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 December 31, 1999
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 February 7, 2000
--------------------- ----------------
$0.01 par value per share 64,246,296
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
<CAPTION>
Part I - Financial Information Page
- ------------------------------ ----
<S> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
December 31, 1999 and March 31, 1999 3
Consolidated Statements of Income for the Three Months Ended
December 31, 1999 and 1998 and the Nine Months Ended
December 31, 1999 and 1998 4
Consolidated Statements of Cash Flows for
the Nine Months Ended December 31, 1999 and 1998 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Part II - Other Information
- ---------------------------
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
</TABLE>
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>
ASSETS
December 31, March 31,
1999 1999
---- ----
<S> <C> <C>
Current assets:
Cash, cash equivalents and short-term investments $ 247,170 $ 312,822
Marketable securities 1,447 4,884
Receivables, less allowances of $83,300 and $72,850, respectively 377,920 149,468
Inventories, net 22,838 22,376
Deferred income taxes 26,802 25,406
Other current assets 87,964 54,509
----------- -----------
Total current assets 764,141 569,465
Property and equipment, net 243,795 181,266
Long-term investments 18,400 18,400
Investments in affiliates 20,938 25,864
Goodwill and other intangibles 83,542 90,682
Long-term deferred income taxes 3,363 5,733
Other assets 46,590 10,463
----------- -----------
$ 1,180,769 $ 901,873
=========== ===========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 89,973 $ 63,881
Accrued liabilities 222,411 172,328
----------- -----------
Total current liabilities 312,384 236,209
Minority interest in consolidated joint venture 3,052 2,733
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares -- --
Common stock, $0.01 par value. Authorized 104,000,000 shares;
issued 63,937,354 and 61,291,849 shares; outstanding 63,937,354 and
61,169,286 shares, respectively 639 613
Paid-in capital 358,516 267,699
Treasury stock, at cost; 122,563 shares at March 31, 1999 -- (4,926)
Retained earnings 512,936 402,112
Accumulated other comprehensive loss (6,758) (2,567)
----------- -----------
Total stockholders' equity 865,333 662,931
----------- -----------
$ 1,180,769 $ 901,873
=========== ===========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenues $ 600,691 $ 520,155 $1,125,698 $ 944,139
Cost of goods sold 299,423 274,378 562,821 497,265
---------- ---------- ---------- ----------
Gross profit 301,268 245,777 562,877 446,874
---------- ---------- ---------- ----------
Operating expenses:
Marketing and sales 67,475 56,451 147,422 123,618
General and administrative 28,237 23,397 68,246 55,454
Research and development 73,424 61,011 187,025 144,358
Amortization of intangibles 2,596 2,479 7,800 3,385
Charge for acquired in-process technology -- -- -- 44,115
---------- ---------- ---------- ----------
Total operating expenses 171,732 143,338 410,493 370,930
---------- ---------- ---------- ----------
Operating income 129,536 102,439 152,384 75,944
Interest and other income, net 4,382 3,942 11,653 10,507
---------- ---------- ---------- ----------
Income before provision for income taxes
and minority interest 133,918 106,381 164,037 86,451
Provision for income taxes 41,214 33,800 50,852 35,172
---------- ---------- ---------- ----------
Income before minority interest 92,704 72,581 113,185 51,279
Minority interest in consolidated
joint venture 157 (50) 134 (321)
---------- ---------- ---------- ----------
Net income $ 92,861 $ 72,531 $ 113,319 $ 50,958
========== ========== ========== ==========
Net income per share:
Basic $ 1.47 $ 1.19 $ 1.82 $ 0.84
========== ========== ========== ==========
Diluted $ 1.38 $ 1.15 $ 1.72 $ 0.81
========== ========== ========== ==========
Number of shares used in computation:
Basic 63,326 60,936 62,390 60,621
========== ========== ========== ==========
Diluted 67,478 63,229 65,835 63,210
========== ========== ========== ==========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
4
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
<CAPTION>
Nine Months
Ended December 31,
1999 1998
---- ----
<S> <C> <C>
Operating activities:
Net income $ 113,319 $ 50,958
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Minority interest in consolidated joint venture (134) 321
Equity in net (income) loss of affiliates (625) 110
Gain on sale of affiliate (842) --
Depreciation and amortization 31,430 31,145
(Gain) loss on sale of fixed assets 402 (3,871)
Gain on sale of marketable securities (6,063) (1,454)
Provision for doubtful accounts 6,427 5,428
Charge for acquired in-process technology -- 44,115
Change in assets and liabilities, net of acquisitions:
Receivables (234,879) (176,546)
Inventories (462) (6,591)
Other assets (71,249) (13,434)
Accounts payable 26,092 8,322
Accrued liabilities 53,016 83,749
Deferred income taxes (535) 478
--------- ---------
Net cash provided by (used in) operating activities (84,103) 22,730
--------- ---------
Investing activities:
Proceeds from sales of marketable securities 7,037 1,818
Proceeds from sale of furniture and equipment 56 8,234
Proceeds from sale of affiliate 8,842 --
Capital expenditures (85,023) (95,697)
Investment in affiliates, net (2,949) (5,128)
Proceeds from maturity of securities -- 17,271
Change in short-term investments, net (20,630) 117,551
Acquisition of Westwood Studios, Inc. -- (122,688)
Acquisition of other subsidiaries, net of cash acquired (582) (11,805)
--------- ---------
Net cash used in investing activities (93,249) (90,444)
--------- ---------
Financing activities:
Proceeds from sales of shares through employee stock
plans and other plans 68,477 21,374
Tax benefit from exercise of stock options 24,797 4,063
Proceeds from minority interest investment in consolidated
joint venture -- 2,109
--------- ---------
Net cash provided by financing activities 93,274 27,546
--------- ---------
Translation adjustment (718) 1,666
--------- ---------
Decrease in cash and cash equivalents (84,796) (38,502)
Beginning cash and cash equivalents 242,208 215,963
--------- ---------
Ending cash and cash equivalents 157,412 177,461
Short-term investments 89,758 23,775
--------- ---------
Ending cash, cash equivalents and short-term investments $ 247,170 $ 201,236
========= =========
</TABLE>
5
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
(unaudited)
<CAPTION>
Nine Months
Ended December 31,
1999 1998
---- ----
<S> <C> <C>
Supplemental cash flow information:
Cash paid during the year for income taxes $ 9,711 $ 22,325
======== ========
Non-cash investing activities:
Change in unrealized appreciation of investments and marketable securities
$ (4,441) $ (384)
======== ========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>
6
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements are unaudited and reflect all adjustments
(consisting only of normal recurring accruals) that, in the opinion of
management, are necessary for a fair presentation of the results for the interim
period. The results of operations for the current interim period are not
necessarily indicative of results to be expected for the current year or any
other period. Certain amounts have been reclassified to conform to the fiscal
2000 presentation.
These consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in Electronic Arts
Inc. (the "Company") Annual Report on Form 10-K for the fiscal year ended March
31, 1999 as filed with the Securities and Exchange Commission ("Commission") on
June 29, 1999.
Note 2. 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 $50,801,000 and $35,057,000 at December 31, 1999
and March 31, 1999, respectively. The long-term portion of prepaid royalties,
included in other assets, was $13,948,000 and $7,602,000 at December 31, 1999
and March 31, 1999, respectively.
Note 3. Inventories
Inventories are stated at the lower of cost or market. Inventories at December
31, 1999 and March 31, 1999 consisted of (in thousands):
- --------------------------------------------------------------------------------
December 31, 1999 March 31, 1999
- --------------------------------------------------------------------------------
Raw materials and work in process $1,848 $2,983
Finished goods 20,990 19,393
- --------------------------------------------------------------------------------
$22,838 $22,376
================================================================================
Note 4. Accrued Liabilities
Accrued liabilities at December 31, 1999 and March 31, 1999 consisted of (in
thousands):
- --------------------------------------------------------------------------------
December 31, 1999 March 31, 1999
- --------------------------------------------------------------------------------
Accrued royalties $69,601 $36,429
Accrued compensation and benefits 53,269 46,541
Accrued expenses 53,058 46,595
Accrued income taxes 34,612 23,724
Warranty reserve 9,594 7,900
Deferred revenue 2,277 8,206
Deferred income taxes -- 2,933
- --------------------------------------------------------------------------------
$222,411 $172,328
================================================================================
7
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 5. Segment Information
<TABLE>
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 Company has four
reportable segments: North America, Europe, Asia Pacific and Japan, which are
organized, managed and analyzed geographically and operate in one industry
segment: the creation, marketing and distribution of entertainment software.
Information about the Company's operations in the North America and foreign
areas for the three and nine months ended December 31, 1999 and 1998 is
presented below:
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months ended December 31, 1999
- ------------------------------------
Net revenues from unaffiliated
customers $ 366,467 $ 213,201 $ 14,630 $ 6,393 $ -- $ 600,691
Intersegment revenues 16,031 10,523 1,756 -- (28,310) --
---------- ---------- ---------- ---------- ---------- ----------
Total net revenues $ 382,498 $ 223,724 $ 16,386 $ 6,393 $ (28,310) $ 600,691
========== ========== ========== ========== ========== ==========
Operating income (loss) $ 86,896 $ 41,732 $ 1,661 $ (437) $ (316) $ 129,536
Interest income $ 2,693 $ 548 $ 60 $ -- $ -- $ 3,301
Depreciation and amortization $ 7,748 $ 2,652 $ 154 $ 221 $ -- $ 10,775
Identifiable assets $ 751,490 $ 389,001 $ 26,460 $ 13,818 $ -- $1,180,769
Capital expenditures $ 16,238 $ 20,786 $ 432 $ 284 $ -- $ 37,740
Nine months ended December 31, 1999
- ----------------------------------
Net revenues from unaffiliated
customers $ 694,125 $ 372,559 $ 37,520 $ 21,494 $ -- $1,125,698
Intersegment revenues 23,751 22,414 4,661 -- (50,826) --
---------- ---------- ---------- ---------- ---------- ----------
Total net revenues $ 717,876 $ 394,973 $ 42,181 $ 21,494 $ (50,826) $1,125,698
========== ========== ========== ========== ========== ==========
Operating income (loss) $ 114,520 $ 35,416 $ 4,035 $ (222) $ (1,365) $ 152,384
Interest income $ 8,676 $ 1,104 $ 123 $ -- $ -- $ 9,903
Depreciation and amortization $ 22,216 $ 8,099 $ 396 $ 719 $ -- $ 31,430
Capital expenditures $ 36,700 $ 46,883 $ 1,024 $ 416 $ -- $ 85,023
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE>
<TABLE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
------- ------ ------ ----- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Three months ended December 31, 1998
- ------------------------------------
Net revenues from unaffiliated
customers $302,060 $195,856 $ 13,811 $ 8,428 $ -- $520,155
Intersegment revenues 6,792 4,799 716 -- (12,307) --
-------- -------- -------- -------- -------- --------
Total net revenues $308,852 $200,655 $ 14,527 $ 8,428 $(12,307) $520,155
======== ======== ======== ======== ======== ========
Operating income $ 35,914 $ 63,415 $ 3,053 $ 57 $ -- $102,439
Interest income $ 1,438 $ 381 $ 22 $ -- $ -- $ 1,841
Depreciation and amortization $ 10,776 $ 4,058 $ 65 $ 526 $ -- $ 15,425
Identifiable assets $569,275 $326,544 $ 20,234 $ 20,437 $ -- $936,490
Capital expenditures $ 21,122 $ 6,472 $ 67 $ 165 $ -- $ 27,826
Nine months ended December 31, 1998
- -----------------------------------
Net revenues from unaffiliated
customers $558,255 $328,382 $ 30,235 $ 27,267 $ -- $944,139
Intersegment revenues 14,008 9,643 716 12 (24,379) --
-------- -------- -------- -------- -------- --------
Total net revenues $572,263 $338,025 $ 30,951 $ 27,279 $(24,379) $944,139
======== ======== ======== ======== ======== ========
Operating income $ 17,289 $ 52,372 $ 3,430 $ 2,853 $ -- $ 75,944
