FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 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 August 1, 2000
------------------------- --------------
$0.01 par value per share 64,953,888
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
------------------------------ ----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
June 30, 2000 and March 31, 2000 3
Consolidated Statements of Operations for the Three Months
Ended June 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for
the Three Months Ended June 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 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
Part II - Other Information
----------------------------
Item 1. Legal Proceedings 38
Item 4. Submission of Matters to a Vote of Security Holders 38
Item 6. Exhibits and Reports on Form 8-K 38
Signatures 39
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>
June 30, March 31,
2000 2000
--------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 296,944 $ 339,804
Marketable securities 2,260 236
Receivables, less allowances of $53,325 and $65,067, respectively 84,974 234,087
Inventories, net 25,705 22,986
Deferred income taxes 27,189 26,963
Other current assets 88,601 81,247
----------- -----------
Total current assets 525,673 705,323
Property and equipment, net 318,448 285,466
Long-term investments 8,400 8,400
Investments in affiliates 18,572 22,601
Goodwill and other intangibles, net 113,141 117,236
Other assets 52,760 53,286
----------- -----------
$ 1,036,994 $ 1,192,312
=========== ===========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 47,573 $ 97,703
Accrued and other liabilities 101,924 167,599
----------- -----------
Total current liabilities 149,497 265,302
Minority interest in consolidated joint venture 4,138 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 64,761,475 and 64,434,544, respectively 647 644
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 419,253 412,682
Retained earnings 474,097 516,368
Accumulated other comprehensive loss (10,701) (6,361)
----------- -----------
Total stockholders' equity 883,359 923,393
----------- -----------
$ 1,036,994 $ 1,192,312
=========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
<CAPTION>
Three Months Ended
June 30,
2000 1999
----------------------
<S> <C> <C>
Net revenues $ 154,799 $ 186,120
Cost of goods sold 77,907 86,251
--------- ---------
Gross profit 76,892 99,869
--------- ---------
Operating expenses:
Marketing and sales 35,193 33,847
General and administrative 22,209 17,708
Research and development 79,213 46,575
Amortization of intangibles 4,654 2,588
--------- ---------
Total operating expenses 141,269 100,718
--------- ---------
Operating loss (64,377) (849)
Interest and other income, net 3,836 4,138
--------- ---------
Income (loss) before provision for (benefit from) income
taxes and minority interest (60,541) 3,289
Provision for (benefit from) income taxes (18,768) 1,052
--------- ---------
Income (loss) before minority interest (41,773) 2,237
Minority interest in consolidated
joint venture (498) 89
--------- ---------
Net income (loss) $ (42,271) $ 2,326
--------- ---------
Net income per share:
Basic N/A $ 0.04
Diluted N/A $ 0.04
Number of shares used in computation:
Basic N/A 61,455
Diluted N/A 64,119
Class A common stock:
Net loss:
Basic $ (38,614) N/A
--------- ---------
Diluted $ (42,271) N/A
--------- ---------
Net loss per share:
Basic $ (0.60) N/A
Diluted $ (0.65) N/A
Number of shares used in computation:
Basic 64,567 N/A
Diluted 64,893 N/A
Class B common stock:
Net loss, net of retained interest in EA.com $ (3,657) N/A
--------- ---------
Net loss per share:
Basic $ (0.61) N/A
Diluted $ (0.61) N/A
Number of shares used in computation:
Basic 6,000 N/A
Diluted 6,000 N/A
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
<CAPTION>
Three Months
Ended June 30,
2000 1999
----------------------
<S> <C> <C>
Operating activities:
Net income (loss) $ (42,271) $ 2,326
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Minority interest in consolidated joint venture 498 (89)
Equity in net loss of affiliates 600 428
Gain on sale of affiliate -- (842)
Depreciation and amortization 15,024 9,897
Loss on sale of fixed assets 108 76
Gain on sale of marketable securities -- (1,210)
Provision for doubtful accounts 725 712
Tax benefit from exercise of stock options -- 4,943
Change in assets and liabilities:
Receivables 148,388 75,459
Inventories (2,719) 6,373
Other assets (2,382) (37,020)
Accounts payable (50,130) (19,770)
Accrued liabilities (65,640) (38,578)
Deferred income taxes 84 (461)
--------- ---------
Net cash provided by operating activities 2,285 2,244
--------- ---------
Investing activities:
Proceeds from sale of property and equipment 317 34
Proceeds from sales of marketable securities, net -- 1,400
Purchase of marketable securities, net (12) --
Proceeds from sale of affiliate -- 8,842
Capital expenditures (50,668) (18,781)
Investment in affiliates, net 2,221 (150)
Change in short-term investments, net 1,018 (47,667)
--------- ---------
Net cash used in investing activities (47,124) (56,322)
--------- ---------
Financing activities:
Proceeds from sales of shares through employee stock
plans and other plans 6,577 13,729
--------- ---------
Net cash provided by financing activities 6,577 13,729
--------- ---------
Translation adjustment (3,547) 79
--------- ---------
Decrease in cash and cash equivalents (41,809) (40,270)
Beginning cash and cash equivalents 246,265 242,208
--------- ---------
Ending cash and cash equivalents 204,456 201,938
Short-term investments 92,488 117,729
--------- ---------
Ending cash, cash equivalents and short-term investments $ 296,944 $ 319,667
--------- ---------
</TABLE>
5
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
(unaudited)
Three Months
Ended June 30,
2000 1999
-----------------------
Supplemental cash flow information:
Cash paid during the year for income taxes $3,641 $1,670
------- --------
Non-cash investing activities:
Change in unrealized appreciation of investments
and marketable securities $(1,116) $(1,414)
------- -------
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 the
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 and Fiscal Quarter
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
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. 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 $51,794,000 and $54,970,000
7
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
at June 30, 2000 and March 31, 2000, respectively. The long-term portion of
prepaid royalties, included in other assets, was $8,169,000 and $11,373,000 at
June 30, 2000 and March 31, 2000, respectively.
