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 September 30, 2000
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.)
209 Redwood Shores Parkway
Redwood City, California 94065
(Address of principal executive offices) (Zip Code)
(650) 628-1500
(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 November 6, 2000
--------------------- -----------------
$0.01 par value per share 132,200,897
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
------------------------------
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
September 30, 2000 and March 31, 2000 3
Consolidated Statements of Operations for the Three Months
Ended September 30, 2000 and 1999 and the Six Months Ended
September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for
the Six Months Ended September 30, 2000 and 1999 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 46
Part II - Other Information
---------------------------
Item 1. Legal Proceedings 48
Item 4. Submission of Matters to a Vote of Security Holders 48
Item 6. Exhibits and Reports on Form 8-K 48
Signatures 49
----------
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(unaudited)
<CAPTION>
September 30, March 31,
2000 2000
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 253,817 $ 339,804
Marketable securities 17,148 236
Receivables, less allowances of $56,094 and $65,067, respectively 148,096 234,087
Inventories, net 19,285 22,986
Deferred income taxes 27,058 26,963
Other current assets 116,700 81,247
----------- -----------
Total current assets 582,104 705,323
Property and equipment, net 335,962 285,466
Long-term investments 8,400 8,400
Investments in affiliates 18,975 22,601
Goodwill and other intangibles, net 108,586 117,236
Other assets 61,073 53,286
----------- -----------
$ 1,115,100 $1,192,312
=========== ==========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 74,689 $ 97,703
Accrued and other liabilities 142,219 167,599
----------- -----------
Total current liabilities 216,908 265,302
Minority interest in consolidated joint venture 4,194 3,617
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 10,000,000 shares -- --
Common Stock
Class A common stock, $0.01 par value. Authorized 400,000,000 shares;
issued and outstanding 131,969,802 and 128,869,088 shares, respectively 1,320 1,288
Class B common stock, $0.01 par value. Authorized 100,000,000
shares; issued and outstanding 6,250,000 and 6,000,000, respectively 63 60
Paid-in capital 459,437 412,038
Retained earnings 435,188 516,368
Accumulated other comprehensive loss (2,010) (6,361)
----------- -----------
Total stockholders' equity 893,998 923,393
----------- -----------
$ 1,115,100 $1,192,312
=========== ==========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues $ 219,900 $ 338,887 $ 374,699 $ 525,007
Cost of goods sold 118,775 177,147 196,682 263,398
--------- --------- --------- ---------
Gross profit 101,125 161,740 178,017 261,609
--------- --------- --------- ---------
Operating expenses:
Marketing and sales 38,263 46,100 73,456 79,947
General and administrative 26,292 22,301 48,501 40,009
Research and development 92,008 67,026 171,221 113,601
Amortization of intangibles 4,716 2,616 9,370 5,204
--------- --------- --------- ---------
Total operating expenses 161,279 138,043 302,548 238,761
--------- --------- --------- ---------
Operating income (loss) (60,154) 23,697 (124,531) 22,848
Interest and other income, net 4,102 3,133 7,938 7,271
--------- --------- --------- ---------
Income (loss) before provision for
(benefit from) income taxes and minority
interest (56,052) 26,830 (116,593) 30,119
Provision for (benefit from) income taxes (17,376) 8,586 (36,144) 9,638
--------- --------- --------- ---------
Income (loss) before minority interest (38,676) 18,244 (80,449) 20,481
Minority interest in consolidated
joint venture (233) (112) (731) (23)
--------- --------- --------- ---------
Net income (loss) $ (38,909) $ 18,132 $ (81,180) $ 20,458
========= ========= ========= =========
Net income per share:
Basic N/A $ 0.15 N/A $ 0.17
Diluted N/A $ 0.14 N/A $ 0.16
Number of shares used in computation:
Basic N/A 124,834 N/A 123,886
Diluted N/A 131,215 N/A 129,819
Class A common stock:
Net loss:
Basic $ (34,860) N/A $ (73,474) N/A
Diluted $ (38,909) N/A $ (81,180) N/A
--------- ---------
Net loss per share:
Basic $ (0.27) N/A $ (0.57) N/A
Diluted $ (0.30) N/A $ (0.62) N/A
Number of shares used in computation:
Basic 130,691 N/A 129,966 N/A
Diluted 131,343 N/A 130,618 N/A
Class B common stock:
Net loss, net of retained interest in EA.com $ (4,049) N/A $ (7,706) N/A
--------- ---------
Net loss per share:
Basic $ (0.67) N/A $ (1.28) N/A
Diluted $ (0.67) N/A $ (1.28) N/A
Number of shares used in computation:
Basic 6,000 N/A 6,000 N/A
Diluted 6,000 N/A 6,000 N/A
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
4
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
<CAPTION>
Six Months
Ended September 30,
2000 1999
--------- ---------
<S> <C> <C>
Operating activities:
Net income (loss) $ (81,180) $ 20,458
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Minority interest in consolidated joint venture 731 23
Equity in net (income) loss of affiliates 197 (336)
Gain on sale of affiliate -- (842)
Depreciation and amortization 31,583 20,655
Loss on sale of fixed assets 420 198
Gain on sale of marketable securities -- (1,286)
Provision for doubtful accounts 3,014 2,140
Tax benefit from exercise of stock options -- 9,889
Change in assets and liabilities:
Receivables 82,977 (118,421)
Inventories 3,701 (1,502)
Other assets (36,332) (52,434)
Accounts payable (23,014) 31,977
Accrued liabilities (26,047) (4,563)
Deferred income taxes 996 94
--------- ---------
Net cash used in operating activities (42,954) (93,950)
--------- ---------
Investing activities:
Proceeds from sale of property and equipment 3,958 55
Proceeds from sales of marketable securities, net -- 1,489
Purchase of marketable securities, net (2,465) --
Proceeds from sale of affiliate -- 8,842
Capital expenditures (86,861) (47,338)
Investment in affiliates, net 722 (2,949)
Change in short-term investments, net 19,632 (19,420)
Acquisition of subsidiaries, net of cash acquired -- (582)
--------- ---------
Net cash used in investing activities (65,014) (59,903)
--------- ---------
Financing activities:
Proceeds from sales of shares through employee stock
plans and other plans 47,434 42,987
--------- ---------
Net cash provided by financing activities 47,434 42,987
--------- ---------
Translation adjustment (5,897) 3,918
--------- ---------
Decrease in cash and cash equivalents (66,431) (106,948)
Beginning cash and cash equivalents 246,265 242,208
--------- ---------
Ending cash and cash equivalents 179,834 135,260
Short-term investments 73,983 89,084
--------- ---------
Ending cash, cash equivalents and short-term investments $ 253,817 $ 224,344
========= =========
</TABLE>
5
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
(unaudited)
Six Months
Ended September 30,
2000 1999
------- -------
Supplemental cash flow information:
Cash paid during the year for income taxes $ 7,992 $ 4,944
======= =======
Non-cash investing activities:
Change in unrealized appreciation of investments and
marketable securities $ 9,670 $ (29)
======= =======
See accompanying notes to consolidated financial statements.
6
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The condensed 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. Certain amounts have been reclassified to conform to the fiscal
2001 presentation.
These condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto included in
Electronic Arts Inc. (the "Company") Annual Report on Form 10-K for the fiscal
year ended March 31, 2000 as filed with the Securities and Exchange Commission
("Commission") on June 29, 2000.
Note 2. Fiscal Year
The Company's fiscal year is reported on a 52/53-week period that ends on the
Saturday nearest to March 31 in each year. The results of operations for fiscal
2001 will contain 53 weeks. Accordingly, the results of operations for the first
half of fiscal 2001 and the first half of fiscal 2000 contain 27 weeks and 26
weeks, respectively. The results of operations for the fiscal quarter ended June
30, 2000 and the fiscal quarter ended June 30, 1999 contain 14 weeks and 13
weeks, respectively. Since the results of an additional week are not material,
and for clarity of presentation, all fiscal periods are treated as ending on a
calendar month.
Note 3. Approval of the Tracking Stock Proposal
On March 22, 2000, the shareholders of Electronic Arts voted on and approved a
proposal (the "Tracking Stock Proposal") to authorize the issuance of a new
series of common stock to be designated as Class B common stock ("Tracking
Stock"), intended to reflect the performance of Electronic Arts' online and
e-Commerce division ("EA.com"). As a result of the approval of the Tracking
Stock Proposal, Electronic Arts' existing common stock has been re-classified as
Class A common stock ("Class A Stock") and that stock will reflect the
performance of Electronic Arts' other businesses ("EA Core").
Note 4. Stock Split
On August 14, 2000, the Company's Board of Directors authorized a two-for-one
stock split of its Class A common stock which was distributed on September 8,
2000 in the form of a stock dividend for shareholders of record at the close of
business on August 25, 2000. All authorized and outstanding share and per share
amounts of Class A common stock in the accompanying consolidated financial
statements for all periods have been restated to reflect the stock split.
7
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 5. Prepaid Royalties
Prepaid royalties consist primarily of prepayments for manufacturing royalties,
original equipment manufacturer (OEM) fees and license fees paid to celebrities
and professional sports organizations for use of their trade name. Also included
in prepaid royalties are prepayments made to independent software developers
under development arrangements that have alternative future uses. Prepaid
royalties are expensed at the contractual royalty rate as cost of goods sold
based on actual net product sales. Management evaluates the future realization
of prepaid royalties quarterly and charges to income any amounts that management
deems unlikely to be realized through product sales. Royalty advances are
classified as current and non-current assets based upon estimated net product
sales for the following year. The current portion of prepaid royalties, included
in other current assets, was $70,366,000 and $54,970,000 at September 30, 2000
and March 31, 2000, respectively. The long-term portion of prepaid royalties,
included in other assets, was $15,735,000 and $11,373,000 at September 30, 2000
and March 31, 2000, respectively.
Note 6. Inventories
Inventories are stated at the lower of cost or market. Inventories at September
30, 2000 and March 31, 2000 consisted of (in thousands):
-------------------------------------------------------------------------------
September 30, 2000 March 31, 2000
-------------------------------------------------------------------------------
Raw materials and work in process $3,918 $ 920
Finished goods 15,367 22,066
-------------------------------------------------------------------------------
$19,285 $22,986
===============================================================================
Note 7. Accrued and Other Liabilities
Accrued liabilities at September 30, 2000 and March 31, 2000 consisted of (in
thousands):
-------------------------------------------------------------------------------
September 30, 2000 March 31, 2000
-------------------------------------------------------------------------------
Accrued compensation and benefits $51,441 $59,580
Accrued expenses 39,433 37,840
Accrued royalties 25,518 36,566
Deferred revenue 17,501 1,847
Warranty reserve 7,461 8,886
Deferred income taxes 865 198
Accrued income taxes - 22,682
-------------------------------------------------------------------------------
$142,219 $167,599
===============================================================================
8
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 8. Segment Information
In 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", which supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise". SFAS No. 131 establishes
standards for the reporting by public business enterprises of information about
product lines, geographic areas and major customers. The method for determining
what information to report is based on the way that management organizes the
operating segments within the Company for making operational decisions and
assessments of financial performance. The Company's chief operating decision
maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO
reviews financial information presented on a consolidated basis accompanied by
disaggregated information about revenues by geographic region and by product
lines for purposes of making operating decisions and assessing financial
performance.