Interest income $ 7,412 $ 1,535 $ 110 $ -- $ -- $ 9,057
Depreciation and amortization $ 21,594 $ 8,196 $ 230 $ 1,125 $ -- $ 31,145
Capital expenditures $ 43,901 $ 50,400 $ 399 $ 997 $ -- $ 95,697
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Information about the Company's net revenues by product line for the three and
nine months ended December 31, 1999 and 1998 is presented below:
================================================================================
(In thousands) Three Months Ended Nine Months Ended
December 31, December 31,
1999 1998 1999 1998
- --------------------------------------------------------------------------------
PlayStation $ 291,002 $ 222,271 $ 471,690 $ 416,118
PC-CD 123,771 104,964 289,154 186,473
Affiliated label 116,423 128,209 222,534 199,688
N64 57,066 57,168 114,873 121,702
License, OEM, Online
and Other 12,429 7,543 27,447 20,158
- --------------------------------------------------------------------------------
$ 600,691 $ 520,155 $1,125,698 $ 944,139
================================================================================
Note 6. Comprehensive Income
In fiscal 1999, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and the display of
comprehensive income and its components (revenues, expenses, gains and losses)
in financial statements. SFAS 130 requires classification of other comprehensive
income in a financial statement and display of other comprehensive income
separately from retained earnings and additional paid-in capital. Other
comprehensive income includes primarily foreign currency translation adjustments
and unrealized gains (losses) on investments.
9
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
<TABLE>
The components of comprehensive income, net of tax, for the three and nine
months ended December 31, 1999 and 1998 were as follows (in thousands):
<CAPTION>
====================================================================================================================================
Three Months Ended Nine Months Ended
December 31, December 31,
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 92,861 $ 72,531 $ 113,319 $ 50,958
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss):
Change in unrealized appreciation (depreciation) of
investments, net of a tax provision (benefit) of $117,
$(13), $519 and $353 248 (27) 1,103 717
Reclassification adjustment for gains realized in net
income, net of a tax benefit of $(1,528), $0, $(1,940)
and $(480) (3,249) -- (4,123) (974)
Foreign currency translation adjustments (4,666) (1,505) (1,171) 1,147
- ------------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss) (7,667) (1,532) (4,191) 890
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income $ 85,194 $ 70,999 $ 109,128 $ 51,848
====================================================================================================================================
</TABLE>
The currency translation adjustments are not adjusted for income taxes as they
relate to indefinite investments in non-U.S. subsidiaries.
Note 7. Earnings Per Share
<TABLE>
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 (in thousands, except per share amounts):
<CAPTION>
====================================================================================================================================
Three Months Ended Nine Months Ended
December 31, December 31,
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $ 92,861 $ 72,531 $113,319 $ 50,958
- ------------------------------------------------------------------------------------------------------------------------------------
Shares used to compute net income per share:
Weighted-average common shares 63,326 60,936 62,390 60,621
Dilutive stock options 4,152 2,293 3,445 2,589
- ------------------------------------------------------------------------------------------------------------------------------------
Dilutive potential common shares 67,478 63,229 65,835 63,210
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Net income per share:
Basic $ 1.47 $ 1.19 $ 1.82 $ 0.84
Diluted $ 1.38 $ 1.15 $ 1.72 $ 0.81
====================================================================================================================================
</TABLE>
10
<PAGE>
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Excluded from the above computation of weighted-average shares for diluted EPS
were options to purchase 75,628, and 146,728 shares of common stock for the
three and nine months ended December 31, 1999, respectively, as the options'
exercise price was greater than the average market price of the common shares.
For the three and nine months ended December 31, 1999, the weighted-average
exercise price of the respective options was $91.94 and $75.13, respectively.
Excluded from the above computation of weighted-average shares for diluted EPS
were options to purchase 2,228,208, and 391,693 shares of common stock for the
three and nine months ended December 31, 1998, respectively, as the options'
exercise price was greater than the average market price of the common shares.
Note 8. New Accounting Pronouncement
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", which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
is 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
on its financial statements.