Note 5. Inventories
Inventories are stated at the lower of cost or market. Inventories at June 30,
2000 and March 31, 2000 consisted of (in thousands):
=============================================================================
June 30, 2000 March 31, 2000
-----------------------------------------------------------------------------
Raw materials and work in process $1,240 $ 920
Finished goods 24,465 22,066
-----------------------------------------------------------------------------
$25,705 $22,986
=============================================================================
Note 6. Accrued and Other Liabilities
Accrued and other liabilities at June 30, 2000 and March 31, 2000 consisted of
(in thousands):
========================================================================
June 30, 2000 March 31, 2000
------------------------------------------------------------------------
Accrued expenses $35,098 $37,840
Accrued compensation and benefits 31,249 59,580
Accrued royalties 21,346 36,566
Warranty reserve 8,688 8,886
Accrued income taxes 2,907 22,682
Deferred revenue 2,473 1,847
Deferred income taxes 163 198
------------------------------------------------------------------------
$101,924 $167,599
========================================================================
Note 7. 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,
8
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
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.
Information about Electronic Arts business segments is presented below for the
three months ended June 30, 2000 and 1999 (in thousands):
<TABLE>
<CAPTION>
=================================================================================================================================
Three Months Ended June 30, 2000
EA Core Adjustments and Electronic Arts
(excl. EA.com) EA.com Eliminations
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $ 146,046 $8,753 $ -- $ 154,799
Group sales 360 -- (360) (a) --
----------------------------------------------------------------------------------------------------------------------------------
Total net revenues 146,406 8,753 (360) 154,799
----------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 76,499 1,408 -- 77,907
Group cost of goods sold -- 360 (360) (a) --
----------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 76,499 1,768 (360) 77,907
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 69,907 6,985 -- 76,892
Operating expenses:
Marketing and sales 33,260 1,933 -- 35,193
General and administrative 19,747 2,462 -- 22,209
Research and development 53,659 17,281 8,273 (b) 79,213
Network development and support -- 8,273 (8,273) (b) --
Amortization of intangibles 3,240 1,414 -- 4,654
----------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 109,906 31,363 -- 141,269
----------------------------------------------------------------------------------------------------------------------------------
Operating loss (39,999) (24,378) -- (64,377)
Interest and other income (expense), net 3,841 (5) -- 3,836
---------------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (36,158) (24,383) -- (60,541)
Benefit from income taxes (18,768) -- -- (18,768)
---------------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (17,390) (24,383) -- (41,773)
Minority interest in consolidated joint venture (498) -- -- (498)
---------------------------------------------------------------------------------------------------------------------------------
Net loss $(17,888) $(24,383) $ -- $(42,271)
=================================================================================================================================
Interest income $ 4,317 $ 28 $ -- $ 4,345
Depreciation and amortization 10,164 4,860 -- 15,024
Identifiable assets 892,731 144,263 -- 1,036,994
Capital expenditures 14,130 36,538 -- 50,668
</TABLE>
9
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
<CAPTION>
=================================================================================================================================
Three Months Ended June 30, 1999
EA Core Adjustments and Electronic Arts
(excl. EA.com) EA.com Eliminations
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $181,730 $ 4,390 $ -- $186,120
Group sales 294 -- (294) (a) --
---------------------------------------------------------------------------------------------------------------------------------
Total net revenues 182,024 4,390 (294) 186,120
---------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 85,246 1,005 -- 86,251
Group cost of goods sold -- 294 (294) (a) --
---------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 85,246 1,299 (294) 86,251
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 96,778 3,091 -- 99,869
Operating expenses:
Marketing and sales 33,452 395 -- 33,847
General and administrative 17,454 254 -- 17,708
Research and development 40,222 3,738 2,615 (b) 46,575
Network development and support -- 2,615 (2,615) (b) --
