UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2002September 30, 2003
OR
[] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ______ to______to_____
Commission File No. 0-17948
ELECTRONIC ARTS INC.
Delaware (State or other jurisdiction of incorporation or organization) | 94-2838567 (I.R.S. Employer Identification No.) |
209 Redwood Shores Parkway Redwood City, California (Address of principal executive offices) | 94065 (Zip Code) |
(650) 628-1500
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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). 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 | Par Value | February 5, 2003 | ||||||
Class A common stock | $0.01 | 143,112,344 |
Outstanding at | ||||||||
Class of Common Stock | Par Value | November 03, 2003 | ||||||
Class A common stock | $ | 0.01 | 148,934,841 |
ELECTRONIC ARTS INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2003
INDEX
Page | ||||||||
Part I — FINANCIAL INFORMATION | ||||||||
Item 1. | Unaudited Condensed Consolidated Financial Statements | |||||||
Condensed Consolidated Balance Sheets September 30, 2003 and March 31, | 3 | |||||||
Condensed Consolidated Statements of Operations for the Three Months Ended the | 4 | |||||||
Condensed Consolidated Statements of Cash Flows for the | 5 | |||||||
Notes to Condensed Consolidated Financial Statements | ||||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | |||||||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | |||||||
Item 4. | Controls and Procedures | |||||||
Part II — | ||||||||
Item 1. | Legal Proceedings | |||||||
Item 4. | Submission of Matters to a Vote of Security Holders | |||||||
Item 6. | Exhibits and Reports on Form 8-K | |||||||
Signatures | ||||||||
Exhibit Index |
2
PART I — FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES(Dollars in thousands)(unaudited) December 31, March 31, 2002 2002 ASSETS Current assets: Cash, cash equivalents and short-term investments $ 1,165,326 $ 796,936 Marketable securities 1,341 6,869 Receivables, less allowances of $206,651 and $115,870, respectively 609,029 190,495 Inventories, net 33,216 23,780 Deferred income taxes 37,732 38,597 Other current assets 82,639 95,866 Total current assets 1,929,283 1,152,543 Property and equipment, net 302,231 308,827 Investments in affiliates 10,231 19,077 Goodwill and other intangibles, net 119,406 110,512 Long-term deferred income taxes 55,628 64,065 Other assets 44,246 44,350 $ 2,461,025 $ 1,699,374 LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 146,816 $ 88,563 Accrued and other liabilities 599,784 364,419 Total current liabilities 746,600 452,982 Minority interest in consolidated joint venture 2,876 3,098 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 142,944,370 and 138,429,269 shares, respectively 1,429 1,384 Class B common stock, $0.01 par value. Authorized 100,000,000 shares; issued and outstanding 4,233,463 and 6,233,413 shares, respectively 42 62 Paid-in capital 796,950 649,777 Retained earnings 914,652 606,795 Accumulated other comprehensive loss (1,524 ) (14,724 ) Total stockholders’ equity 1,711,549 1,243,294 $ 2,461,025 $ 1,699,374 (unaudited) September 30, March 31, (In thousands, except share data) 2003 2003 (a) Current assets: Cash and cash equivalents $ 376,125 $ 949,995 Short-term investments 1,358,049 637,623 Marketable equity securities 771 1,111 Receivables, net of allowances of $126,806 and $164,634, respectively 202,802 82,083 Inventories, net 39,209 39,679 Deferred income taxes 117,682 117,180 Other current assets 98,405 83,466 Total current assets 2,193,043 1,911,137 Property and equipment, net 273,305 262,252 Investments in affiliates 12,909 20,277 Goodwill 88,650 86,031 Other intangibles, net 19,784 21,301 Long-term deferred income taxes 13,840 13,523 Other assets 15,503 45,012 $ 2,617,034 $ 2,359,533 Current liabilities: Accounts payable $ 129,348 $ 106,329 Accrued and other liabilities 416,251 464,547 Total current liabilities 545,599 570,876 Commitments and contingencies — — Minority interest in consolidated joint venture — 3,918 Stockholders’ equity: Preferred stock, $0.01 par value. 10,000,000 shares authorized — — Common stock Class A common stock, $0.01 par value. 400,000,000 shares authorized;
296,959,700 and 288,266,610 shares issued and outstanding, respectively 2,970 2,883 Class B common stock, $0.01 par value. 100,000,000 shares authorized;
200,130 and 225,130 shares issued and outstanding, respectively 2 2 Paid-in capital 1,036,717 856,428 Retained earnings 1,018,848 923,892 Accumulated other comprehensive income 12,898 1,534 Total stockholders’ equity 2,071,435 1,784,739 $ 2,617,034 $ 2,359,533
See accompanying Notes to Condensed Consolidated Financial Statements.