Note 9. Subsequent Event
Acquisition of Kesmai
In February 2000, the Company acquired Kesmai, a Virginia-based company that
develops and publishes online games, in exchange for $22,500,000 in cash and
103,227 shares of the Company's common stock valued at $8,650,000. The
transaction is expected to be accounted for under the purchase method.
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Quarterly Report on Form 10-Q and in particular Management's Discussion and
Analysis of Financial Condition and Results of Operations contains
forward-looking statements 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. Risk 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 21 to 23, as well as in our Annual Report on Form
10-K for the fiscal year ended March 31, 1999 as filed with the Securities and
Exchange Commission on June 29, 1999 and other documents filed with the
Commission.
We derive revenues primarily from shipments of entertainment software, which
includes EA Studio CD products for dedicated entertainment systems (that we call
CD-video games), EA Studio CD personal computer products (or PC-CD), EA Studio
cartridge products and Affiliated Label (or AL) products that are published by
third parties and distributed or co-published by us. We also derive revenues
from licensing of EA Studio products and Affiliated Label products through
hardware companies (or OEMs) and online subscription revenues.
<TABLE>
Information about our net revenues for North America and foreign areas for the
three and nine months ended December 31, 1999 and 1998 is summarized below (in
thousands):
<CAPTION>
====================================================================================================================================
December 31, December 31, Increase/
1999 1998 (Decrease) % change
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Revenues for the Three Months Ended:
North America $ 366,467 $ 302,060 $ 64,407 21.3%
- ------------------------------------------------------------------------------------------------------------------------------------
Europe $ 213,201 $ 195,856 $ 17,345 8.9%
Asia Pacific $ 14,630 $ 13,811 $ 819 5.9%
Japan $ 6,393 $ 8,428 $ (2,035) (24.1%)
- ------------------------------------------------------------------------------------------------------------------------------------
International $ 234,224 $ 218,095 $ 16,129 7.4%
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Net Revenues $ 600,691 $ 520,155 $ 80,536 15.5%
====================================================================================================================================
Net Revenues for the Nine Months Ended:
North America $ 694,125 $ 558,255 $ 135,870 24.3%
- ------------------------------------------------------------------------------------------------------------------------------------
Europe $ 372,559 $ 328,382 $ 44,177 13.5%
Asia Pacific $ 37,520 $ 30,235 $ 7,285 24.1%
Japan $ 21,494 $ 27,267 $ (5,773) (21.2%)
- ------------------------------------------------------------------------------------------------------------------------------------
International $ 431,573 $ 385,884 $ 45,689 11.8%
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Net Revenues $1,125,698 $ 944,139 $ 181,559 19.2%
====================================================================================================================================
</TABLE>
12
<PAGE>
North America Net Revenues
The increase in North America net revenues for the three months ended December
31, 1999, compared to the same period last year was primarily due to:
o A 41% increase in PlayStation revenues due to the shipment of key releases
including NBA Live 2000, Tomorrow Never Dies, Knockout Kings 2000 and
continued strong sales of Madden NFL 2000.
o A 33% increase in PC-CD revenues due to new releases such as Theme Park
World and catalog sales of Sim City 3000 and Command and Conquer: Tiberian
Sun.
o Offset by a decline in AL revenues primarily due to the acquisition of an
affiliate, Accolade, in the first quarter of the current fiscal year by a
third party.
For the nine months ended December 31, 1999, the increase in North America net
revenues compared to the same period last year was attributed to:
o A 55% increase in PC-CD revenues due to strong sales of Sim City 3000 and
Command and Conquer: Tiberian Sun.
o A 25% increase in PlayStation revenues due to the release of titles such as
NBA 2000 and Tomorrow Never Dies in the third fiscal quarter and Madden NFL
2000 in the second fiscal quarter of the current year.
o As well as a 16% increase in AL revenues primarily due to the distribution
of titles published by Square EA offset by the acquisition of an affiliate,
Accolade, by a third party.
International Net Revenues
The increase in international net revenues for the three months ended December
31, 1999, compared to the same period last year was primarily attributable to:
o A 26% increase in European PlayStation revenues driven by the release of
Tomorrow Never Dies and FIFA 2000, which was partially offset by a decrease
in N64 revenues due to a weak market for N64 products.
o An increase in Asia Pacific revenues due to the release of Tomorrow Never
Dies and catalog sales of Command and Conquer: Tiberian Sun.
o Offset of increases by a decline in PlayStation revenues in Japan due to
strong prior year comparisons of World Cup 98 and Theme Aquarium.
For the nine months ended December 31, 1999, the increase in international
revenues compared to the same period last year was due to:
o A 52% increase in Europe PC-CD revenues due to sales of Command and
Conquer: Tiberian Sun, Sim City 3000, Dungeon Keeper 2 and Theme Park
World, which were offset by a decrease in N64 revenues due to a weak market
for N64 products.
o A 78% increase in Asia Pacific PC-CD revenues also due to the success of
Command and Conquer: Tiberian Sun and Sim City 3000.
o Offset a 68% decline in by Japan PlayStation revenue primarily due to
strong sales of FIFA: Road to the World Cup and World Cup 98 in the prior
year.