As a result of the approval of the Tracking Stock proposal to authorize issuance
of a new series of common stock designated as Class B common stock, intended to
reflect the performance of EA.com, management considers EA.com to be a separate
reportable segment. Accordingly, prior period information has been restated to
disclose separate segments. The Company operates in two principal business
segments globally:
o Electronic Arts core ("EA Core") business segment: creation, marketing and
distribution of entertainment software.
o EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online and ongoing
management of subscriptions of online games.
Please see the discussion regarding segment reporting in the MD&A.
9
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about Electronic Arts business segments is presented below for the three and six months ended September 30, 2000 and
1999 (in thousands):
---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $210,563 $ 9,337 $ - $ 219,900
Group sales 683 - (683)(a) -
---------------------------------------------------------------------------------------------------------------------------------
Total net revenues 211,246 9,337 (683) 219,900
---------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 116,085 2,690 - 118,775
Group cost of goods sold - 683 (683)(a) -
---------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 116,085 3,373 (683) 118,775
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 95,161 5,964 - 101,125
Operating expenses:
Marketing and sales 36,752 1,511 - 38,263
General and administrative 24,142 2,150 - 26,292
Research and development 64,195 16,887 10,926 (b) 92,008
Network development and support - 10,926 (10,926)(b) -
Amortization of intangibles 3,221 1,495 - 4,716
---------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 128,310 32,969 - 161,279
---------------------------------------------------------------------------------------------------------------------------------
Operating loss (33,149) (27,005) - (60,154)
Interest and other income, net 4,090 12 - 4,102
---------------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (29,059) (26,993) - (56,052)
Benefit from income taxes (17,376) - - (17,376)
---------------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (11,683) (26,993) - (38,676)
Minority interest in consolidated joint venture (233) - - (233)
---------------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(11,916) $(26,993) $ - $(38,909)
=================================================================================================================================
Interest income $ 4,082 $ 21 $ - $ 4,103
Depreciation and amortization 11,746 4,813 - 16,559
Identifiable assets 953,087 162,013 - 1,115,100
Capital expenditures 15,120 21,073 - 36,193
</TABLE>
10
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended September 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $334,107 $4,780 $ - $ 338,887
Group sales 614 - (614) (a) -
---------------------------------------------------------------------------------------------------------------------------------
Total net revenues 334,721 4,780 (614) 338,887
---------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 175,716 1,431 - 177,147
Group cost of goods sold - 614 (614) (a) -
---------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 175,716 2,045 (614) 177,147
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 159,005 2,735 - 161,740
Operating expenses:
Marketing and sales 45,773 327 - 46,100
General and administrative 21,925 376 - 22,301
Research and development 56,537 6,899 3,590 (b) 67,026
Network development and support - 3,590 (3,590) (b) -
Amortization of intangibles 2,587 29 - 2,616
---------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 126,822 11,221 - 138,043
---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 32,183 (8,486) - 23,697
Interest and other income, net 3,133 - - 3,133
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 35,316 (8,486) - 26,830
Provision for income taxes 8,586 - - 8,586
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 26,730 (8,486) - 18,244
Minority interest in consolidated joint venture (112) - - (112)
---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $26,618 $(8,486) $ - $18,132
=================================================================================================================================
Interest income $ 3,650 $ - $ - $ 3,650
Depreciation and amortization 10,686 72 - 10,758
Identifiable assets 990,047 13,563 - 1,003,610
Capital expenditures 19,989 8,568 - 28,557
</TABLE>
11
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Six Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $356,609 $ 18,090 $ - $ 374,699
Group sales 1,043 - (1,043) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total net revenues 357,652 18,090 (1,043) 374,699
---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 192,584 4,098 - 196,682
Group cost of goods sold - 1,043 (1,043) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 192,584 5,141 (1,043) 196,682
---------------------------------------------------------------------------------------------------------------------------
Gross profit 165,068 12,949 - 178,017
Operating expenses:
Marketing and sales 70,012 3,444 - 73,456
General and administrative 43,889 4,612 - 48,501
Research and development 117,854 34,168 19,199 (b) 171,221
Network development and support - 19,199 (19,199) (b) -
Amortization of intangibles 6,461 2,909 - 9,370
---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 238,216 64,332 - 302,548
---------------------------------------------------------------------------------------------------------------------------
Operating loss (73,148) (51,383) - (124,531)
Interest and other income, net 7,931 7 - 7,938
---------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (65,217) ( 51,376) - (116,593)
Benefit from income taxes (36,144) - - (36,144)
---------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (29,073) (51,376) - (80,449)
Minority interest in consolidated joint venture (731) - - (731)
---------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(29,804) $ (51,376) $ - $ (81,180)
===========================================================================================================================
Interest income $ 8,399 $ 49 $ - $ 8,448
Depreciation and amortization 21,910 9,673 - 31,583
Capital expenditures 29,250 57,611 - 86,861
</TABLE>
12
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Six Months Ended September 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $515,837 $ 9,170 $ - $ 525,007
Group sales 908 - (908) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total net revenues 516,745 9,170 (908) 525,007
---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 260,962 2,436 - 263,398
Group cost of goods sold - 908 (908) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 260,962 3,344 (908) 263,398
---------------------------------------------------------------------------------------------------------------------------
Gross profit 255,783 5,826 - 261,609
Operating expenses:
Marketing and sales 79,225 722 - 79,947
General and administrative 39,379 630 - 40,009
Research and development 96,759 10,637 6,205 (b) 113,601
Network development and support - 6,205 (6,205) (b) -
Amortization of intangibles 5,175 29 - 5,204
---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 220,538 18,223 - 238,761
---------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 35,245 (12,397) - 22,848
Interest and other income, net 7,271 - - 7,271
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 42,516 (12,397) - 30,119
Provision for income taxes 9,638 - - 9,638
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 32,878 (12,397) - 20,481
Minority interest in consolidated joint venture (23) - - (23)
---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 32,855 $(12,397) $ - $ 20,458
===========================================================================================================================
Interest income $ 6,602 $ - $ - $ 6,602
Depreciation and amortization 20,494 161 - 20,655
Capital expenditures 38,413 8,925 - 47,338
<FN>
(a) Represents elimination of intercompany sales of Electronic Arts packaged
goods products to EA.com, and represents elimination of royalties paid to
Electronic Arts by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support to Research and Development.
</FN>
</TABLE>
13
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about the Company's operations in North America and foreign areas for the three and six months ended September 30, 2000
and 1999 is presented below:
-----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months ended September 30, 2000
-------------------------------------
Net revenues from unaffiliated
customers $152,842 $49,949 $9,527 $7,582 $ - $ 219,900
Intercompany revenues 1,303 4,337 2,539 - (8,179) -
----------------------------------------------------------------------------------------
Total net revenues 154,145 54,286 12,066 7,582 (8,179) 219,900
========================================================================================
Operating income (loss) (33,210) (28,343) 454 792 153 (60,154)
Interest income 3,115 830 158 - - 4,103
Depreciation and amortization 13,190 3,021 235 113 - 16,559
Identifiable assets 772,853 301,059 21,664 19,524 - 1,115,100
Capital expenditures 31,642 4,056 295 200 - 36,193
Long-lived assets 309,392 156,326 3,950 4,182 - 473,850
Six months ended September 30, 2000
-----------------------------------
Net revenues from unaffiliated
customers $224,598 $101,843 $21,639 $26,619 $ - $ 374,699
Intercompany revenues 5,279 8,818 6,557 - (20,654) -
----------------------------------------------------------------------------------------
Total net revenues 229,877 110,661 28,196 26,619 (20,654) 374,699
========================================================================================
Operating income (loss) (79,710) (51,212) 1,871 3,389 1,131 (124,531)
Interest income 6,249 1,936 263 - - 8,448
Depreciation and amortization 25,660 5,270 373 280 - 31,583
Capital expenditures 73,435 12,481 671 274 - 86,861
Three months ended September 30, 1999
-------------------------------------
Net revenues from unaffiliated
customers $225,608 $89,993 $13,516 $9,770 $ - $ 338,887
Intercompany revenues 4,088 7,853 2,135 - (14,076) -
----------------------------------------------------------------------------------------
Total net revenues 229,696 97,846 15,651 9,770 (14,076) 338,887
========================================================================================
Operating income 21,087 1,776 1,279 595 (1,040) 23,697
Interest income 3,420 182 48 - - 3,650
Depreciation and amortization 6,884 3,430 105 339 - 10,758
Identifiable assets 666,710 294,281 25,174 17,445 - 1,003,610
Capital expenditures 12,973 15,241 298 45 - 28,557
Long-lived assets 195,831 118,266 3,134 3,589 320,820
Six months ended September 30, 1999
-----------------------------------
Net revenues from unaffiliated
customers $327,658 $156,794 $25,454 $15,101 $ - $ 525,007
Intercompany revenues 7,720 12,646 2,905 - (23,271) -
----------------------------------------------------------------------------------------
Total net revenues 335,378 169,440 28,359 15,101 (23,271) 525,007
========================================================================================
Operating income (loss) 27,624 (6,135) 2,184 215 (1,040) 22,848
Interest income 5,983 529 90 - - 6,602
Depreciation and amortization 14,468 5,447 242 498 - 20,655
Capital expenditures 20,462 26,152 592 132 - 47,338
</TABLE>
14
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about the Company's net revenues by product line for the three and
six months ended September 30, 2000 and 1999 is presented below:
--------------------------------------------------------------------------------
(In thousands) Three Months Ended Six Months Ended
September 30, September 30,
2000 1999 2000 1999
-------------------------------------------------
PC $81,669 $101,787 $152,150 $165,383
PlayStation 65,157 111,437 94,658 180,688
Online Subscription 7,145 3,593 15,456 6,974
PlayStation 2 2,737 - 13,018 -
N64 10,161 45,965 10,767 57,807
License, OEM and Other 6,435 3,426 9,735 8,044
Affiliated label 46,596 72,679 78,915 106,111
--------------------------------------------------------------------------------
$219,900 $338,887 $374,699 $525,007
================================================================================
Note 9. Comprehensive Income (Loss)
<TABLE>
The components of comprehensive income, net of tax, for the three and six months
ended September 30, 2000 and 1999 were as follows:
-----------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) Three Months Ended Six Months Ended
September 30, September 30,
2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (loss) $(38,909) $18,132 $(81,180) $20,458
-----------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss):
Change in unrealized appreciation of investments, net of a
tax provision of $(78), $468, $(424) and $402 10,864 995 10,094 855
Reclassification adjustment for gains realized in net
income for 1999, net of a tax benefit of $(24) and $(412) - (52) - (874)
Foreign currency translation adjustments (2,173) 3,394 (5,743) 3,495
-----------------------------------------------------------------------------------------------------------------
Total other comprehensive income 8,691 4,337 4,351 3,476
-----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
Total comprehensive income (loss) $(30,218) $22,469 $(76,829) $23,934
=================================================================================================================
</TABLE>
The currency translation adjustments are not adjusted for income taxes as they
relate to indefinite investments in non-U.S. subsidiaries.
Note 10. Earnings (Loss) Per Share
The following summarizes the computations of Basic Earnings Per Share ("EPS")
and Diluted EPS. Basic EPS is computed as net earnings divided by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock-based compensation plans including stock options, restricted stock
awards, warrants and other convertible securities using the treasury stock
method.