Amortization of intangibles 2,588 -- -- 2,588
---------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 93,716 7,002 -- 100,718
---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 3,062 (3,911) -- (849)
Interest and other income, net 4,138 -- -- 4,138
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 7,200 (3,911) -- 3,289
Provision for income taxes 1,052 -- -- 1,052
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 6,148 (3,911) -- 2,237
Minority interest in consolidated joint venture 89 -- -- 89
---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 6,237 $ (3,911) $ -- $ 2,326
=================================================================================================================================
Interest income $ 2,952 $ -- $ -- $ 2,952
Depreciation and amortization 9,808 89 -- 9,897
Identifiable assets 860,013 3,052 -- 863,065
Capital expenditures 18,424 357 -- 18,781
<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>
10
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about the Company's operations in the North America and foreign
areas for the three months ended June 30, 2000 and 1999 is presented below:
<TABLE>
<CAPTION>
====================================================================================================================================
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months ended June 30, 2000
Net revenues from unaffiliated
customers $ 71,756 $ 51,894 $ 12,112 $ 19,037 $ -- $ 154,799
Intercompany revenues 3,976 4,481 4,018 -- (12,475) --
-------------------------------------------------------------------------------------
Total net revenues 75,732 56,375 16,130 19,037 (12,475) 154,799
=====================================================================================
Operating income (loss) (46,500) (22,869) 1,417 2,597 978 (64,377)
Interest income 3,134 1,106 105 -- -- 4,345
Depreciation and amortization 12,470 2,249 138 167 -- 15,024
Identifiable assets 669,655 316,441 25,532 25,366 -- 1,036,994
Capital expenditures 41,793 8,425 376 74 -- 50,668
Long-lived assets 285,386 154,849 3,928 4,111 -- 448,274
Three months ended June 30, 1999
Net revenues from unaffiliated
customers $ 102,050 $ 66,801 $ 11,938 $ 5,331 $ -- $ 186,120
Intercompany revenues 3,632 4,793 770 -- (9,195) --
-------------------------------------------------------------------------------------
Total net revenues 105,682 71,594 12,708 5,331 (9,195) 186,120
=====================================================================================
Operating income (loss) 6,537 (7,911) 905 (380) -- (849)
Interest income 2,563 347 42 -- -- 2,952
Depreciation and amortization 7,584 2,017 137 159 -- 9,897
Identifiable assets 580,339 244,896 24,840 12,990 -- 863,065
Capital expenditures 7,489 10,911 294 87 -- 18,781
Long-lived assets 183,931 99,999 2,833 3,040 -- 289,803
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Information about the Company's net revenues by product line for the three
months ended June 30, 2000 and 1999 is presented below:
=====================================================
(In thousands) Three Months Ended
June 30,
2000 1999
-----------------------------------------------------
PC $70,481 $63,596
PlayStation 29,501 69,251
PlayStation 2 10,281 --
Online Subscriptions 8,311 3,381
N64 606 11,842
License, OEM and Other 3,300 4,618
Affiliated label 32,319 33,432
-----------------------------------------------------
$154,799 $186,120
=====================================================
11
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 8. Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, for the three months
ended June 30, 2000 and 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
===================================================================================
Three Months Ended
June 30,
2000 1999
-----------------------------------------------------------------------------------
<S> <C> <C>
Net income (loss) $(42,271) $2,326
-----------------------------------------------------------------------------------
Other comprehensive loss:
Change in unrealized appreciation of investments, net
of tax benefit of $(346) and $(65) (770) (139)
Reclassification adjustment for gain realized in net
income for 1999, net of a tax benefit of $(387) -- (823)
Foreign currency translation adjustments (3,570) 101
-----------------------------------------------------------------------------------
Total other comprehensive loss (4,340) (861)
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
Total comprehensive income (loss) $(46,611) $1,465
===================================================================================
</TABLE>
The currency translation adjustments are not adjusted for income taxes as they
relate to indefinite investments in non-U.S. subsidiaries.
Note 9. Earnings 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.
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.