13
<PAGE>
<TABLE>
Information about our net revenues by product line for the three and nine months
ended December 31, 1999 and 1998 is presented below (in thousands):
<CAPTION>
====================================================================================================================================
December 31, December 31, Increase/
1999 1998 (Decrease) % change
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Revenues for the Three Months Ended:
EA Studio:
- ----------
PlayStation $ 291,002 $ 222,271 $ 68,731 30.9%
PC-CD $ 123,771 $ 104,964 $ 18,807 17.9%
N64 $ 57,066 $ 57,168 $ (102) (0.2%)
License, OEM, Online and Other $ 12,429 $ 7,543 $ 4,886 64.8%
- ------------------------------------------------------------------------------------------------------------------------------------
$ 484,268 $ 391,946 $ 92,322 23.6%
Affiliated Label: $ 116,423 $ 128,209 $ (11,786) (9.2%)
- -----------------
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Net Revenues $ 600,691 $ 520,155 $ 80,536 15.5%
- ------------------------------------------------------------------------------------------------------------------------------------
Net Revenues for the Nine Months Ended:
EA Studio:
- ----------
PlayStation $ 471,690 $ 416,118 $ 55,572 13.4%
PC-CD $ 289,154 $ 186,473 $ 102,681 55.1%
N64 $ 114,873 $ 121,702 $ (6,829) (5.6%)
License, OEM, Online and Other $ 27,447 $ 20,158 $ 7,289 36.2%
- ------------------------------------------------------------------------------------------------------------------------------------
$ 903,164 $ 744,451 $ 158,713 21.3%
Affiliated Label: $ 222,534 $ 199,688 $ 22,846 11.4%
- -----------------
- ------------------------------------------------------------------------------------------------------------------------------------
Consolidated Net Revenues $1,125,698 $ 944,139 $ 181,559 19.2%
====================================================================================================================================
</TABLE>
PlayStation Product Net Revenues
The increase in PlayStation revenue for the three months ended December 31, 1999
was due to more products released compared to the same period last year. We
released 10 PlayStation titles in the current quarter compared to six in the
prior year. Key releases for the quarter include FIFA 2000, Tomorrow Never Dies,
NBA 2000 and Knockout Kings 2000.
For the nine months ended December 31, 1999 we released 20 PlayStation products
compared to 16 in the same period last year. Key releases for the year include
FIFA 2000, Tomorrow Never Dies, Madden NFL 2000, NBA 2000 and Knockout Kings
2000.
We expect revenues from PlayStation products to grow in fiscal 2000, but as
revenues for these products increase, we do not expect to maintain the same
growth rates as those in the prior years. Sony has announced the release of
PlayStation II in the United States and Europe in the fall of 2000. Although
PlayStation products will be playable on the PlayStation II, we expect sales of
current PlayStation products to decline in the coming fiscal year.
14
<PAGE>
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 CD-based software products compatible with
the PlayStation. Pursuant to the Sony Agreement, we engage Sony to supply
PlayStation CDs for distribution by us. Accordingly, we have limited ability to
control our supply of PlayStation CD products or the timing of their delivery.
See Risk Factors - "Our platform licensors are our chief competitors and
frequently control the manufacturing of our video game products".
Personal Computer CD Product Net Revenues
For the three months ended December 31, 1999 PC-CD revenues increased due to
strong sales of catalog titles such as Command and Conquer: Tiberian Sun and Sim
City 3000. We released 10 PC-CD products during the quarter compared to nine in
the same period last year. Key releases for the quarter included FIFA 2000 and
Theme Park World.
For the nine months ended December 31, 1999 we released 21 PC-CD products
compared to 20 in the same period last year. The increase for the nine months
ended December 31, 1999 was primarily due to the success of Command and Conquer:
Tiberian Sun, released in the second quarter of fiscal 2000 and catalog sales of
Sim City 3000, released in the fourth quarter of fiscal 1999. Other key titles
released in the current year included FIFA 2000 and Need For Speed IV.
We expect revenues from PC-CD products to grow in fiscal 2000, but as revenues
for these products increase, we do not expect to maintain the same growth rates
as those in the prior periods.
N64 Product Net Revenues
For the three months ended December 31, 1999, revenues were flat compared to the
same period last year, primarily due to a weak market for N64 products. Key
releases for the quarter included Knockout Kings 2000 and NBA 2000.
For the nine months ended December 31, 1999 the decrease in N64 revenues was due
to the weak market for N64 products as well as strong comparisons of World Cup
98 in the prior year. Key releases for the year included WCW Mayhem and Knockout
Kings 2000. We expect revenues from N64 products to continue to decline in
fiscal 2000.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64
cartridges for distribution by us. Accordingly, we have little ability to
control our supply of N64 cartridges or the timing of their delivery. A shortage
of microchips or other factors outside our control could impair our ability to
obtain an adequate supply of cartridges.
In connection with our purchases of N64 cartridges for distribution in North
America, Nintendo requires us to provide irrevocable letters of credit prior to
Nintendo's acceptance of purchase orders from us for purchases of these
cartridges. For purchases of N64 cartridges for distribution in Japan and
Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo
maintains a policy of not accepting returns of N64 cartridges. Because of these
and other factors, the carrying of an inventory of cartridges entails
significant capital and risk. See Risk Factors - "Our platform licensors are our
chief competitors and frequently control the manufacturing of our video game
products".
15
<PAGE>
Affiliated Label Product Net Revenues
The decrease in Affiliated Label net revenues for the three months ended
December 31, 1999 compared to the same period last year was primarily due to the
acquisition of Accolade by a third party. Prior year titles distributed under
the Accolade agreement included Test Drive V and Test Drive: Off Road 2 for
PlayStation and PC-CD. This decrease was partially offset by the distribution of
titles by DreamWorks, Interactive and Square EA, including Final Fantasy VIII.