15
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Net income (loss) per share was calculated on a consolidated basis until Class A
common stock and Class B common stock were created as a result of the approval
of the Tracking Stock Proposal, see Note 3. Subsequent to the approval of the
Tracking Stock Proposal, net income (loss) per share is computed individually
for Class A common stock and Class B common stock.
<TABLE>
(in thousands, except per share amounts):
--------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three months ended September 30,
2000 2000 2000 1999
Class A common Class A common Class B Electronic
stock-EA Core stock-EA Core common Arts common
Basic Diluted stock-EA.com stock
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income (loss) $(34,860) $(38,909) $(4,049) $18,132
--------------------------------------------------------------------------------------------------------------------------
Shares used to compute net income
(loss) per share:
Weighted-average common shares 130,691 130,691 6,000 124,834
Dilutive stock equivalents - 652 - 6,381
--------------------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 130,691 131,343 6,000 131,215
==========================================================================================================================
--------------------------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $(0.27) N/A $(0.67) $0.15
Diluted N/A $(0.30) $(0.67) $0.14
--------------------------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------------
Six months ended September 30,
2000 2000 2000 1999
Class A common Class A common Class B Electronic
stock-EA Core stock-EA Core common Arts common
Basic Diluted stock-EA.com stock
--------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(73,474) $(81,180) $(7,706) $20,458
--------------------------------------------------------------------------------------------------------------------------
Shares used to compute net income
(loss) per share:
Weighted-average common shares 129,966 129,966 6,000 123,886
Dilutive stock equivalents - 652 - 5,933
--------------------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 129,966 130,618 6,000 129,819
==========================================================================================================================
--------------------------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $(0.57) N/A $(1.28) $0.17
Diluted N/A $(0.62) $(1.28) $0.16
--------------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Due to the net loss reported for the three and six months ended September 30,
2000, for the EA core segment, stock options have been excluded from the Diluted
EPS calculation. Had net income been reported in these periods, dilutive
potential common shares would have been 138,087,000 and 136,614,000 for Class A
common stock for the three and six months ended September 30, 2000,
respectively.
Excluded from the above computation of weighted-average shares for diluted EPS
were options to purchase 805,212 and 1,318,595 shares of common stock for the
three and six months ended September 30, 2000, respectively, as the options'
exercise price was greater than the average market price of the common shares.
For the three and six months ended September 30, 2000, the weighted-average
exercise price of the respective options was $48.60 and $44.99, respectively.
Excluded from the above computation of weighted-average shares for diluted EPS
were options to purchase 82,000, and 1,112,000 shares of common stock for the
three and six months ended September 30, 1999, respectively, as the options'
exercise price was greater than the average market price of the common shares.
For the three and six months ended September 30, 1999, the weighted-average
exercise price of the respective options was $33.44 and $29.83, respectively.
Note 11. New Accounting Pronouncements
In July 2000, the Emerging Issues Task Force reached a consensus on issue No.
00-15 ("EITF 00-15"), "Classification in the Statement of Cash Flows of the
Income Tax Benefit Realized by a Company upon Employee Exercise of a
Nonqualified Stock Option". The EITF concluded that income tax benefits realized
upon an employee's exercise of a nonqualified stock option should be classified
as an operating cash flow. Accordingly, the Company reclassified tax benefits
resulting from the exercise of stock options on its Consolidated Statements of
Cash Flows.
In July 2000, the Emerging Issues Task Force issued No. 00-10 ("EITF 00-10"),
"Accounting for Shipping and Handling Fees and Costs", and concluded that all
amounts billed to a customer in a sale transaction related to shipping and
handling, if any, represent revenue to the vendor and, therefore, should be
classified as revenue. The adoption of EITF 00-10 did not have a significant
impact on the results of operations, financial position or cash flows.
In May 2000, the Emerging Issues Task Force issued No. 00-14 ("EITF 00-14"),
"Accounting for Certain Sales Incentives". EITF 00-14 states that for a sales
incentive that will not result in a loss on the sale of a product or service, a
vendor should recognize the cost of the incentive at the latter of the date at
which the related revenue is recorded or the date at which the incentive is
offered. If the sales incentive will result in a loss on the sale of the product
or service, the vendor should not recognize a liability for the sales incentive
until the related revenue is recognized. Secondly, for certain sales incentives
that entitle a customer to receive a reduction
17
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
in the price of a product or service in the form of a refund or rebate, the
vendor should recognize a liability for those sales incentives based on an
estimated amount of refunds or rebates that may be claimed by customers. The
Task Force also concluded that the reduction in or refund of the selling price
resulting from any cash sales incentive should be classified as a reduction in
revenue and if the sales incentive offered is a free product or service
delivered at the time of sale, the cost of the free product or service should be
classified as an expense. The adoption of EITF 00-14 did not have a material
impact on its results of operations, financial position or cash flows for the
Company.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25)". FIN 44 clarifies the
application of APB Opinion No. 25 for certain issues: (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. Generally, FIN 44 is effective July 1, 2000.
The adoption of FIN 44 did not have a material impact on the Company's
consolidated financial position or results of operations.
In March 2000, the Emerging Issues Task Force issued No. 00-03 ("EITF 00-03"),
"Application of AICPA SOP 97-2, "Software Revenue Recognition," to Arrangements
That Include the Right to Use Software Stored on Another Entity's Hardware",
which discusses the effect on revenue recognition of a software vendor's
obligation to host its software that previously was licensed to a customer. The
EITF has reached the conclusion that, if the customer is unable to utilize the
software on the customer's hardware or contract with another party unrelated to
the vendor to host the software, then the arrangement with the customer is
outside the scope of SOP 97-2 and should be treated as a service contract. The
adoption of EITF 00-03 did not have a material impact on the Company's financial
position and results of operations.
In March 2000, the Emerging Issues Task Force issued No. 00-02 ("EITF 00-02"),
"Accounting for Web Site Development Costs". EITF 00-02 states that all costs
relating to software used to operate a web site and relating to development of
initial graphics and web page design should be accounted for using Statement of
Position ("SOP") 98-1. Under this SOP, costs incurred in the preliminary project
stage should be expensed as incurred, as should most training and data
conversion costs. External direct costs of materials and services and internal
direct payroll-related costs should be capitalized once certain criteria are
met. EITF 00-02 is effective for all fiscal quarters beginning after June 30,
2000. The Company's accounting policy for internal-use software, as required by
SOP 98-1, incorporated the requirements of EITF 00-02.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101("SAB 101"), "Revenue Recognition," which outlines
the basic criteria that must be met to recognize revenue and provides guidance
for presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with the SEC. SAB 101 is effective the
fourth fiscal quarter of fiscal years beginning after December 15,
18
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
1999 as amended by SAB 101B. The Company believes the adoption of SAB 101 will
not have a material impact on the Company's financial position and results of
operations.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No.
133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB Statement No. 133" which establish
accounting and reporting standards for derivative instruments and hedging
activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning
of the first quarter of the fiscal year beginning after June 15, 2000. The
Company is determining the effect of SFAS 133, 137 and 138 on its financial
statements.
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". SOP 98-1 requires that consulting, hardware,
software and direct payroll-related costs associated with the implementation of
customized internal-use software be capitalized and amortized over the estimated
useful life of the software. These costs relate to game site application and
infrastructure design and development, as well as costs related to providing
customer account management and building in e-Commerce functionality and
interfaces. SOP 98-1 is effective for financial statements issued for fiscal
years beginning after December 15, 1998. As of September 30, 2000, the Company
has capitalized $43,342,000 of these costs associated with the effort to build
the EA.com website and infrastructure.
Note 12. Subsequent Events
o EA.com Gamesite Launch:
On October 4, 2000, EA.com launched its gamesite on the worldwide web
and Games Channel on AOL, in accordance with its agreement with AOL. This site
provides online games to subscribers of AOL's service and to visitors of the AOL
and EA web properties.
o PlayStation 2:
On October 26, 2000, Sony released its new console platform, PlayStation
2, in North America.
19
<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, the following
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contains forward-looking statements about circumstances that have
not yet occurred. All statements, trend analysis and other information contained
below relating to markets, our products and trends in revenue, as well as other
statements including words such as "anticipate", "believe" or "expect" and
statements in the future tense are forward-looking statements. These
forward-looking statements are subject to business and economic risks and actual
events or our actual future results could differ materially from those set forth
in the forward-looking statements due to such risks and uncertainties. We will
not necessarily update information if any forward-looking statement later turns
out to be inaccurate. Risks and uncertainties that may affect our future results
and performance include, but are not limited to, those discussed under the
heading "Risk Factors" below at pages 37 to 45, as well as in our Annual Report
on Form 10-K for the fiscal year ended March 31, 2000 as filed with the
Securities and Exchange Commission on June 29, 2000 and other documents filed
with the Commission.
We derive revenues primarily from shipments of entertainment software, which
includes EA Studio products for dedicated entertainment systems (that we call
video game systems or consoles such as PlayStation, PlayStation 2 and Nintendo
64), EA Studio personal computer products (or PC), Co- Publishing products that
are co-published and distributed by us, and Affiliated Label (or AL) products
that are published by third parties and distributed by us. We also derive
revenues from licensing of EA Studio products and AL products through hardware
companies (or OEM), online subscription and e-Commerce revenues.
<TABLE>
Information about our net revenues for North America and foreign areas for the
three and six months ended September 30, 2000 and 1999 is summarized below (in
thousands):
----------------------------------------------------------------------------------------------------------
<CAPTION>
September 30, September 30,
2000 1999 Decrease % change
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Revenues for the Three Months Ended:
North America $152,842 $225,608 $(72,766) (32.3)%
-------------------------------------------------------------------------------
Europe 49,949 89,993 (40,044) (44.5)%
Asia Pacific 9,527 13,516 (3,989) (29.5)%
Japan 7,582 9,770 (2,188) (22.4)%
-------------------------------------------------------------------------------
International 67,058 113,279 (46,221) (40.8)%
-------------------------------------------------------------------------------
Consolidated Net Revenues $219,900 $338,887 $(118,987) (35.1)%
===============================================================================
</TABLE>
20
<PAGE>
<TABLE>
----------------------------------------------------------------------------------------------------------
<CAPTION>
September 30, September 30, Increase/
2000 1999 (Decrease) % change
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Revenues for the Six Months Ended:
North America $224,598 $327,658 $(103,060) (31.5)%
-------------------------------------------------------------------------------
Europe 101,843 156,794 (54,951) (35.0)%
Asia Pacific 21,639 25,454 (3,815) (15.0)%
Japan 26,619 15,101 11,518 76.3%
-------------------------------------------------------------------------------
International 150,101 197,349 (47,248) (23.9)%
-------------------------------------------------------------------------------
Consolidated Net Revenues $374,699 $525,007 $(150,308) (28.6)%
===================== ====================== ================ =================
</TABLE>
North America Net Revenues
The decrease in North America net revenues for the three months ended September
30, 2000, compared to the same period last year was primarily due to:
o A 38% decrease in PlayStation revenues due to the console transition to
PlayStation 2. We released five titles in the quarter compared to seven in
the comparable prior year period.
o A 78% decrease in Nintendo 64 (or N64) revenues also related to the console
transition. We released one title in the quarter compared to four releases
in the comparable prior year period.
o These decreases were partially offset by an increase in PC revenues due to
the strong sales of The Sims and The Sims Livin' Large.