12
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
<CAPTION>
(in thousands, except per share amounts):
====================================================================================================================================
Three months ended June 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) $(38,614) $(42,271) $ (3,657) $ 2,326
------------------------------------------------------------------------------------------------------------------------------------
Shares used to compute net income
(loss) per share:
Weighted-average common shares 64,567 64,567 6,000 61,455
Dilutive stock equivalents -- 326 -- 2,664
------------------------------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 64,567 64,893 6,000 64,119
====================================================================================================================================
------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $ (0.60) N/A $ (0.61) $ 0.04
Diluted N/A $ (0.65) $ (0.61) $ 0.04
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Due to the net loss reported for the three months ended June 30, 2000 for the EA
Core segment, stock options have been excluded from the Diluted EPS calculation.
Had net income been reported, dilutive potential common shares would have been
67,389,000 for Class A common stock for the three months ended June 30, 2000.
The Diluted EPS calculation for Class A common stock, presented above, includes
the potential dilution from the conversion of Class B common stock to Class A
common stock in the event that the initial public offering for Class B common
stock does not occur. Net loss used for the calculation of Diluted EPS for Class
A common stock is $(42,271,000). This net loss includes the remaining 15%
interest in EA.com, which is directly attributable to outstanding Class B
shares, which would be included in the Class A common stock EPS calculation in
the event that the initial public offering for Class B common stock does not
occur.
Excluded from the above computation of weighted-average shares for diluted EPS
for the three months ended June 30, 2000 were options to purchase 1,092,000
shares of Class A common stock, as the options' exercise price was greater than
the average market price of the common shares. The weighted-average exercise
price of these respective options was $79.18.
Excluded from the above computation of weighted-average shares for diluted EPS
for the three months ended June 30, 1999 were options to purchase 194,000 shares
of common stock as the options' exercise price was greater than the average
market price of the common shares. The weighted-average exercise price of these
respective options was $52.81.
13
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 10. 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. EITF 00-10 is effective no later than the required
implementation date for SAB 101. The Company does not expect EITF 00-10 to have
a significant impact on the results of operations, financial position or cash
flows on EITF 00-10's effective date.
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 classifed as an expense. The
Company does not expect EITF 00-14 to have a material impact on its results of
operations, financial position or cash flows.
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.
14
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
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, 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 June 30, 2000, the Company has
capitalized $30,303,000 of these costs associated with the effort to build the
EA.com website and infrastructure.
15
<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 28 to 35, 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 Affiliated Label products
through hardware companies (or OEMs), online subscription and e-Commerce
revenues.
Information about our net revenues for North America and foreign areas for the
three months ended June 30, 2000 and 1999 is summarized below (in thousands):
<TABLE>
<CAPTION>
June 30, June 30, Increase/
2000 1999 (Decrease) % change
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
North America $71,756 $102,050 $(30,294) (29.7)%
--------------------------------------------------------------------
Europe 51,894 66,801 (14,907) (22.3)%
Asia Pacific 12,112 11,938 174 1.5 %
Japan 19,037 5,331 13,706 257.1 %
--------------------------------------------------------------------
International 83,043 84,070 (1,027) (1.2)%
--------------------------------------------------------------------
Consolidated Net Revenues $154,799 $186,120 $(31,321) (16.8)%
====================================================================
</TABLE>
North America Net Revenues
The decrease in North America net revenues for the three months ended June 30,
2000 compared to the same period last year was primarily attributable to:
o Expected declines in sales of PlayStation and Nintendo 64 ("N64") titles.
PlayStation net revenues decreased 84% and Nintendo 64 net revenues
decreased 93% due to no new titles shipping in the current quarter for
both platforms as well as a general market weakness.
o These decreases were partially offset by an 81% increase in AL revenues
primarily due to the shipment of titles published by Square EA.
16
<PAGE>
o Over 190% increase in online subscription revenues for North America
compared to the prior year due to subscription revenues generated from
Worldplay and Kesmai games and increase in average paying subscribers
related to Ultima Online.
o A 10% increase in PC revenues due to the continuing strong catalog sales
of The Sims, shipped in the fourth quarter of fiscal 2000, as well as the
current year release of SimCity 3000 Unlimited and Shogun: Total War.
International Net Revenues
The slight decrease in international net revenues for the three months ended
June 30, 2000 compared to the three months ended June 30, 1999 was attributable
to the following:
o Europe's net revenues decreased by 22% primarily due to market weakness,
lower AL sales due to product delays and lower Nintendo 64 sales due to
no new titles shipping in the current quarter.
o Asia Pacific's net revenues increased slightly due to strong PC sales of
The Sims and Shogun: Total War offset by a decline in PlayStation and
Nintendo 64 sales with no significant new titles shipping in the current
quarter.
o Japan's net revenues increased over 250% compared to the prior year
primarily due to the shipment of our first PlayStation 2 title, FIFA
Soccer World Championship.