For the nine months ended December 31, 1999 AL revenues increased due to the
distribution of titles by Square EA, including Final Fantasy VIII, partially
offset by the termination of our distribution agreement with Accolade which was
acquired by a third party.
<TABLE>
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income
<CAPTION>
====================================================================================================================================
Percent of Net Revenues Percent of Net Revenues
Three months ended December 31, Nine months ended December 31,
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cost of goods sold 49.8% 52.7% 50.0% 52.7%
Marketing and sales 11.2 10.9 13.1 13.1
General and administrative 4.7 4.5 6.1 5.9
Research and development 12.2 11.7 16.6 15.3
Charge for acquired in-process technology -- -- -- 4.7
Amortization of intangibles 0.5 0.5 0.7 0.4
Interest and other income, net 0.7 0.8 1.0 1.1
Income taxes - effective tax rate 30.8 31.8 31.0 40.7
Net income 15.5% 13.9% 10.1% 5.4%
====================================================================================================================================
</TABLE>
Cost of Goods Sold
Cost of goods sold as a percentage of net revenues decreased for the three
months ended December 31, 1999 compared to the same period last year primarily
due to:
o An increase in sales of higher margin PlayStation titles.
o A decrease in sales of lower margin N64 titles.
o An overall decrease in sales of Affiliated Label titles combined with
higher average margins in ALs resulting from a higher percentage of
co-published titles.
For the nine months ended December 31, 1999, cost of goods sold as a percentage
of revenues decreased due to:
o Increased sales of higher margin PC-CD titles.
o Higher sales of higher margin AL co-published titles.
o A decrease in sales of lower margin N64 titles.
o Higher sales of internally developed titles including Command and Conquer:
Tiberian Sun and Sim City 3000.
16
<PAGE>
Marketing and Sales
Marketing and sales expenses for the three months ended December 31, 1999
increased primarily due to increased television, print and Internet advertising
to support a higher number of releases in the quarter compared to the same
period last year.
For the nine months ended December 31, 1999, marketing and sales expenses
increased in absolute dollars due to increased television, print and Internet
advertising to support higher revenues. The increase was also due to additional
headcount expenses related to the continued expansion of our worldwide
distribution business.
General and Administrative
General and administrative expenses increased for the three and nine months
ended December 31, 1999 primarily due to an increase in payroll and occupancy
costs to support the increased growth in North America and Europe operations.
Research and Development
Research and development expenses increased for the three and nine months ended
December 31, 1999 due to:
o Additional headcount related expenses attributable to increased in-house
development capacity due to a higher number of SKU's to be released in
fiscal 2000.
o An increase in online development spending, including the acquisition and
integration of PlayNation, an online software developer, in the second
quarter of the current fiscal year.
o An increase in development spending for next generation console products
including development for the PlayStation II.
Charge for Acquired In-Process Technology
In connection with the acquisition of Westwood in September 1998, we allocated
and expensed $41,836,000 of the purchase price to acquired in-process
technology. Additionally, in connection with the acquisition of two software
development companies, in the first quarter of fiscal 1999, we incurred a total
charge of $2,279,000 for acquired in-process technology. These charges were made
after we concluded that the in-process technology had not reached technological
feasibility and had no alternative future use after taking into consideration
the potential for usage of the software in different products and resale of the
software.
Amortization of Intangibles
The increase in amortization of intangibles for the nine months ended December
31, 1999 resulted primarily from the acquisition of Westwood in September 1998.
Interest and Other Income, Net
Interest and other income, net, increased in absolute dollars for the three
months ended December 31, 1999 compared to the same period last year primarily
due to higher interest income and realized gains on sales of marketable
securities. These increases were partially
17
<PAGE>
offset by a write-off of a note receivable from an affiliate in the current
quarter as well as a gain on sale of land in the same quarter last year.
For the nine months ended December 31, 1999, interest and other income, net,
increased compared to the same period last year primarily due to realized gains
on sales of marketable securities and the sale of our interest in an affiliate.
These gains were partially offset by a write-off of a note receivable from an
affiliate in the current year as well as a gain on sale of land recognized in
the prior year.
Income Taxes
The Company's effective tax rate for the three and nine months ended December
31, 1999 was lower than the comparable prior year period (excluding the effect
of the one-time charges in the prior year) primarily as a result of a projected
higher portion of international income for fiscal 2000 subject to a lower
foreign tax rate as compared to the prior year. The tax rate for the nine months
ended December 31, 1998 was negatively affected as there was no tax benefit
recorded for a portion of the charges related to the acquired in-process
technology. Excluding the effect of these charges, the effective tax rate for
the nine months ended December 31, 1998 would have been 33.0%.
Net Income
The increase in net income for the three months ended December 31, 1999 is
primarily related to higher revenues and gross profits as compared to the same
periods last year partially offset by higher operating expenses.
For the nine months ended December 31, 1999 the increase was also due to
one-time charges for purchased in process technology in the prior year.
Excluding the one-time charges in the prior year, net income would have been
$88,464,000 for the nine months ended December 31, 1998. The increase in net
income, excluding the prior year one-time charges, was $24,855,000 or 28%.
18
<PAGE>
Liquidity and Capital Resources
As of December 31, 1999, our working capital was $451,757,000 compared to
$333,256,000 at March 31, 1999. Cash, cash equivalents and short-term
investments decreased by approximately $65,652,000 during the nine months ended
December 31, 1999 as we used $84,103,000 of cash in operations and $85,023,000
in capital expenditures, offset by $68,477,000 provided through the sale of
equity securities under our stock plans, proceeds from the sale of an affiliate,
and the sale of marketable securities.