The decrease in North America net revenues for the six months ended September
30, 2000, compared to the same period last year was primarily due to:
o A 54% decrease in PlayStation revenues due to the console transition to
PlayStation 2. We released six titles in the six months ended September 30,
2000 compared to ten in the comparable prior year period.
o An 80% decrease in N64 revenues also related to the console transition. We
released one title in the six months ended September 30, 2000 compared to
four releases in the comparable prior year period.
o These decreases were partially offset by an increase in PC revenues due to
the strong sales of The Sims and The Sims Livin' Large.
International Net Revenues
The decrease in international net revenues for the three months ended September
30, 2000, compared to the same period last year was primarily attributable to:
o Europe's net revenues decreased 45% primarily due to market weakness, lower
PC sales with fewer titles shipping in the quarter and the strong sales of
Command & Conquer Tiberian Sun for the PC in the comparable prior year
period as well as weakness in the Euro currency. In addition, PlayStation
revenue decreased 50% due to fewer titles shipping during the console
transition.
21
<PAGE>
o European AL sales decreased due to a weaker market and fewer hit titles as
compared to the prior year.
o Asia Pacific's net revenues decreased 30%, mainly in PC revenues, due to
the strong sales of Command & Conquer Tiberian Sun in the comparable prior
year period.
o Japan's net revenues decreased 22% due to a 94% decrease in PlayStation
revenues attributable to significantly reduced PlayStation market, no new
titles released in the current quarter as well as strong sales of FIFA 1999
in the comparable prior year period. This was offset by the revenue on two
PlayStation 2 titles: FIFA Soccer World Championship and Xfire.
The decrease in international net revenues for the six months ended September
30, 2000, compared to the same period last year was primarily attributable to:
o Europe's net revenues decreased 35% primarily due to market weakness, lower
AL sales due to fewer hit titles released in the current year, lower PC
sales with fewer titles shipping in the quarter and the strong sales of
Command & Conquer Tiberian Sun for the PC in the comparable prior year
period as well as weakness in the Euro currency. In addition, PlayStation
revenue decreased 24% due to fewer titles shipping during the console
transition period.
o Asia Pacific's net revenues decreased 15%, mainly due to the decrease in
PlayStation revenues as there were no significant new titles released in
the current year. Lower AL sales also contributed to the decrease as
compared to the prior year.
o Japan's net revenues increased 76% compared to the prior year primarily due
to the shipment of two PlayStation 2 titles, FIFA Soccer World Championship
and Xfire.
<TABLE>
Information about our net revenues by product line for the three and six months
ended September 30, 2000 and 1999 is presented below (in thousands):
-----------------------------------------------------------------------------------------------------------
<CAPTION>
September 30, September 30, Increase/
2000 1999 (Decrease) % change
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Revenues for the Three Months Ended:
EA Studio:
----------
PC $81,669 $101,787 $(20,118) (19.8)%
PlayStation 65,157 111,437 (46,280) (41.5)%
Online Subscriptions 7,145 3,593 3,552 98.9%
PlayStation 2 2,737 - 2,737 N/A
N64 10,161 45,965 (35,804) (77.9)%
License, OEM and Other 6,435 3,426 3,009 87.8%
------------------------------------------------------------------------
173,304 266,208 (92,904) (34.9)%
Affiliated Label: 46,596 72,679 (26,083) (35.9)%
----------------- ------------------------------------------------------------------------
Consolidated Net Revenues $219,900 $338,887 $(118,987) (35.1)%
========================================================================
</TABLE>
22
<PAGE>
<TABLE>
-----------------------------------------------------------------------------------------------------------
<CAPTION>
September 30, September 30, Increase/
2000 1999 (Decrease) % change
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Revenues for the Six Months Ended:
EA Studio:
----------
PC $152,150 $165,383 $ (13,233) (8.0)%
PlayStation 94,658 180,688 (86,030) (47.6)%
Online Subscriptions 15,456 6,974 8,482 121.6 %
PlayStation 2 13,018 - 13,018 N/A
N64 10,767 57,807 (47,040) (81.4)%
License, OEM and Other 9,735 8,044 1,691 21.0 %
------------------------------------------------------------------------
295,784 418,896 (123,112) (29.4)%
Affiliated Label: 78,915 106,111 (27,196) (25.6)%
----------------- ------------------------------------------------------------------------
Consolidated Net Revenues $374,699 $525,007 $(150,308) (28.6)%
========================================================================
</TABLE>
Personal Computer Product Net Revenues
We released four PC titles in the second quarter of the current fiscal year
compared to six for the same period last year. The decrease in sales of PC
products for the three and six months ended September 30, 2000 was primarily
attributable to fewer titles and the release of a major title, Command & Conquer
Tiberian Sun, in the second quarter of the previous year. This decrease was
offset by strong sales of The Sims and The Sims Livin' Large in the current
year.
PlayStation Product Net Revenues
We released five PlayStation titles in the second quarter of the current fiscal
year compared to seven for the same period last year, including Madden NFL. As
expected, PlayStation sales decreased for the three months and six months ended
September 30, 2000 compared to the prior year primarily attributable to the
PlayStation 2 platform transition. Although our PlayStation products are
playable on the PlayStation 2 console, we expect sales of current PlayStation
products to continue to decline in fiscal 2001.
Under the terms of a licensing agreement with Sony Computer Entertainment of
America in July 1994 (the "Sony Agreement"), as amended, we are authorized to
develop and distribute CD-based software products compatible with the
PlayStation. Pursuant to the Sony Agreement, we engage Sony to supply
PlayStation CDs for distribution by us. Accordingly, we have limited ability to
control our supply of PlayStation CD products or the timing of their delivery.
See Risk Factors - "Our platform licensors are our chief competitors and
frequently control the manufacturing of our video game products", below.
Online Net Revenues
The increase in online revenues for the three and six months ended September 30,
2000 as compared to the three and six months ended September 30, 1999 was
attributable to the following:
o We generated over $1,400,000 in subscription revenues for Kesmai and
Worldplay products in the current quarter and over $3,800,000 for the six
months ended September 30, 2000. These products were part of the Kesmai
acquisition which occurred in the fourth
23
<PAGE>
quarter of fiscal 2000. It is anticipated that the subscription revenues
associated with these services will be eliminated as these products will be
shut-down or converted into ad revenue-based offerings in future quarters.
o The average number of paying customers for Ultima Online increased to over
190,000 for the three months ended September 30, 2000 as compared to over
120,000 for the same period last year and was over 194,000 for the six
months ended September 30, 2000 as compared to over 116,000 for the same
period last year. This increase was due to continued strong sales of Ultima
Online, the addition of new events and parties within the Ultima worlds and
the release of Ultima Renaissance in April 2000. Ultima Renaissance added
features including new houses and land mass.
o We established servers for Ultima Online in Korea in September 1999, Taiwan
in November 1999 and Australia in January 2000 which resulted in new
customers for the three months and six months ended September 30, 2000, as
compared to the same periods last year.
PlayStation 2 Product Net Revenues
We released our first two PlayStation 2 titles, FIFA Soccer World Championship
and Xfire, in Japan during the first half of fiscal 2001.
N64 Product Net Revenues
We released one N64 title in the second quarter of fiscal 2001 compared to four
titles during the same period last year. The expected decrease in N64 revenues
for the three months and six months ended September 30, 2000, compared to the
same period last year was primarily due to fewer releases. The decrease is also
due to the weaker market for Nintendo 64 products in the current year. We expect
revenues for N64 products to continue to decline significantly in fiscal 2001.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64
cartridges for distribution by us. Accordingly, we have little ability to
control our supply of N64 cartridges or the timing of their delivery. A shortage
of microchips or other factors outside our control could impair our ability to
obtain an adequate supply of cartridges.
In connection with our purchases of N64 cartridges for distribution in North
America, Nintendo requires us to provide irrevocable letters of credit prior to
Nintendo's acceptance of purchase orders from us for purchases of these
cartridges. For purchases of N64 cartridges for distribution in Japan and
Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo
maintains a policy of not accepting returns of N64 cartridges. Because of these
and other factors, the carrying of an inventory of cartridges entails
significant capital and risk. See Risk Factors - "Our platform licensors are our
chief competitors and frequently control the manufacturing of our video game
products", below.
License, OEM and Other Revenues
The increase in license, OEM and other revenues for the three and six months
ended September 30, 2000 was primarily a result of higher licensing revenue in
Europe due to revenue generated from an exclusive distribution agreement.
Affiliated Label Product Net Revenues
The decrease in Affiliated Label net revenues for the three and six months ended
September 30, 2000 compared to the same periods last year was primarily due to
the strong sales of Final
24
<PAGE>
Fantasy VIII in the prior year, the acquisition of Accolade, formerly an AL, by
a third party in the first quarter of the prior year, our acquisition of
DreamWorks Interactive, formerly an AL, in the fourth quarter of the prior year
and fewer hit AL product releases.
Operations by Segment
As a result of the approval of the Tracking Stock proposal (see Note 3) to
authorize issuance of a new series of common stock designated as Class B common
stock, intended to reflect the performance of EA.com, management considers
EA.com to be a separate reportable segment. Accordingly, prior period
information has been restated to disclose this separate segment. We operate in
two principal business segments globally:
o Electronic Arts core ("EA Core") business segment: creation, marketing and
distribution of entertainment software.
o EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online and ongoing
management of subscriptions of online games.
EA.com, a division of Electronic Arts Inc., represents Electronic Arts' online
and e-Commerce businesses. EA.com's business includes subscription revenues
collected for Internet game play on our websites, sales of packaged goods for
Internet-only based games and sales of Electronic Arts games sold through EA.com
websites. The statement of operations includes all revenues and costs directly
attributable to EA.com, including charges for shared facilities, functions and
services used by EA.com and provided by Electronic Arts. Certain costs and
expenses have been allocated based on management's estimates of the cost of
services provided to EA.com by Electronic Arts.