Information about our worldwide net revenues by product line for the three
months ended June 30, 2000 and 1999 is presented below (in thousands):
<TABLE>
<CAPTION>
June 30, June 30, Increase/
2000 1999 (Decrease) % change
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
EA Studio:
PC $70,481 $ 63,596 $ 6,885 10.8 %
PlayStation 29,501 69,251 (39,750) (57.4)%
PlayStation 2 10,281 -- 10,281 N/A
Online Subscriptions 8,311 3,381 4,930 145.8 %
N64 606 11,842 (11,236) (94.9)%
License, OEM and Other 3,300 4,618 (1,318) (28.5)%
-----------------------------------------------------------------
122,480 152,688 (30,208) (19.8)%
Affiliated Label: 32,319 33,432 (1,113) (3.3)%
-----------------------------------------------------------------
Consolidated Net Revenues $154,799 $186,120 $(31,321) (16.8)%
=================================================================
</TABLE>
Personal Computer Product Net Revenues
We released four PC titles in the first quarter of the current fiscal year
compared to five PC titles for the same period last year. The worldwide increase
in sales of PC revenues was primarily attributable to the continued strong
catalog sales of The Sims. The increase was also due to the shipment of key
releases during the quarter, including sales of Euro 2000, SimCity 3000
Unlimited and Shogun: Total War. This increase was mitigated by strong sales of
SimCity 3000 in the prior year.
We expect revenues from PC products to grow in fiscal 2001, but as revenues for
these products increase, they may not grow at the current rate.
17
<PAGE>
PlayStation Product Net Revenues
We released one title for the PlayStation console in Europe and Asia Pacific
only, during the first quarter of fiscal 2001 compared to three titles released
worldwide in the first quarter of fiscal 2000. The expected decrease in
PlayStation product sales was primarily attributable to the shipment of only a
single title during the first quarter of the current year as compared to three
worldwide titles shipped in the same period last year. Further contributing to
the decrease was general PlayStation market weakness and shortage of PlayStation
hardware in both the United States and Europe.
Sony has announced the release of the PlayStation 2 console in the United States
in October 2000 and Europe in November 2000. Although our PlayStation products
will be 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 entered into with Sony Computer
Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are
authorized to develop and distribute software products compatible with the
PlayStation. Pursuant to the Sony Agreement, we engage Sony to manufacture
PlayStation Compact Disks for distribution by us. Accordingly, we have limited
ability to control our supply of PlayStation products or the timing of their
delivery.
PlayStation 2 Product Net Revenues
We released our first PlayStation 2 console title in Japan during the first
quarter of fiscal 2001, FIFA Soccer World Championship, which had $10,281,000 in
net revenues.
Online Net Revenues
The increase in online revenues for the three months ended June 30, 2000 as
compared to the three months ended June 30, 1999 was attributable to the
following:
o We generated over $2,400,000 in revenues for Kesmai and Worldplay
products in the current quarter which were not part of the EA.com product
offerings in the prior year. It is anticipated that subscription revenues
associated with Kesmai and Worldplay products will decrease, as most of
these games will be converted to our advertising-supported, free
offerings when our game site goes live. We are currently in Beta and
expect to go live in the late summer to fall of this year.
o The average number of paying customers for Ultima Online increased to
over 183,000 as compared to over 113,000 for the same period last year.
o The increase in paying customers was partially due to continued strong
sales of Ultima Online, which includes new events, land masses, new homes
and parties within the Ultima worlds.
o In addition, 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 ended June 30, 2000,
as compared to the same period last year.
Nintendo 64 Product Net Revenues
The expected decrease in N64 revenues for the three months ended June 30, 2000
compared to the same period last year was primarily due to no new products
released during the current quarter and only one new product shipped in the
fourth quarter of last year. The decrease was
18
<PAGE>
also due to the weak market for Nintendo 64 products in the current year. We
expect revenues from 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.
License, OEM and Other Revenues
The decrease in license, OEM and other revenues was primarily a result of lower
license revenues in North America due to revenues generated from two significant
licensing deals signed in the prior year.
Affiliated Label Product Net Revenues
AL product sales decreased during the current quarter compared to the same
period last year due to lower sales in Europe partially offset by higher sales
in North America. This decrease was partially offset by an increase in revenues
generated from the distribution of titles by Square EA in the current year as
compared to the same period last year.
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.