Reserves for bad debts and sales returns increased from $72,850,000 at March 31,
1999 to $83,300,000 at December 31, 1999. 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 $247,170,000 in cash, cash equivalents and
short-term investments. Management believes the existing cash, cash equivalents,
short-term investments, marketable securities and cash generated from operations
will be sufficient to meet cash and investment requirements on both a short-term
and long-term basis.
Future Commitments with America Online, Inc.
In November 1999, we entered into a five-year agreement with America Online,
Inc. ("AOL") to become exclusively responsible for game content on the AOL Games
Channel in North America and for content in the games channels on these four AOL
brands: AOL.com, CompuServe, Netcenter/Netscape and ICQ. Under terms of the
agreement, we guaranteed AOL $81 million as follows:
o $50 million for carriage payments (including certain advertising fees) for
rights to program the Games Channel on AOL and the game channels on AOL's
four other Internet properties. We paid $25 million upon signing. We will
pay AOL $6.25 million at launch of Electronic Arts' online and e-Commerce
business division's ("EA.com") web site, which we expect to occur in the
summer of fiscal year 2001, and $6.25 million for each of three successive
annual anniversaries.
o $31 million as an advance of minimum guaranteed revenue share for revenues
generated by advertising, subscriptions, anchor tenancies, and other
commercial transactions on EA.com's sites. We paid AOL $11 million upon
signing and will pay them four annual installments of $5 million.
We also made a commitment to spend $15 million in offline media advertisements
promoting EA.com's online games, including those on the AOL service, during the
term of the agreement.
Tracking Stock Proposal
The stockholders of Electronic Arts are scheduled to vote on 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 EA.com. At the time of authorization of the Tracking
Stock, Electronic Arts' existing common stock will be re-classified as Class A
common stock ("Class A Stock") and that stock will be intended to reflect the
performance of Electronic Arts' core business ("EA") including a "Retained
Interest" in EA.com.
Upon authorization of the Tracking Stock, Electronic Arts will sell shares to
AOL representing 10% of the equity value of EA.com and issue shares representing
5% of the equity of EA.com in exchange for 103,227 shares of Electronic Arts
Class A common stock issued in conjunction witht the purchase of Kesmai to News
America Incorporated. The Company will also issue a warrant to AOL which
represents 5 percent of the initial equity attributable to EA.com
19
<PAGE>
YEAR 2000 DISCLOSURE
As of the date of this filing, we have not incurred any significant business
disruptions as a result of Year 2000 issues. However, while no such occurrence
has developed, Year 2000 issues that may arise related to key suppliers and
service providers may not become apparent immediately. We have received
assurances of Year 2000 compliance from key suppliers. We have also received
assurances from key service providers such as financial institutions, our
payroll service provider, and our retirement plan administrator as to their Year
2000 readiness. We will continue to monitor our own systems and our business
partners to identify and address any potential risk situations related to the
Year 2000. We can provide no assurance that we will not be adversely affected by
these suppliers and service providers due to noncompliance in the future.
Euro Conversion
On January 1, 1999, eleven of the fifteen member countries of the European Union
established fixed conversion rates between their existing currencies (the
"legacy currency") and the one common legal currency known as the "Euro". From
January 1, 1999 through June 30, 2002 the countries will be able to use their
legacy currencies or the Euro to transact business. By July 1, 2002, at the
latest, the conversion to the Euro will be complete at which time the legacy
currencies will no longer be legal tender. The fixed conversion rates between
their existing currencies have eliminated exchange rate risk between the member
countries.
The conversion to the Euro has reduced the number of forward contracts that we
use to hedge the exchange rate risk. The forward contracts that were used to
hedge the individual legacy currencies have been replaced by a single Euro hedge
contract and the intercompany transactions among subsidiaries within the
European Union are no longer subject to exchange rate risk.
We do not anticipate any material impact from the Euro conversion on our
financial information systems which currently accommodate multiple currencies.
Due to numerous uncertainties, we cannot reasonably estimate the effect that the
Euro conversion issue will have on our pricing or market strategies, and the
impact, if any, it will have on our financial condition and results of
operations.
20
<PAGE>
Risk Factors
Electronic Arts' business is subject to many risks and uncertainties which may
affect our future financial performance. Some of those important risks and
uncertainties which may cause our operating results to vary or which may
materially and adversely affect our operating results are as follows:
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 computer, 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, SimCity 3000, the follow on
product to SimCity 2000, was expected to ship in fiscal 1998, at the time of our
acquisition of Maxis. Due to additional development delays, that product did not
ship until the fourth quarter of fiscal year 1999. Also, Tiberian Sun, which was
expected to ship in fiscal 1999 at the time of our acquisition of Westwood
Studios, was not released until the second quarter of fiscal 2000 due to
development delays. Additionally, development risks for CD-ROM products can
cause particular difficulties in predicting quarterly results because brief
manufacturing lead times allow finalizing products and projected release dates
late in a quarter. Our revenues and earnings are dependent on our ability to
meet our product release schedules, and our failure to meet those schedules
could result in revenues and earnings which fall short of analysts' expectations
for any individual quarter and the fiscal year.