25
<PAGE>
<TABLE>
Information about our operations by segment for fiscal 2001 and 2000 is
presented below (in thousands):
---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $210,563 $ 9,337 $ - $219,900
Group sales 683 - (683) (a) -
---------------------------------------------------------------------------------------------------------------------------------
Total net revenues 211,246 9,337 (683) 219,900
---------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 116,085 2,690 - 118,775
Group cost of goods sold - 683 (683) (a) -
---------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 116,085 3,373 (683) 118,775
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 95,161 5,964 - 101,125
Operating expenses:
Marketing and sales 36,752 1,511 - 38,263
General and administrative 24,142 2,150 - 26,292
Research and development 64,195 16,887 10,926 (b) 92,008
Network development and support - 10,926 (10,926) (b) -
Amortization of intangibles 3,221 1,495 - 4,716
---------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 128,310 32,969 - 161,279
---------------------------------------------------------------------------------------------------------------------------------
Operating loss (33,149) (27,005) - (60,154)
Interest and other income, net 4,090 12 - 4,102
---------------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (29,059) (26,993) - (56,052)
Benefit from income taxes (17,376) - - (17,376)
---------------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (11,683) (26,993) - (38,676)
Minority interest in consolidated joint venture (233) - - (233)
---------------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(11,916) $(26,993) $ - $(38,909)
=================================================================================================================================
</TABLE>
<TABLE>
Allocation of retained interest (in thousands):
---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net loss before retained interest in EA.com $(11,916) $(26,993) $ - $(38,909)
Net loss related to retained interest in EA.com (22,944) 22,944 - -
---------------------------------------------------------------------------------------------------------------------------------
Net loss $(34,860) $ (4,049) $ - $(38,909)
=================================================================================================================================
</TABLE>
26
<PAGE>
<TABLE>
---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended September 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $334,107 $4,780 $ - $338,887
Group sales 614 - (614) (a) -
---------------------------------------------------------------------------------------------------------------------------------
Total net revenues 334,721 4,780 (614) 338,887
---------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 175,716 1,431 - 177,147
Group cost of goods sold - 614 (614) (a) -
---------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 175,716 2,045 (614) 177,147
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 159,005 2,735 - 161,740
Operating expenses:
Marketing and sales 45,773 327 - 46,100
General and administrative 21,925 376 - 22,301
Research and development 56,537 6,899 3,590 (b) 67,026
Network development and support - 3,590 (3,590) (b) -
Amortization of intangibles 2,587 29 - 2,616
---------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 126,822 11,221 - 138,043
---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 32,183 (8,486) - 23,697
Interest and other income, net 3,133 - - 3,133
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 35,316 (8,486) - 26,830
Provision for income taxes 8,586 - - 8,586
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 26,730 (8,486) - 18,244
Minority interest in consolidated joint venture (112) - - (112)
---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $26,618 $(8,486) $ - $18,132
=================================================================================================================================
</TABLE>
27
<PAGE>
<TABLE>
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Six Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $356,609 $18,090 $ - $374,699
Group sales 1,043 - (1,043) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total net revenues 357,652 18,090 (1,043) 374,699
---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 192,584 4,098 - 196,682
Group cost of goods sold - 1,043 (1,043) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 192,584 5,141 (1,043) 196,682
---------------------------------------------------------------------------------------------------------------------------
Gross profit 165,068 12,949 - 178,017
Operating expenses:
Marketing and sales 70,012 3,444 - 73,456
General and administrative 43,889 4,612 - 48,501
Research and development 117,854 34,168 19,199 (b) 171,221
Network development and support - 19,199 (19,199) (b) -
Amortization of intangibles 6,461 2,909 - 9,370
---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 238,216 64,332 - 302,548
---------------------------------------------------------------------------------------------------------------------------
Operating loss (73,148) (51,383) - (124,531)
Interest and other income, net 7,931 7 - 7,938
---------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (65,217) (51,376) - (116,593)
Benefit from income taxes (36,144) - - (36,144)
---------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (29,073) (51,376) - (80,449)
Minority interest in consolidated joint venture (731) - - (731)
---------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(29,804) $(51,376) $ - $(81,180)
===========================================================================================================================
</TABLE>
<TABLE>
Allocation of retained interest (in thousands):
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Six Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net loss before retained interest in EA.com $(29,804) $(51,376) $ - $(81,180)
Net loss related to retained interest in EA.com (43,670) 43,670 - -
---------------------------------------------------------------------------------------------------------------------------
Net loss $(73,474) $ (7,706) $ - $(81,180)
===========================================================================================================================
</TABLE>
28
<PAGE>
<TABLE>
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Six Months Ended September 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $515,837 $9,170 $ - $525,007
Group sales 908 - (908) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total net revenues 516,745 9,170 (908) 525,007
---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 260,962 2,436 - 263,398
Group cost of goods sold - 908 (908) (a) -
---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 260,962 3,344 (908) 263,398
---------------------------------------------------------------------------------------------------------------------------
Gross profit 255,783 5,826 - 261,609
Operating expenses:
Marketing and sales 79,225 722 - 79,947
General and administrative 39,379 630 - 40,009
Research and development 96,759 10,637 6,205 (b) 113,601
Network development and support - 6,205 (6,205) (b) -
Amortization of intangibles 5,175 29 - 5,204
---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 220,538 18,223 - 238,761
---------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 35,245 (12,397) - 22,848
Interest and other income, net 7,271 - - 7,271
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 42,516 (12,397) - 30,119
Provision for income taxes 9,638 - - 9,638
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 32,878 (12,397) - 20,481
Minority interest in consolidated joint venture (23) - - (23)
---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $32,855 $(12,397) $ - $20,458
===========================================================================================================================
<FN>
(a) Represents elimination of intercompany sales of Electronic Arts packaged
goods products to EA.com, and represents elimination of royalties paid to
Electronic Arts by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support to Research
and Development.
</FN>
</TABLE>
29
<PAGE>
<TABLE>
The following table presents pro-forma results of operations allocating taxes
between EA Core and EA.com. Consolidated taxes have been allocated to EA Core
and EA.com on a pro rata basis based on the consolidated effective tax rates,
thereby giving EA.com the tax benefit of its losses which is utilized by the
consolidated group. Such tax benefit could not be recognized by EA.com on a
stand-alone basis. The sum of tax expense and tax benefit for EA Core and EA.com
is the same as consolidated tax expense and tax benefit. This presentation
represents how management analyzes each segment of the business (in thousands):
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended September 30, 2000
EA Core EA.com Adjustments and
(excl. EA.com) Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loss before benefit from income taxes and minority
interest $(29,059) $(26,993) $- $(56,052)
Benefit from income taxes (9,008) (8,368) - (17,376)
---------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (20,051) (18,625) - (38,676)
Minority interest in consolidated joint venture (233) - - (233)
---------------------------------------------------------------------------------------------------------------------------
Net loss $(20,284) $(18,625) $- $(38,909)
===========================================================================================================================
---------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for (benefit from)
income taxes and minority interest $35,316 $(8,486) $- $26,830
Provision for (benefit from) income taxes 11,302 (2,716) - 8,586
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 24,014 (5,770) - 18,244
Minority interest in consolidated joint venture (112) - - (112)
---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $23,902 $(5,770) $- $18,132
===========================================================================================================================
---------------------------------------------------------------------------------------------------------------------------
Six Months Ended September 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income taxes and minority
interest $(65,217) $(51,376) $- $(116,593)
Benefit from income taxes (20,217) (15,927) - (36,144)
---------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (45,000) (35,449) - (80,449)
Minority interest in consolidated joint venture (731) - - (731)
---------------------------------------------------------------------------------------------------------------------------
Net loss $(45,731) $(35,449) $- $(81,180)
===========================================================================================================================
---------------------------------------------------------------------------------------------------------------------------
Six Months Ended September 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for (benefit from)
income taxes and minority interest $42,516 $(12,397) $- $30,119
Provision for (benefit from) income taxes 13,606 (3,968) - 9,638
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 28,910 (8,429) - 20,481
Minority interest in consolidated joint venture (23) - - (23)
---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $28,887 $ (8,429) $- $20,458
===========================================================================================================================
</TABLE>
30
<PAGE>
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income
(Loss)
<TABLE>
Information about our costs and expenses, interest and other income, net, income
taxes and net income (loss) for the three and six months ended September 30,
2000 and 1999 is presented below:
<CAPTION>
Percent of Net Revenues Percent of Net Revenues
-------------------------- -------------------------
Three Months Ended Six Months Ended
Sept 30, Sept 30,
-------------------------- --------------------------
2000 1999 2000 1999
--------- ------------- ------------ ----------
<S> <C> <C> <C> <C>
Cost of goods sold 54.0 % 52.3 % 52.5 % 50.2 %
Marketing and sales 17.4 13.6 19.6 15.2
General and administrative 12.0 6.6 12.9 7.6
Research and development (includes 41.8 19.8 45.7 21.6
Network development and support)
Amortization of intangibles 2.1 0.8 2.5 1.0
Interest and other income, net 1.9 0.9 2.1 1.4
Income taxes - effective tax rate 31.0 32.0 31.0 32.0
Net income (loss) (17.7) % 5.4 % (21.7) % 3.9 %
</TABLE>
Cost of Goods Sold. Cost of goods sold as a percentage of net revenues increased
for the three months and six months ended September 30, 2000 compared to the
same period last year primarily due to:
o A decrease in the average margins on PlayStation products due to an
increase, as a percent of revenue, in lower margin catalogue products as
compared to the prior year.
o A decrease in the average margins on PC products due to an increase, as a
percent of revenue, in lower margin catalogue products as compared to the
prior year. In addition, prior year included higher sales of higher margin
internally developed titles such as Command & Conquer Tiberian Sun, Sim
City 3000, and Dungeon Keeper 2.
o Offset by a decrease in sales of lower margin N64 titles.
Marketing and Sales. Marketing and sales expenses for the three months ended
September 30, 2000 decreased in absolute dollars by 17% and decreased 8% for the
six months ended September 30, 2000, primarily attributed to:
o Lower television, print and Internet advertising due to fewer number of
releases in the quarter compared to the same period last year. In addition,
prior year reflects a large advertising effort to support the release of
Command & Conquer Tiberian Sun.
o Decrease in cooperative advertising associated with lower revenues in
Europe and North America.
o Offset by an increase in EA.com marketing and sales staff required to
support the future launch of the game site. In future periods, EA.com
intends to further increase marketing and advertising spending in order to
promote the game site and the Games Channel on AOL.
31
<PAGE>
General and Administrative. General and administrative expenses increased for
the three months ended September 30, 2000 in absolute dollars by 18% and
increased 21% for the six months ended September 30, 2000, primarily attributed
to:
o The expansion of the EA.com staff and additional administrative-related
costs required to support the growth of the EA.com business. We anticipate
a continued increase in the absolute dollars spent on general and
administrative related expenses.
o Increase in bad debt due to a write off of a receivable as a result of the
default of payment from a customer in Europe.
o Increase in depreciation expense for Europe due to the implementation of a
new online transaction processing system.
Research and Development (excluding Network Development and Support). Research
and development expenses increased for the three months ended September 30, 2000
in absolute dollars by 28% and 42% for the six months ended September 30, 2000,
primarily attributed to:
o Increase in research and development expenses by EA.com (including expenses
incurred by EA core on behalf of EA.com) due to an increase in the number
of online projects in development and increased development staff. The type
of games that will be in development will most likely increase in
complexity and depth. To support this effort, EA.com may be required to
increase its development and production expenses.
o An increase in development spending for next generation console products
including development for the PlayStation 2 console.
o The increase is also due to research and development expenses related to
the acquisition of DreamWorks Interactive, a software development company,
in the fourth quarter of the prior fiscal year.
Network Development and Support. The increase in network development and support
expenses was primarily due to increased spending for the EA.com network
infrastructure and the network support organization in preparation for the
launch of the EA.com game site and the Games Channel on the AOL service. Certain
costs associated with EA.com's infrastructure build have been capitalized in
accordance with SOP 98-1. EA.com will begin amortizing these costs
commencing with the October launch of these sites. In addition, resources
previously associated with developing this infrastructure will be reallocated to
maintaining these sites and building new enhancements for EA.com web properties.
As such, the related costs for these resources will be either expensed or
capitalized as required by this SOP.
Amortization of Intangibles. The amortization of intangibles results primarily
from the acquisitions of Westwood, Kesmai, ABC Software and other acquisitions.
Amortization of intangibles was $3,221,000 for EA Core and $1,495,000 for EA.com
for the three months ended September 30, 2000. Amortization of intangibles was
$6,461,000 for EA Core and $2,909,000 for EA.com for the six months ended
September 30, 2000. Amortization of intangibles was $2,616,000 for EA Core for
the three months ended September 30, 1999 and $5,204,000 for EA Core for the six
months ended September 30, 1999. There was no amortization of intangibles for
EA.com in the same periods of the prior year.