(a) | Derived from audited financial statements. |
3
ELECTRONIC ARTS INC. AND SUBSIDIARIES(In thousands, except per share data)(unaudited) Three Months Ended Nine Months Ended December 31, December 31, 2002 2001 2002 2001 Net revenues $ 1,233,726 $ 832,878 $ 2,019,114 $ 1,254,984 Cost of goods sold 558,680 400,853 898,936 607,642 Gross profit 675,046 432,025 1,120,178 647,342 Operating expenses: Marketing and sales 139,492 93,875 260,380 179,699 General and administrative 42,250 31,833 95,366 80,451 Research and development 112,558 97,406 301,667 285,766 Amortization of intangibles 2,245 6,359 6,736 19,309 Restructuring and asset impairment charges 9,378 14,051 9,378 14,051 Total operating expenses 305,923 243,524 673,527 579,276 Operating income 369,123 188,501 446,651 68,066 Interest and other income (expense), net (4,439 ) 3,515 (115 ) 10,292 Income before provision for income taxes and minority interest 364,684 192,016 446,536 78,358 Provision for income taxes 113,052 59,525 138,426 24,291 Income before minority interest 251,632 132,491 308,110 54,067 Minority interest in consolidated joint venture (1,413 ) (199 ) (253 ) 147 Net income $ 250,219 $ 132,292 $ 307,857 $ 54,214 Class A common stock: Net income: Basic $ 253,694 $ 138,998 $ 317,495 $ 72,387 Diluted $ 250,219 $ 132,292 $ 307,857 $ 54,214 Net income per share: Basic $ 1.79 $ 1.01 $ 2.26 $ 0.53 Diluted $ 1.69 $ 0.92 $ 2.10 $ 0.38 Number of shares used in computation: Basic 141,889 137,103 140,193 136,457 Diluted 148,025 143,399 146,860 142,847 Class B common stock: Net loss, net of retained interest in EA.com $ (3,475 ) $ (6,706 ) $ (9,638 ) $ (18,173 ) Net loss per share: Basic $ (0.86 ) $ (1.11 ) $ (1.84 ) $ (3.02 ) Diluted $ (0.86 ) $ (1.11 ) $ (1.84 ) $ (3.02 ) Number of shares used in computation: Basic 4,051 6,028 5,247 6,023 Diluted 4,051 6,028 5,247 6,023 Three Months Ended Six Months Ended (unaudited) September 30, September 30, (In thousands, except per share data) 2003 2002 2003 2002 Net revenue $ 530,005 $ 453,490 $ 883,386 $ 785,388 Cost of goods sold 213,762 200,867 363,725 343,321 Gross profit 316,243 252,623 519,661 442,067 Operating expenses: Marketing and sales 64,041 55,514 123,125 120,888 General and administrative 36,032 27,453 66,792 53,116 Research and development 113,493 96,164 204,615 186,044 Amortization of intangibles 810 2,246 1,490 4,491 Total operating expenses 214,376 181,377 396,022 364,539 Operating income 101,867 71,246 123,639 77,528 Interest and other income, net 9,130 1,177 13,979 4,324 Income before provision for income taxes and minority interest 110,997 72,423 137,618 81,852 Provision for income taxes 34,409 22,451 42,662 25,374 Income before minority interest 76,588 49,972 94,956 56,478 Minority interest in consolidated joint venture — 262 — 1,160 Net income $ 76,588 $ 50,234 $ 94,956 $ 57,638 Net earnings (loss) per share: Class A common stock: Net income: Basic $ 76,588 $ 53,407 $ 94,956 $ 63,801 Diluted $ 76,588 $ 50,234 $ 94,956 $ 57,638 Net earnings per share: Basic $ 0.26 $ 0.19 $ 0.32 $ 0.23 Diluted $ 0.25 $ 0.17 $ 0.31 $ 0.20 Number of shares used in computation: Basic 294,836 279,686 292,263 278,633 Diluted 307,779 293,237 304,013 292,538 Class B common stock: Net loss, net of retained interest in EA.com N/A $ (3,173 ) N/A $ (6,163 ) Net loss per share: Basic N/A $ (0.57 ) N/A $ (1.07 ) Diluted N/A $ (0.57 ) N/A $ (1.07 ) Number of shares used in computation: Basic N/A 5,547 N/A 5,759 Diluted N/A 5,547 N/A 5,759
See accompanying Notes to Condensed Consolidated Financial Statements.