New Video Game Platforms Create Additional Technical and Business Model
Uncertainties
A large portion of our revenues are derived from the sale of products
for play on proprietary video game platforms such as the Sony PlayStation and
Nintendo 64. 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 PlayStation platform, the
PlayStation II, expected to be released in the United States in the fall of
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, and we do not know whether the
terms of those agreements will be favorable.
Our Business Is Both Seasonal and Cyclical
Our business is seasonal with a significant percentage of our revenues
occurring in the December quarter. Our business is also cyclical; videogame
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 if its cycle and new platforms are emerging, buying patterns
may change.
21
<PAGE>
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 platforms in the United States in September 1999, and Sony
expects to ship its PlayStation II product in the fall of 2000. Nintendo has
also announced that a new system will be released in calendar year 2000. We
expect sales of our products for the current Nintendo and Sony platforms to slow
in anticipation of those new platforms, and to slow significantly upon market
release of those new platforms.
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 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.
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.
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, including EA.com. 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.
22
<PAGE>
Proliferation and Assertion of Patents Poses Serious Risks to Our Online
Business.
Many patents have been issued that may apply to widely used Internet
technologies. Additionally, many less 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 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.
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 experiencing. 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 the 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.
Foreign Sales and Currency Fluctuations
For fiscal 1999 and the nine months of fiscal 2000, international net
revenues comprised 42% and 38% respectively 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. As a result of current
economic conditions in Asia, we are subject to additional foreign currency risk.
Though we do not currently derive a significant portion of revenues and
operating profits from sales in Asia and other developing countries, our foreign
currency exposure may increase as operations in these countries grow and if
current economic trends in Asia continue. Any of these factors may significantly
harm our business.
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 may 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,
entertainment, media or electronics industries or the securities markets in
general. For example, since the beginning of fiscal year 2000, the price per
share of our common stock ranged from $45.6250 to $120.9375.
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.
23
<PAGE>
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 December 31, 1999, we had foreign exchange contracts, all with maturities of
less than three months to purchase and sell approximately $285,575,000 in
foreign currencies, primarily British Pounds, European Currency Units ("Euro"),
Canadian Dollars, Japanese Yen and other currencies.
Fair value represents the difference in value of the contracts at the spot rate
and the forward rate, plus the unamortized premium or discount. 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.
<TABLE>
The table below provides information about our foreign currency forward exchange
contracts at December 31, 1999. 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. All
contracts mature within three months.
<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 $115,158 1.6151 $ (27)
Euro 77,580 1.0141 246
Canadian Dollar 20,424 1.4689 (9)
Japanese Yen 11,650 105.3600 (272)
Swiss Franc 1,902 1.5777 8
Australian Dollar 6,711 .6391 (41)
Brazilian Real 1,891 1.8510 (21)
South African Rand 5,018 9.9795 (24)
Sweden Krona 3,997 13.7420 (26)
Denmark Krone 2,991 11.8810 (4)
Norway Krone 2,501 12.9198 5
- ------------------------------------------------------------------------------------------------------------------------------------
Total $249,823 $ (165)
- ------------------------------------------------------------------------------------------------------------------------------------
Foreign currency to be purchased under contract:
British Pound $ 35,752 1.6155 $ (34)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 35,752 $ (34)
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Grand total $285,575 $ (199)
====================================================================================================================================
</TABLE>
24
<PAGE>
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 December 31, 1999,
our cash equivalents, short-term and long-term investments included debt
securities of $186,612,000. Notwithstanding our efforts to manage interest rate
risks, there can be no assurances that we will be adequately protected against
the risks associated with interest rate fluctuations.
The table below presents the amounts and related weighted average interest rates
of our investment portfolio at December 31, 1999:
Average
Interest Rate Cost Fair Value
- --------------------------------------------------------------------------------
(Dollars in thousands)
Cash equivalents
Fixed rate 0.00% $ -- $ --
Variable rate 4.60% $78,454 $78,454
Short-term investments
Fixed rate 3.96% $83,820 $83,958
Variable rate 6.27% $ 5,800 $ 5,799
Long-term investments
Fixed rate 0.00% $ -- $ --
Variable rate 6.34% $18,400 $18,179
- --------------------------------------------------------------------------------
Maturity dates for short-term investments range from 6 months to 3 years.
25
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to pending claims. Management, after review and
consultation with counsel, considers that any liability from the
disposition of such lawsuits in the aggregate would not have a material
adverse effect upon the consolidated financial position or results of
operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
none
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
26
<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
February 14, 2000 Executive Vice President and
Chief Financial and Administrative Officer
27
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<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 247,170
<SECURITIES> 1,447
<RECEIVABLES> 461,220
<ALLOWANCES> 83,300
<INVENTORY> 22,838
<CURRENT-ASSETS> 764,141
<PP&E> 356,318
<DEPRECIATION> 112,523
<TOTAL-ASSETS> 1,180,769
<CURRENT-LIABILITIES> 312,384
<BONDS> 0
0
0
<COMMON> 639
<OTHER-SE> 864,694
<TOTAL-LIABILITY-AND-EQUITY> 1,180,769
<SALES> 1,125,698
<TOTAL-REVENUES> 1,125,698
<CGS> 562,821
<TOTAL-COSTS> 562,821
<OTHER-EXPENSES> 410,493
<LOSS-PROVISION> 6,427
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 164,037
<INCOME-TAX> 50,852
<INCOME-CONTINUING> 113,185
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 113,319
<EPS-BASIC> 1.82
<EPS-DILUTED> 1.72
</TABLE>