Interest and Other Income, Net. Interest and other income, net, increased in
absolute dollars for the three months ended September 30, 2000 primarily due to
higher interest income in the
32
<PAGE>
current year attributable to investments in longer term securities, with
maturities no greater than three years, resulting in higher interest rates.
Interest and other income, net, increased for the six months ended September 30,
2000 due to higher interest income in the current year offset by a gain on sale
of marketable securities and a sale of a minority interest in an affiliate in
the same period last year.
Income Taxes. Our effective tax rate was 31.0% for the three months and six
months ended September 30, 2000 and 32% for the three months and six months
ended September 30, 1999. The effective tax rate was lower than the comparable
prior year period primarily as a result of a projected higher portion of
international income for fiscal 2001 subject to a lower foreign tax rate as
compared to the prior year.
Net Income (Loss). In absolute dollars, reported net loss increased for the
three and six months ended September 30, 2000 primarily related to lower
revenues and gross profits as well as higher costs and expenses, as a percent of
net revenues, compared to the same period last year. The increase was also due
to an increase in the number of products in development and higher network
development and support costs in preparation for new online products and our
game site and the Games Channel on the AOL service.
Excluding goodwill and non-cash compensation charges in the amount of
$3,951,000, net of taxes, for the three months ended September 30, 2000, net
loss would have been $34,958,000. Excluding goodwill and non-cash compensation
charges in the amount of $2,007,000, net of taxes, for the three months ended
September 30, 1999, net income would have been $20,139,000. Excluding goodwill
and non-cash compensation charges in the amount of $7,549,000, net of taxes, for
the six months ended September 30, 2000, net loss would have been $73,631,000.
Excluding goodwill and non-cash compensation charges in the amount of $3,838,00,
net of taxes for the six months ended September 30, 1999, net income would have
been $24,296,000.
33
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2000, our working capital was $365,196,000 compared to
$440,021,000 at March 31, 2000. Cash, cash equivalents and short-term
investments decreased by approximately $85,987,000 during the six months ended
September 30, 2000 as we used $42,954,000 of cash in operations and $86,861,000
in capital expenditures, offset by $47,434,000 provided through the sale of
equity securities under our stock plans as well as proceeds from the sale of
property and equipment.
Reserves for bad debts and sales returns decreased from $65,067,000 at March 31,
2000 to $56,094,000 at September 30, 2000. 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.
Our principal source of liquidity is $253,817,000 in cash, cash equivalents 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 on both a short-term
and long-term basis.
Included in the amounts above is the following for the EA.com business:
o To date, EA.com has been funded solely by Electronic Arts. No interest
charge has been reflected in the accompanying consolidated financial
statements. Excess cash generated from operations is transferred to
Electronic Arts. We anticipate these funding procedures will continue in
the near-term. Electronic Arts may, at its discretion, provide funds to
EA.com under a debt arrangement, instead of treating such funding as a
capital contribution.
o During the six months ended September 30, 2000, EA.com used $53,417,000 of
cash in operations, $57,611,000 in capital expenditures for computer
equipment, network infrastructure and related software (including
$28,281,000 of consulting, hardware, software and direct payroll and
payroll-related costs associated with the implementation of customized
internal-use software), offset by $111,066,000 provided through the capital
contribution from Electronic Arts.
Impact of Recently Issued Accounting Standards
In July 2000, the Emerging Issues Task Force reached a consensus on issue No.
00-15 ("EITF 00-15"), "Classification in the Statement of Cash Flows of the
Income Tax Benefit Realized by a Company upon Employee Exercise of a
Nonqualified Stock Option". The EITF concluded that income tax benefits realized
upon an employee's exercise of a nonqualified stock option should be classified
as an operating cash flow. Accordingly, the Company reclassified tax benefits
resulting from the exercise of stock options on its Consolidated Statements of
Cash Flows.
34
<PAGE>
In July 2000, the Emerging Issues Task Force issued No. 00-10 ("EITF 00-10"),
"Accounting for Shipping and Handling Fees and Costs", and concluded that all
amounts billed to a customer in a sale transaction related to shipping and
handling, if any, represent revenue to the vendor and, therefore, should be
classified as revenue. The adoption of EITF 00-10 did not have a significant
impact on the results of operations, financial position or cash flows.
In May 2000, the Emerging Issues Task Force issued No. 00-14 ("EITF 00-14"),
"Accounting for Certain Sales Incentives". EITF 00-14 states that for a sales
incentive that will not result in a loss on the sale of a product or service, a
vendor should recognize the cost of the incentive at the latter of the date at
which the related revenue is recorded or the date at which the incentive is
offered. If the sales incentive will result in a loss on the sale of the product
or service, the vendor should not recognize a liability for the sales incentive
until the related revenue is recognized. Secondly, for certain sales incentives
that entitle a customer to receive a reduction in the price of a product or
service in the form of a refund or rebate, the vendor should recognize a
liability for those sales incentives based on an estimated amount of refunds or
rebates that may be claimed by customers. The Task Force also concluded that the
reduction in or refund of the selling price resulting from any cash sales
incentive should be classified as a reduction in revenue and if the sales
incentive offered is a free product or service delivered at the time of sale,
the cost of the free product or service should be classified as an expense. The
adoption of EITF 00-14 did not have a material impact on its results of
operations, financial position or cash flows for the Company.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25)". FIN 44 clarifies the
application of APB Opinion No. 25 for certain issues: (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. Generally, FIN 44 is effective July 1, 2000.
The adoption of FIN 44 did not have a material impact on the Company's
consolidated financial position or results of operations.
In March 2000, the Emerging Issues Task Force issued No. 00-03 ("EITF 00-03"),
"Application of AICPA SOP 97-2, "Software Revenue Recognition," to Arrangements
That Include the Right to Use Software Stored on Another Entity's Hardware",
which discusses the effect on revenue recognition of a software vendor's
obligation to host its software that previously was licensed to a customer. The
EITF has reached the conclusion that, if the customer is unable to utilize the
software on the customer's hardware or contract with another party unrelated to
the vendor to host the software, then the arrangement with the customer is
outside the scope of SOP 97-2 and should be treated as a service contract. The
adoption of EITF 00-03 did not have a material impact on the Company's financial
position and results of operations.
In March 2000, the Emerging Issues Task Force issued No. 00-02 ("EITF 00-02"),
"Accounting for Web Site Development Costs". EITF 00-02 states that all costs
relating to software used to operate a web site and relating to development of
initial graphics and web page design should be accounted for using Statement of
Position ("SOP") 98-1. Under this SOP, costs incurred in the preliminary project
stage should be expensed as incurred, as should most training and data
conversion costs. External direct costs of materials and services and internal
direct payroll-
35
<PAGE>
related costs should be capitalized once certain criteria are met. EITF 00-02 is
effective for all fiscal quarters beginning after June 30, 2000. The Company's
accounting policy for internal-use software, as required by SOP 98-1,
incorporated the requirements of EITF 00-02.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101("SAB 101"), "Revenue Recognition," which outlines
the basic criteria that must be met to recognize revenue and provides guidance
for presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with the SEC. SAB 101 is effective the
fourth fiscal quarter of fiscal years beginning after December 15, 1999 as
amended by SAB 101B. The Company believes the adoption of SAB 101 will not have
a material impact on the Company's financial position and results of operations.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No.
133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB Statement No. 133" which establishes
accounting and reporting standards for derivative instruments and hedging
activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning
of the first quarter of the fiscal year beginning after June 15, 2000. The
Company is determining the effect of SFAS 133, 137 and 138 on its financial
statements.
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". SOP 98-1 requires that consulting, hardware,
software and direct payroll-related costs associated with the implementation of
customized internal-use software be capitalized and amortized over the estimated
useful life of the software. These costs relate to game site application and
infrastructure design and development, as well as costs related to providing
customer account management and building in e-Commerce functionality and
interfaces. SOP 98-1 is effective for financial statements issued for fiscal
years beginning after December 15, 1998. As of September 30, 2000, the Company
has capitalized $43,342,000 of these costs associated with the effort to build
the EA.com website and infrastructure.
36
<PAGE>
RISK Factors
Electronic Arts' business is subject to many risks and uncertainties which may
affect our future financial performance. Some of those important risks and
uncertainties which may cause our operating results to vary or which may
materially and adversely affect our operating results are as follows:
Risk Factors Relating to Our Core Business
Platform Transitions Such as the One Now Occurring Typically Depress the Market
for Video Game Software Until New Platforms Achieve a Wide Market Acceptance
When new video game platforms are announced or introduced into the market,
consumers typically reduce their purchases of video games for current platforms
in anticipation of new platforms being available. During that period, sales of
our video game products can be expected to slow or even decline until new
platforms have achieved a wide market and consumer acceptance. We are currently
in such a transition. Sony has shipped its PlayStation 2 product in Japan and
North America and expects to ship the PlayStation 2 console in Europe in
November 2000. For the December quarter and the current fiscal year, the
manufacturing shortages announced by Sony of the PlayStation 2 units in North
America and Europe pose serious uncertainty. In addition, Nintendo and Microsoft
have announced that their new console systems will be released in calendar year
2001. Current sales of our products for the existing PlayStation and Nintendo 64
platforms have been adversely affected. We expect this trend to continue until
one or more of these new consoles achieve a wide installed base of consumers.
New Video Game Platforms Create Additional Technical and Business Model
Uncertainties
Large portions of our revenues are derived from the sale of products for
play on proprietary video game platforms such as the Sony PlayStation. The
success of our products is significantly affected by acceptance of the new video
game hardware systems and the life span of older hardware platforms and our
ability to accurately predict which platforms will be most successful.
Sometimes we will spend development and marketing resources on products
designed for new video game systems that have not yet achieved large installed
bases or will continue product development for older hardware platforms that may
have shorter life cycles than we expected. Conversely, if we do not develop for
a platform that achieves significant market acceptance, or discontinue
development for a platform that has a longer life cycle than expected, our
revenue growth may be adversely affected.
For example, the Sega Dreamcast console launched in Japan in early 1999 and
in the United States in September of 1999. We have no products under development
for this platform. Should this platform achieve wide market acceptance, our
revenue growth may be adversely affected. Similarly, we released a variety of
products for the new Sony platform, the PlayStation 2. Should that platform not
achieve wide acceptance by consumers, we will have spent a disproportionate
amount of our resources for this platform. Additionally, we have not negotiated
publishing agreements with Sony, Sega or Nintendo for their next generation
platforms, or with Microsoft for their new console system, and we do not know
whether the terms of those agreements will be favorable.
Product Development Schedules Are Frequently Unreliable and Make Predicting
Quarterly Results Difficult
Product development schedules, particularly for new hardware platforms and
high-end multimedia personal computers, or PCs, are difficult to predict because
they involve creative processes, use of new
37
<PAGE>
development tools for new platforms and the learning process, research and
experimentation associated with development for new technologies. For example,
Tiberian Sun, which was expected to ship in fiscal 1999 at the time of our
acquisition of Westwood Studios, was not released until the second quarter of
fiscal 2000 due to development delays. Additionally, 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. Our revenues and earnings are
dependent on our ability to meet our product release schedules, and our failure
to meet those schedules could result in revenues and earnings which fall short
of analysts' expectations for any individual quarter and the fiscal year.