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Dollars in thousands)(unaudited)
Nine Months | ||||||||||||
Ended December 31, | ||||||||||||
2002 | 2001 | |||||||||||
Operating activities: | ||||||||||||
Net income | $ | 307,857 | $ | 54,214 | ||||||||
Adjustments to reconcile net income to net cash | ||||||||||||
provided by (used in) operating activities: | ||||||||||||
Minority interest in consolidated joint venture | 253 | (147 | ) | |||||||||
Equity in net income of affiliates | (4,213 | ) | (2,134 | ) | ||||||||
Gain on sale of affiliate | — | (200 | ) | |||||||||
Depreciation and amortization | 74,329 | 83,551 | ||||||||||
Non-cash restructuring and asset impairment charges | 1,352 | 6,503 | ||||||||||
Permanent impairment of investments in affiliates | 10,590 | — | ||||||||||
Loss on sale of fixed assets | 106 | 372 | ||||||||||
Loss on marketable securities | 273 | — | ||||||||||
Bad debt expense | 7,804 | 7,142 | ||||||||||
Stock-based compensation | 864 | 2,263 | ||||||||||
Tax benefit from exercise of stock options | 36,765 | 16,789 | ||||||||||
Change in assets and liabilities: | ||||||||||||
Receivables | (424,567 | ) | (296,077 | ) | ||||||||
Inventories | (9,436 | ) | (9,232 | ) | ||||||||
Other assets | (13,999 | ) | (46,892 | ) | ||||||||
Accounts payable | 58,222 | 80,638 | ||||||||||
Accrued and other liabilities | 229,392 | 95,364 | ||||||||||
Deferred income taxes | 7,918 | (497 | ) | |||||||||
Net cash provided by (used in) operating activities | 283,510 | (8,343 | ) | |||||||||
Investing activities: | ||||||||||||
Proceeds from sale of property and equipment | 679 | 258 | ||||||||||
Proceeds from sale of affiliate | — | 570 | ||||||||||
Proceeds from sale of marketable securities | 4,794 | — | ||||||||||
Capital expenditures | (34,470 | ) | (40,056 | ) | ||||||||
Investment in affiliates, net | (531 | ) | 2,918 | |||||||||
Sales/purchases of short-term investments, net | (151,630 | ) | (64,624 | ) | ||||||||
Distribution from investment in affiliate | 3,000 | — | ||||||||||
Proceeds from minority interest investment | (751 | ) | — | |||||||||
Acquisition, net of cash acquired | (12,868 | ) | — | |||||||||
Net cash used in investing activities | (191,777 | ) | (100,934 | ) | ||||||||
Financing activities: | ||||||||||||
Proceeds from sales of Class A shares through employee stock plans and other plans | 109,876 | 73,556 | ||||||||||
Proceeds from sales of Class B shares through employee stock plans and other plans | 1 | — | ||||||||||
Purchase of treasury shares | — | (11,922 | ) | |||||||||
Net cash provided by financing activities | 109,877 | 61,634 | ||||||||||
Translation adjustment | 11,632 | 2,369 | ||||||||||
Increase (decrease) in cash and cash equivalents | 213,242 | (45,274 | ) | |||||||||
Beginning cash and cash equivalents | 552,826 | 419,812 | ||||||||||
Ending cash and cash equivalents | 766,068 | 374,538 | ||||||||||
Short-term investments | 399,258 | 112,304 | ||||||||||
Ending cash, cash equivalents and short-term investments | $ | 1,165,326 | $ | 486,842 | ||||||||
5
ELECTRONIC ARTS INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)(Dollars in thousands)(unaudited)
Nine Months | |||||||||
Ended December 31, | |||||||||
2002 | 2001 | ||||||||
Supplemental cash flow information: | |||||||||
Cash paid during the period for income taxes | $ | 5,358 | $ | 7,582 | |||||
Non-cash investing activities: | |||||||||
Change in unrealized appreciation (loss) on investments and marketable securities | $ | 3,075 | $ | (1,443 | ) | ||||
Non-cash financing activities: | |||||||||
Conversion of 2,000,000 shares of Class B common stock for 206,454 shares of Class A common stock | $ | 9,353 | $ | — | |||||
Six Months Ended | ||||||||
(unaudited) | September 30, | |||||||