19
<PAGE>
Information about our operations by segment for fiscal 2000 and 1999 is
presented below (in thousands):
<TABLE>
<CAPTION>
=================================================================================================================================
Three Months Ended June 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $ 146,046 $8,753 $ -- $ 154,799
Group sales 360 -- (360) (a) --
----------------------------------------------------------------------------------------------------------------------------------
Total net revenues 146,406 8,753 (360) 154,799
----------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 76,499 1,408 -- 77,907
Group cost of goods sold -- 360 (360) (a) --
----------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 76,499 1,768 (360) 77,907
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 69,907 6,985 -- 76,892
Operating expenses:
Marketing and sales 33,260 1,933 -- 35,193
General and administrative 19,747 2,462 -- 22,209
Research and development 53,659 17,281 8,273 (b) 79,213
Network development and support -- 8,273 (8,273) (b) --
Amortization of intangibles 3,240 1,414 -- 4,654
----------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 109,906 31,363 -- 141,269
----------------------------------------------------------------------------------------------------------------------------------
Operating loss (39,999) (24,378) -- (64,377)
Interest and other income (expense), net 3,841 (5) -- 3,836
---------------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (36,158) (24,383) -- (60,541)
Benefit from income taxes (18,768) -- -- (18,768)
---------------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (17,390) (24,383) -- (41,773)
Minority interest in consolidated joint venture (498) -- -- (498)
---------------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(17,888) $(24,383) $ -- $(42,271)
=================================================================================================================================
<CAPTION>
Allocation of retained interest (in thousands):
===========================================================================================================================
Three Months Ended June 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 $(17,888) $(24,383) $ -- $(42,271)
Net loss related to retained interest in EA.com (20,726) 20,726 -- --
---------------------------------------------------------------------------------------------------------------------------
Net loss $(38,614) $ (3,657) $ -- $(42,271)
===========================================================================================================================
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
=================================================================================================================================
Three Months Ended June 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net revenues from unaffiliated customers $181,730 $ 4,390 $ -- $186,120
Group sales 294 -- (294) (a) --
---------------------------------------------------------------------------------------------------------------------------------
Total net revenues 182,024 4,390 (294) 186,120
---------------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 85,246 1,005 -- 86,251
Group cost of goods sold -- 294 (294) (a) --
---------------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 85,246 1,299 (294) 86,251
---------------------------------------------------------------------------------------------------------------------------------
Gross profit 96,778 3,091 -- 99,869
Operating expenses:
Marketing and sales 33,452 395 -- 33,847
General and administrative 17,454 254 -- 17,708
Research and development 40,222 3,738 2,615 (b) 46,575
Network development and support -- 2,615 (2,615) (b) --
Amortization of intangibles 2,588 -- -- 2,588
---------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 93,716 7,002 -- 100,718
---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 3,062 (3,911) -- (849)
Interest and other income, net 4,138 -- -- 4,138
---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 7,200 (3,911) -- 3,289
Provision for income taxes 1,052 -- -- 1,052
Income (loss) before minority interest 6,148 (3,911) -- 2,237
---------------------------------------------------------------------------------------------------------------------------------
Minority interest in consolidated joint venture 89 -- -- 89
Net income (loss) $ 6,237 $(3,911) $ -- $ 2,326
=================================================================================================================================
<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>
The increase in net revenues for EA.com for the three months ended June 30, 2000
as compared to the three months ended June 30, 1999 was attributable to the
following:
o Higher online revenues from increased subscriptions to Ultima Online.
o Online revenues generated from Kesmai and Worldplay games.
21
<PAGE>
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):
<TABLE>
<CAPTION>
===========================================================================================================================
Three Months Ended June 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Loss before benefit from income taxes
and minority interest $(36,158) $(24,383) $ - $(60,541)
Benefit from income taxes (11,209) (7,559) - (18,768)
---------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (24,949) (16,824) - (41,773)
Minority interest in consolidated joint venture (498) - - (498)
---------------------------------------------------------------------------------------------------------------------------
Net loss $(25,447) $(16,824) $ - $(42,271)
===========================================================================================================================
<CAPTION>
===========================================================================================================================
Three Months Ended June 30, 1999
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income (loss) before provision for (benefit from) $7,200 $(3,911) $ -
income taxes and minority interest $3,289
Provision for (benefit from) income taxes 2,304 (1,252) - 1,052
---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 4,896 (2,659) - 2,237
Minority interest in consolidated joint venture 89 - - 89
---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $4,985 $(2,659) $ - $2,326
===========================================================================================================================
</TABLE>
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income
(Loss)
Information about our costs and expenses, interest and other income, net, income
taxes and net income (loss) for the three months ended June 30, 2000 and 1999 is
presented below:
Percent of Net
Revenues
-----------------------
Three Months Ended
June 30,
-----------------------
2000 1999
-------- ----------
Cost of goods sold 50.3 % 46.3%
Marketing and sales 22.7 18.2
General and administrative 14.3 9.5
Research and development (includes Network
Development and Support) 51.2 25.0
Amortization of intangibles 3.0 1.4
Interest and other income, net 2.5 2.2
Income taxes - effective tax rate 31.0 32.0
Net income (loss) (27.3)% 1.2%
22
<PAGE>
Cost of Goods Sold. Cost of goods sold as a percentage of revenues increased
during the three months ended June 30, 2000 as compared to the same period last
year due to:
o A decrease, as a percentage of revenues, of higher margin PlayStation
products as compared to the prior year.
