted upon by the
Stockholders:
To approve an amendment to the Company's 1991 Stock Option
Plan (the "1991 Plan") to increase the number of shares of the
Company's common stock reserved for issuance under the 1991
Plan by 900,000 shares from a total of 9,900,000 shares to a
total of 10,800,000 shares.
Votes
-------------------------------------------------------------
For Against Abstain
--- ------- -------
30,934,021 16,081,700 200,387
To ratify the appointment of KPMG Peat Marwick LLP as
independent accountants for the Company for the current fiscal
year.
Votes
-------------------------------------------------------------
For Against Abstain
--- ------- -------
47,168,174 23,381 24,553
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - The following exhibits are filed as part of this
report: None
(b) No reports on Form 8-K were filed by the Registrant during the
three months ended June 30, 1996.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRONIC ARTS INC.
(Registrant)
/s/E. STANTON MCKEE
-----------------------------
DATED: E. STANTON MCKEE
August 13, 1996 Senior Vice President and
Chief Financial and Administrative Officer
(Duly authorized officer)
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