Our Business Is Both Seasonal and Cyclical
Our business is highly seasonal with a significant percentage of our
revenues occurring in the December quarter. In our 2001 fiscal year, we expect
these seasonal trends to be magnified by general industry factors, including the
current platform transition and the concentration of our product releases in the
second half of fiscal 2001. In addition, we are continuing to invest
significantly in our online operation, EA.com. Our business is also cyclical;
video game platforms have historically had a life cycle of four to six years,
and decline as more advanced platforms are being introduced. As one group of
platforms is reaching the end of its cycle and new platforms are emerging,
buying patterns may change. Purchases of products for older platforms may slow
at a faster rate than sales of new platforms. We are currently in such a
platform transition. Sega introduced its latest platform in the United States in
September 1999, and Sony has shipped its PlayStation 2 console in Japan and
North America and expects to ship its PlayStation 2 product in Europe in
November 2000. Nintendo and Microsoft have also announced that their new console
systems will be released in calendar year 2001. Sales of our current products
for the current Nintendo and Sony platforms have already been adversely
affected, and we expect this trend to continue until one or more new platforms
achieves a wide installed base of consumers.
The Impact of e-Commerce and Online Games on Our Business Is Not Known
While we do not currently derive significant revenues from online sales of
our packaged products, we believe that such form of distribution will become a
more significant factor in our business in the future. E-commerce is becoming an
increasingly popular method for conducting business with consumers. How that
form of distribution will affect the more traditional retail distribution, at
which we have historically had success, and over what time period, is uncertain.
In addition, we expect the number and popularity of online games to increase and
become a significant factor in the interactive games business generally. We do
not know how that increase generally, or the emerging business of EA.com
specifically, will affect the sales of packaged goods.
Our Business, Our Products, and Our Distribution Are Subject to Increasing
Regulation in Key Territories
Legislation is increasingly introduced which may affect the content of our
products and their distribution. For example, privacy rules in the United States
and Europe impose various restrictions on our web sites. Those rules vary by
territory while of course the Internet recognizes no geographical boundaries.
Other countries such as Germany have adopted laws regulating content transmitted
over the Internet that are stricter than current United States laws. In the
United States, in response to recent events, the federal and several state
governments are considering content restrictions on products such as those made
by us as well as restrictions on distribution of such products. Any one or more
of these factors could harm our business.
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Our Platform Licensors Are Our Chief Competitors and Frequently Control the
Manufacturing of Our Video Game Products
Our agreements with hardware licensors, which are also our chief
competitors, typically give significant control to the licensor over the
approval and manufacturing of our products. This fact could, in certain
circumstances, leave us unable to get our products approved, manufactured and
shipped to customers. In most events, control of the approval and manufacturing
process by the platform licensors increases both our manufacturing lead times
and costs as compared to those we can achieve independently. For example, in
prior years, we experienced delays in obtaining approvals for and manufacturing
of PlayStation products which caused delays in shipping those products. The
potential for additional delay or refusal to approve or manufacture our products
continues with our platform licensors. Such occurrences would harm our business
and adversely affect our financial performance.
Proliferation and Assertion of Patents Poses Serious Risks to our Business
Many patents have been issued that may apply to widely used game
technologies. Additionally, many recently issued patents are now being asserted
against Internet implementations of existing games. Several such patents have
been asserted against us. For example, we currently have a lawsuit pending
regarding our publication of games that can be played both alone and with others
over the Internet in which the patent holder has moved to enjoin the sale of EA
personal computer products that can be played alone and over the Internet. Such
claims can harm our business. We will incur substantial expenses in evaluating
and defending against such claims, regardless of the merits of the claims. In
the event that there is a determination that we have infringed a third party
patent, we could incur significant monetary liability and be prevented from
using the rights in the future.
Risk Factors Relating to Our Online Business
Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate
its Business and Prospects
EA.com's business is still in the developing stages, so evaluating its
business and prospects will be more difficult than would be the case for a more
mature business. We will continue to encounter the risks and difficulties faced
in launching a new business, and we may not achieve our goals or may be
compelled to change the manner in which we seek to develop the business. These
uncertainties as to the future operations of EA.com will increase the difficulty
we face in completing and pursuing the essential plans for the development of
the business and will also make it more difficult for our stockholders and
securities analysts to predict the operating results of this business.
EA.com Has a History of Losses and Expects To Continue To Incur Losses and May
Never Achieve Profitability
EA.com has incurred substantial losses to date, including the current
fiscal year. We expect EA.com to continue to incur losses as it develops its
business. EA.com will be required to maintain the significant support, service
and product enhancement demands of online users, and we cannot be certain that
EA.com will produce sufficient revenues from its operations to support these
costs. Even if profitability is achieved, EA.com may not be able to sustain it
over a period of time.
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Our Agreements with America Online May Not Prove Successful to the Development
of EA.com's Business
We have announced a series of agreements with America Online ("AOL") for
the offering of our games through AOL for online play. These agreements require
that we make substantial guaranteed payments to AOL and that we commit our
resources to the pursuit of the online game opportunity. We cannot be assured
that the substantial costs associated with the AOL agreements will be justified
by the revenues generated from that relationship. In addition, restrictions
included in the AOL agreements limiting other channels we may develop for
offering online games may limit our ability to diversify our online distribution
strategies. The success for us of the AOL agreements will also be a result of
AOL's performance under the agreements, a factor over which we will have very
little control.
We Have Very Limited Experience with Online Games and May Not Be Able To Operate
This Business Effectively
Offering games solely for online play is a substantial departure from our
traditional business of selling packaged software games. We anticipate employing
various pricing models, including subscription fees, "pay to play fees" and
advertising. We have very little experience with developing optimal pricing
strategies for online games and no experience in "pay to play" pricing or in
securing advertising revenue for online services. Similarly, we are
inexperienced in predicting usage patterns for our games. Because of our
inexperience in this area, we may not be effective in achieving success that may
otherwise be attainable from offering our games online.
Online Games Have Risks That Are Not Associated with Our Traditional Business
Online games, particularly multiplayer games, pose risks to player
enjoyment that do not generally apply to packaged game sales. Players frequently
would not be acquainted with other players, which may adversely affect the
playing experience. Social issues raised by a player's conduct may impact the
experience for other players. We have not determined whether or how we might
monitor or proctor player behavior to mitigate behavior that impairs the game
experience. In addition, there are substantial technical challenges to be met
both in the introduction of our games online and in maintaining an effective
game playing environment over time. If these risks are not successfully
controlled and technical challenges resolved, potential customers for our games
may be unwilling to play in sufficient volume to allow us to attain or sustain
profitability.
We May Not Be Able To Obtain the Required Licenses To Offer Our Games Online
If we are unable to reach terms with certain licensors for our games, we
will not be able to offer certain of our games for online play. Many of
Electronic Arts' most popular games feature characters, trademarks, people or
concepts for which we have licenses from third parties. As an example, our EA
SPORTS products typically contain content licensed from a sports and players'
association. In certain instances, the terms of these licenses will not allow us
to offer the games for online play without negotiating an additional license. We
cannot be certain that the licensors will be amenable to a license for online
games involving their content or, even if they are, that we will be able to
reach terms with them for such use. We may be forced to agree to terms that
ultimately materially impair the economic value to us of the online game market.
Proliferation and Assertion of Patents Poses Serious Risks to the Business of
EA.com
Many patents have been issued that may apply to widely used Internet
technologies. Additionally, many recently issued patents are now being asserted
against Internet implementations of older technologies. Several such patents
have been asserted against us. For example, we currently have a lawsuit pending
regarding our publication of games that can be played both alone and with others
over
40
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the Internet in which the patent holder has moved to enjoin the sale of EA
personal computer products that can be played alone and over the Internet. Such
claims can harm our business. We will incur substantial expenses in evaluating
and defending against such claims, regardless of the merits of the claims. In
the event that there is a determination that we have infringed a third party
patent, we could incur significant monetary liability and be prevented from
using the rights in the future.
Development of EA.com's Business Will Require Significant Capital, and We Cannot
Be Assured That It Will Be Available
EA.com will not be successful if it does not receive the very substantial
financing that will be required to launch its business. Electronic Arts has
agreed to provide a limited amount of funding to EA.com, but this financing
alone will not be sufficient for the development of EA.com's business. Any
additional funding that is obtained from EA may either be treated as a revolving
credit advance or would increase EA's retained interest in EA.com and
correspondingly decrease the interest of the holders of outstanding shares of
Class B common stock. The attraction of additional equity or debt financing for
EA.com from third parties may not be possible or may only be possible on terms
that result in significant dilution to Class A and Class B common stockholders
or interest or other costs and debt-related restrictions on the operation of the
business.
If Use of the Internet Does Not Continue To Develop and Reliably Support the
Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed
EA.com's success depends upon growth in the use of the Internet as a medium
for playing games. Although the Internet is experiencing rapid growth in the
number of users, this growth is a recent phenomenon and may not continue.
Furthermore, despite this growth in usage, the use of the Internet for
sophisticated games like ours is relatively new. Our business would be seriously
harmed if:
o use of the Internet does not continue to increase or increases more
slowly than expected,
o the infrastructure for the Internet does not effectively support online
game play,
o concerns over the secure transmission of confidential information over
public networks inhibit the growth of the Internet as a means of
conducting commercial transactions, or
o government regulations regarding Internet content, privacy or other
conditions impede the effectiveness of the Internet to users.
Capacity Restraints May Restrict the Use of the Internet as a Forum for Game
Play, Resulting in Decreased Demand for Our Products
The Internet infrastructure may not be able to support the demands placed
on it by increased usage or the limited capacity of networks to transmit large
amounts of data. Other risks associated with commercial use of the Internet
could slow its growth, including:
o outages and other delays resulting from the inadequate reliability of
the network infrastructure,
o slow development of enabling technologies and complementary products,
and
o limited availability of cost-effective, high speed access.
Delays in the development or adoption of new equipment standards or
protocols required to handle increased levels of Internet activity, or increased
governmental regulation, would cause the
41
<PAGE>
Internet to fail to gain, or lose, viability as a means of game playing. If
these or any other factors cause use of the Internet for commerce to slow or
decline, the Internet may not prove viable as a commercial marketplace. This, in
turn, would result in decreased demand for EA.com's products and services.
To Become and Remain Competitive, EA.com Must Continually Develop and Expand New
Content. This Is Inherently Risky and Expensive.
EA.com's success depends on our ability to develop products and services
for the initial launch of the EA.com site and our ability to continually expand
the content on that site. Our agreement with AOL requires us to develop new
games under our relationship with AOL. We cannot assure you that products will
be developed on time, in a cost effective manner, or that they will be
successful.
We May Not Be Able To Respond to Rapid Technological Change
The market for Internet products and services is characterized by rapid
technological change and evolving industry standards. Both in completing the
design and implementation of our network infrastructure and thereafter, we will
be required to continually improve performance, features, reliability and
capacity of our network infrastructure. We cannot assure you that we will be
successful in responding rapidly or in a cost effective manner to such
developments.