o Lower margins from License/OEM revenues as compared to the prior year due
to sales of low margin products in the current year.
o A decrease in sales of higher margin AL co-published titles which made up
a greater amount of total AL revenues in the same period last year.
o Offset by a decrease in sales of lower margin N64 titles.
o Also partially offset by higher margin subscription revenues for the
three months ended June 30, 2000 as compared to the same period last
year.
Marketing and Sales. Marketing and sales expenses increased in absolute dollars
by 4% primarily attributed to:
o Increased staff required for EA.com to support the game site and
marketing-related headcount additions associated with the Kesmai
acquisition in the fourth quarter of fiscal 2000. EA.com intends to
further increase marketing and advertising spending in order to promote
our game site and Games Channel on AOL.
o Increased advertising in Japan and Europe.
o Offset by higher prior year advertising and sales spending in North
America.
General and Administrative. General and administrative expenses increased in
absolute dollars by 25% primarily due to:
o Increase in depreciation expense for Europe due to the implementation of
a new online transaction processing system.
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.
Research and Development (excluding Network Development and Support). The
increase in absolute dollars by 61% for research and development expenses
(excluding network development and support) was due to:
o Increase in research and development expenses by EA.com due to an
increase in the number of online projects in development and increased
development staff. Although the total number of online games in
development at any given point going forward will not increase
significantly, 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 Additional headcount-related expenses attributable to the increased
in-house development capacity.
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 a software development company in the fourth quarter
of the prior fiscal year.
23
<PAGE>
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 formation of the EA.com customer support organization in
preparation for the live game site and the Games Channel on the AOL service. As
a result, we expect network development and support expenses to increase in
absolute dollars in the future.
Amortization of Intangibles. The amortization of intangibles results primarily
from the acquisitions of Westwood, Kesmai, ABC Software and other acquisitions.
Amortization of intangibles was $3,240,000 for EA Core and $1,414,000 for
EA.com.
Interest and Other Income, Net. Interest and other income, net, decreased in
absolute dollars primarily due to the realized gains on the sale of marketable
securities and gain on the sale of a minority interest in an affiliate in the
prior year. Those gains in the prior year were partially offset by higher
interest income in the current year.
Income Taxes. Our effective tax rate was 31.0% for the three months ended June
30, 2000 and 32.0% for the three months ended June 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 primarily
related to lower revenues and gross profits as well as higher costs and expenses
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 charges in the amount of $3,598,000, net of
taxes, in the current year, net loss would have been $38,673,000. Excluding
goodwill and non-cash charges in the amount of $1,831,000, net of taxes in the
prior year, net income would have been $4,157,000.
24
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000, our working capital was $376,176,000 compared to
$440,021,000 at March 31, 2000. Cash, cash equivalents and short-term
investments decreased by approximately $42,860,000 during the three months ended
June 30, 2000. We generated $2,285,000 of cash from operations and used
$50,668,000 in capital expenditures. In addition, $6,577,000 was provided
through the sale of equity securities under our stock plans.
Reserves for bad debts and sales returns decreased from $65,067,000 at March
31, 2000 to $53,325,000 at June 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 $296,944,000 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 of
Electronic Arts and EA.com for the next twelve months and the foreseeable
future.
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 three months ended June 30, 2000, EA.com used
$33,942,000 of cash in operations, $36,538,000 in capital expenditures
for computer equipment, network infrastructure and related software
(including $15,243,000 of consulting, hardware, software and direct
payroll and payroll-related costs associated with the implementation of
customized internal-use software), offset by $68,543,000 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.
25
<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. EITF 00-10 is effective no later than the required
implementation date for SAB 101. We do not expect EITF 00-10 to have a
significant impact on the results of operations, financial position or cash
flows on EITF 00-10's effective date.
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 classifed as an expense. We do
not expect EITF 00-14 to have a material impact on the Company's results of
operations, financial position or cash flows.
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 our 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. Our 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
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as amended by SAB 101B. We believe the adoption of SAB 101 will not have a
material impact on our 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 June 30, 2000, we have
capitalized $30,303,000 of these costs associated with the effort to build the
EA.com website and infrastructure.