Increasing Governmental Regulation of the Internet Could Limit the Market for
Our Products
As Internet commerce continues to evolve, we expect that federal, state and
foreign governments will adopt laws and regulations covering issues such as user
privacy, taxation of goods and services provided over the Internet, pricing,
content and quality of products and services. It is possible that legislation
could expose companies involved in electronic commerce to liability, taxation or
other increased costs, any of which could limit the growth of electronic
commerce generally. Legislation could dampen the growth in Internet usage and
decrease its acceptance as a communications and commercial medium. If enacted,
these laws and regulations could limit the market for EA.com's products.
If We Do Not Maintain Our Relationship with Outside Consultants Such as Andersen
Consulting, Our Ability To Develop Our Online Business Will Be Impaired
Because approximately 20% of the staff creating, designing, and developing
the infrastructure for EA.com's website and network interface is being provided
by outside consultants such as Andersen Consulting, losing the business
relationship with such consultants would cause EA.com to lose an important
component of its website implementation team. Given the intense competition for
qualified technical consultants, EA.com may not be able to retain these
consultants or, if necessary, replace them. If it cannot do so, its ability to
develop its business will be impaired.
Our Revenues Have Been Heavily Dependent on a Single Product and Would Be
Adversely Affected if That Product's Popularity Were To Decline
In the near term, EA.com's revenues to date have consisted primarily of
revenues from sales of our online product Ultima Online, and we would be
adversely affected if revenues from that product were to decline for any reason
and not be replaced. We expect the online game market to become increasingly
competitive, and it is possible that other producer's current or future games
could cause our revenue from Ultima Online to decline. In addition, popularity
of Ultima Online could decline over time simply because of consumer preference
for new game experiences.
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We Invest Very Heavily in Research and Development and Network Development and
Support for EA.com, and We Cannot Be Assured That We Will Achieve Revenues That
Validate This Level of Spending
We have invested, and expect to continue to invest, very heavily in
research and development and network development and support for our website and
online games. We will need to expand EA.com's revenues substantially for it to
achieve profitability with these levels of expenditure being required, and we
may not be able to do so. If we cannot increase revenues to profitable levels,
the value of EA.com will be impaired. In order to develop the broad games
offerings that we envision for our online operations it will be necessary to
engage in significant developmental efforts both to adapt existing EA games to
the online format and to create new online games. Our agreements with AOL
require us to maintain a substantial commitment to online game development and
we cannot be assured that we will realize acceptable returns from this
investment.
Online Product Development Schedules Are Unreliable and Make Predicting
Quarterly Results Difficult
Online product development schedules, particularly for Internet based games
are difficult to predict because they involve creative processes, use of new
development tools, Internet latency issues, a learning process to better
understand Internet based game mechanics, and research and experimentation
associated with development for new online technologies. Additionally,
development risks for Internet based products can cause particular difficulties
in predicting quarterly results because of the challenges associated with game
testing, live Beta testing, integration into network servers and integration on
to the Games web site and may impact the release ("go live") dates of products
during a particular quarter. Our revenues and operating costs are dependent on
our ability to meet our product "go live" schedules, and our failure to meet
those schedules could result in revenues falling short of analysts'
expectations, with no corresponding decrease in expenses, resulting in increased
operating losses for EA.com.
General Risk Factors
We Face Intense Competition for Talent from Highly Valued Internet Companies
Competition for employees in the interactive software business continues to
be intense. Recently, the most intense competition for recruiting and retaining
key employees is from Internet companies. The large equity positions frequently
offered to key executives and creative talent in such companies and the actual
or perceived opportunity for rapid stock price appreciation of these companies
make their compensation packages attractive to those who are already working in
more mature companies. This situation creates difficulty for us to compete for
the attraction and retention of executive and key creative talent.
Because of the Intense Competition for Qualified Technical, Creative, Marketing
and Other Personnel, We May Not Be Able To Attract and Retain the Personnel
Necessary for our Businesses
The market for technical, creative, marketing and other personnel essential
to the development of online businesses and management of our online and core
businesses is extremely competitive, and we may not be able to attract and
retain the employees we need. In addition, the rising cost of real estate in the
San Francisco Bay area - the location of our headquarters and largest studio,
has increased dramatically, and has made recruiting from other areas and
relocating employees to our headquarters more difficult. If we cannot
successfully recruit and retain the employees we need, our ability to develop
and manage our businesses will be impaired.
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Foreign Sales and Currency Fluctuations
For both the six months ended September 30, 2000 and the fiscal year ended
March 31, 2000 international net revenues comprised 40% of total consolidated
net revenues. We expect foreign sales to continue to account for a significant
and growing portion of our revenues. Such sales are subject to unexpected
regulatory requirements, tariffs and other barriers. Additionally, foreign sales
are primarily made in local currencies which may fluctuate. While we hedge
against foreign currency fluctuations, we cannot control translation issues such
as that currently present with the Euro. For example, our European revenues in
the six months ended September 30, 2000 were adversely impacted by a devaluation
of the Euro as compared to the prior year. If the current trend continues, the
devaluation will have a continued adverse effect for the year on our sales and
net income. Any of these factors may significantly harm our business.
Increased Difficulties in Forecasting Results
During platform transition periods, where the success of our products is
significantly impacted by the changing market for our products, forecasting our
revenues and earnings is more difficult than in more stable or rising product
markets. The demand for our products may decline during a transition faster than
we anticipate, negatively impacting both revenues and earnings. Sony announced
that it has shipped only half of the number of PlayStation 2 units to retail in
North America at launch than it had originally planned, and that it expects to
ship significantly fewer units than planned at launch in November in Europe as
well. Shortages were announced as being caused by shortages of components for
manufacturing. Depending on the number and the timing of units actually
available for the December 2000 holidays and the quarter ended March 31, 2001,
these shortages will adversely impact our sales of PlayStation 2 products in the
same periods.
We cannot predict the impact of recent actions and comments by the SEC and FASB
Recent actions and comments from the SEC have focused on the integrity of
financial reporting. In addition, the FASB and other regulatory accounting
agencies have recently introduced several new or proposed accounting standards,
some of which represent a significant change from current industry practices.
For example, In December 1999, the SEC issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." SAB 101 provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements of
all public registrants. In response to numerous requests for interpretive
guidance of SAB 101, the effective date of the standard has been delayed twice.
SAB 101 became effective during the first quarter of fiscal 2001. SAB 101 did
not have a material effect on the underlying strength or weakness of our
consolidated business operations as measured by the dollar value of our product
shipments and cash flows.
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 our common stock in any given period. As a result of the
factors discussed in this report and other factors that may arise in the future,
the market price of our common stock historically has been, and we expect will
continue to be subject to significant fluctuations over a short period of time.
These fluctuations may be due to factors specific to us, to changes in analysts'
earnings estimates, or to factors affecting the computer, software, Internet,
entertainment, media or electronics businesses or the securities markets in
general.
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For example, during fiscal year ended March 31, 2000, the price per share of our
common stock ranged from $22.82 to $60.47 and $26.59 to $54.47 during the six
months ended September 30, 2000.
Because of these and other factors affecting our 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.
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Item 3: Quantitative and Qualitative Disclosures About Market Risk
Market Risk
-----------
We are exposed to various market risks, including the changes in foreign
currency exchange rates and interest rates. Market risk is the potential loss
arising from changes in market rates and prices. Foreign exchange contracts used
to hedge foreign currency exposures and short-term investments are subject to
market risk. We do not consider our cash and cash equivalents to be subject to
interest rate risk due to their short maturities. We do not enter into
derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rate Risk
We utilize foreign exchange contracts to hedge foreign currency exposures of
underlying assets and liabilities, primarily certain intercompany receivables
that are denominated in foreign currencies thereby limiting our risk. Gains and
losses on foreign exchange contracts are reflected in the income statement. At
September 30, 2000, we had foreign exchange contracts, all with maturities of
less than six months to purchase and sell approximately $206,572,000 in foreign
currencies, primarily British Pounds, European Currency Units ("Euro"), Canadian
Dollars, Japanese Yen and other currencies.
Fair value represents the difference in value of the contracts at the spot rate
and the forward rate. The counter parties to these contracts are substantial and
creditworthy multinational commercial banks. The risks of counter party
nonperformance associated with these contracts are not considered to be
material. Notwithstanding our efforts to manage foreign exchange risks, there
can be no assurances that our hedging activities will adequately protect us
against the risks associated with foreign currency fluctuations.
<TABLE>
The table below provides information about our foreign currency forward exchange
contracts at September 30, 2000. The information is provided in U.S. dollar
equivalents and presents the notional amount (forward amount), the weighted
average contractual foreign currency exchange rates and fair value.
-------------------------------------------------------------------------------------------------------------------
<CAPTION>
Weighted- Average
Contract Amount Contract Rate Fair Value
-------------------------------------------------------------------------------------------------------------------
(in thousands) (in thousands)
<S> <C> <C> <C>
Foreign currency to be sold under contract:
British Pound $136,081 1.4743 $(95)
Euro 29,019 0.9068 750
Japanese Yen 13,984 102.9800 667
Canadian Dollar 7,447 1.4772 129
South African Rand 4,309 7.1936 25
Brazilian Real 910 1.8670 (11)
Korean Won 894 1119.0000 (3)
Norway Krone 773 9.0493 2
Denmark Krone 595 8.4000 3
Sweden Krone 314 9.5536 3
-------------------------------------------------------------------------------------------------------------------
Total $194,326 $1,470
-------------------------------------------------------------------------------------------------------------------
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-------------------------------------------------------------------------------------------------------------------
Foreign currency to be purchased under contract:
British Pound $12,246 1.4754 $ 102
-------------------------------------------------------------------------------------------------------------------
Total $12,246 $ 102
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
Grand Total $206,572 $1,572
-------------------------------------------------------------------------------------------------------------------
</TABLE>
While the contract amounts provide one measurement of the volume of these
transactions, they do not represent the amount of our exposure to credit risk.
The amounts (arising from the possible inabilities of counterparties to meet the
terms of their contracts) are generally limited to the amounts, if any, by which
the counterparties' obligations exceed our obligations as these contracts can be
settled on a net basis at our option. We control credit risk through credit
approvals, limits and monitoring procedures.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. We manage our interest rate risk by maintaining an
investment portfolio primarily consisting of debt instruments of high credit
quality and relatively short average maturities. We also manage our interest
rate risk by maintaining sufficient cash and cash equivalent balances such that
we are typically able to hold our investments to maturity. At September 30,
2000, our cash equivalents, short-term and long-term investments included debt
securities of $178,077,000. Notwithstanding our efforts to manage interest rate
risks, there can be no assurances that we will be adequately protected against
the risks associated with interest rate fluctuations.
The table below presents the amounts and related weighted-average interest rates
of our investment portfolio at September 30, 2000:
----------------------------------------------------------------------
Average Interest
Rate Cost Fair Value
----------------------------------------------------------------------
(Dollars in thousands)
Cash equivalents
Fixed rate 0.00% $ - $ -
Variable rate 5.86% $95,694 $95,694
Short-term investments
Fixed rate 4.05% $64,198 $63,983
Variable rate 6.63% $10,000 $10,000
Long-term investments
Fixed rate 0.00% $ - $ -
Variable rate 6.35% $8,400 $8,328
----------------------------------------------------------------------
Maturity dates for short-term investments range from 6 months to 3 years.
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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
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
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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
November 14, 2000 Executive Vice President and
Chief Financial and Administrative Officer
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