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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
expects to ship the PlayStation 2 console in North America in October 2000 and
Europe in November 2000. Nintendo and Microsoft have also 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 intend to launch a
variety of products for the new Sony platform, the PlayStation 2, expected to be
released in the United States in October 2000. 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 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
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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, and
particularly in the September quarter, 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. Accordingly, we expect significant losses in the September quarter. 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 beginning 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 expects to ship its PlayStation 2 product in
North America in October 2000 and 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.
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
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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. Further, we are required under our agreement with AOL
to launch our game site within a specified time period or be subject to certain
penalties, including AOL's right to terminate the agreement. We were not
successful in meeting a June 1, 2000 initial launch target and we may not be
successful in achieving other specified launch targets. 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 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
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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 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.
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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 and Proxicom, Our Ability To Develop Our Online Business Will Be
Impaired
Because approximately 29% 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 and Proxicom, 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 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 the three months ended June 30, 2000 international net revenues
comprised 54% of total consolidated net revenues. For 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. For example, our
European revenues in fiscal 2000 were adversely impacted by a devaluation of the
Euro as compared to the prior year. Our foreign currency exposure may increase
if this trend continues. 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.
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. For example, during fiscal year ended March 31, 2000, the price per
share of our common stock ranged from $45.63 to $120.94 and $53.19 to $78.13
during the three months ended June 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 June 30, 2000, we had foreign exchange contracts, all with maturities of less
than nine months to purchase and sell approximately $238,692,000 in foreign
currencies, primarily British Pounds, European Currency Units ("Euros"),
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 counterparties to these contracts are substantial and
creditworthy multinational commercial banks. The risks of counterparty
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.
The table below provides information about our foreign currency forward exchange
contracts at June 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.
<TABLE>
<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 $135,905 1.5287 $2,462
Euro 45,259 0.9630 1,272
Canadian Dollar 8,821 1.4737 54
Japanese Yen 15,730 104.2600 74
Australian Dollar 1,567 0.6028 21
Brazilian Real 875 1.8279 (1)
South African Rand 4,532 6.8394 30
Swedish Krona 2,249 8.8935 (7)
---------------------------------------------------------------------------------------------------------
Total $214,938 $3,905
---------------------------------------------------------------------------------------------------------
</TABLE>
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Foreign currency to be purchased
under contract:
British Pound $23,754 1.5011 $ 150
--------------------------------------------------------------------------------
Total $23,754 $ 150
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Grand total $238,692 $4,055
--------------------------------------------------------------------------------
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 June 30, 2000, our
cash equivalents, short-term and long-term investments included debt securities
of $185,676,000. 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 following table presents the amounts and related weighted average interest
rates of our investment portfolio at June 30, 2000:
-----------------------------------------------------------------
Average Interest
Rate Cost Fair Value
-----------------------------------------------------------------
(Dollars in thousands)
Cash equivalents
Fixed rate 0.00% $ - $ -
Variable rate 4.51% $84,788 $84,788
Short-term investments
Fixed rate 4.05% $82,497 $82,488
Variable rate 6.68% $10,000 $10,000
Long-term investments
Fixed rate 0.00% $ - $ -
Variable rate 6.35% $8,400 $8,248
------------------------------------------------------------------
Maturity dates for short-term investments range from 6 months to 3 years.
37
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to pending claims and litigation. Management,
after review and consultation with counsel, considers that any
liability from the disposition of such lawsuits in the aggregate would
not have a material adverse effect upon the consolidated financial
position or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders, held on July 27, 2000,
the stockholders elected the following individuals for one-year terms
to the Board of Directors: M. Richard Asher, William J. Byron, Daniel
H. Case III, Gary M. Kusin, Timothy Mott and Lawrence F. Probst III.
These individuals have received a plurality of the votes eligible to
vote, voting either in person or by proxy.
In addition, the following matters were voted upon by the Stockholders:
To approve Electronic Arts Inc. 2000 Employee Stock Purchase Plan and
reserve 500,000 shares of the Company's Class A common stock for
issuance under the Plan.
Votes
--------------------------------------------------------------
For Against Abstain
--- ------- -------
56,260,200 663,338 31,657
To ratify the appointment of KPMG LLP as independent accountants for
the Company for the current fiscal year.
Votes
--------------------------------------------------------------
For Against Abstain
--- ------- -------
56,906,459 34,810 13,926
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
38
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRONIC ARTS INC.
(Registrant)
/s/E. STANTON MCKEE
-------------------
DATED: E. STANTON MCKEE
August 14, 2000 Executive Vice President and
Chief Financial and Administrative Officer
39