(In thousands) | 2003 | 2002 | ||||||
OPERATING ACTIVITIES | ||||||||
Net income | $ | 94,956 | $ | 57,638 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Minority interest in consolidated joint venture | — | (1,160 | ) | |||||
Depreciation and amortization | 30,847 | 49,373 | ||||||
Equity in net income of affiliates | (113 | ) | (1,313 | ) | ||||
Other-than-temporary impairment of assets | 589 | 2,830 | ||||||
Loss on sale of property, equipment and marketable equity securities | 45 | 115 | ||||||
Stock-based compensation | 429 | 2,161 | ||||||
Tax benefit from exercise of stock options | 40,169 | 16,866 | ||||||
Change in assets and liabilities: | ||||||||
Accounts receivable, net | (133,034 | ) | 52,900 | |||||
Inventories, net | (406 | ) | (38,586 | ) | ||||
Other assets | 13,167 | (59,870 | ) | |||||
Accounts payable | 25,309 | 31,726 | ||||||
Accrued and other liabilities | (43,711 | ) | (27,111 | ) | ||||
Net cash provided by operating activities | 28,247 | 85,569 | ||||||
INVESTING ACTIVITIES | ||||||||
Proceeds from sale of property and equipment | 88 | 411 | ||||||
Proceeds from sale of investments in affiliate | 8,467 | — | ||||||
Capital expenditures | (28,690 | ) | (23,386 | ) | ||||
Purchase of investments in affiliates | — | (405 | ) | |||||
Purchase of short-term investments | (1,270,579 | ) | (264,480 | ) | ||||
Proceeds from maturities and sales of short-term investments | 547,792 | 218,268 | ||||||
Distribution from investment in affiliate | — | 3,000 | ||||||
Acquisition of subsidiary, net of cash acquired | — | (12,868 | ) | |||||
Net cash used in investing activities | (742,922 | ) | (79,460 | ) | ||||
FINANCING ACTIVITIES | ||||||||
Proceeds from sales of common stock through employee stock plans and other plans | 139,875 | 61,282 | ||||||
Repurchase of Class B common stock | (225 | ) | — | |||||
Dividend to joint venture and purchase of minority interest | (5,100 | ) | (751 | ) | ||||
Repayment of Class B notes receivable | 128 | — | ||||||
Net cash provided by financing activities | 134,678 | 60,531 | ||||||
Effect of foreign exchange on cash and cash equivalents | 6,127 | 8,005 | ||||||
Increase (decrease) in cash and cash equivalents | (573,870 | ) | 74,645 | |||||
Beginning cash and cash equivalents | 949,995 | 552,826 | ||||||
Ending cash and cash equivalents | 376,125 | 627,471 | ||||||
Short-term investments | 1,358,049 | 293,297 | ||||||
Ending cash, cash equivalents and short-term investments | $ | 1,734,174 | $ | 920,768 | ||||
Supplemental cash flow information: | ||||||||
Cash paid during the period for income taxes | $ | 4,567 | $ | 4,052 | ||||
Non-cash investing activities: | ||||||||
Change in unrealized appreciation (loss) on investments and marketable equity securities | $ | (2,186 | ) | $ | 2,635 | |||
Non-cash financing activities: | ||||||||
Conversion of 2,000,000 shares of Class B common stock for 412,908 shares of Class A common stock | $ | — | $ | 9,353 | ||||
See accompanying Notes to Condensed Consolidated Financial Statements.
65
ELECTRONIC ARTS INC. AND SUBSIDIARIES
Note 1. Basis of Presentation(1) BASIS OF PRESENTATION
The condensed consolidated financial statementsCondensed 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 periods presented. The results of operations for the current interim periodperiods are not necessarily indicative of results to be expected for the current year or any other period. Certain prior year amounts have been reclassified to conform to the fiscal 20032004 presentation.
These condensed consolidated financial statementsCondensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statementsConsolidated Financial Statements and notesNotes thereto included in the Electronic Arts Inc. (the “Company”(“EA”) Annual Report on Form 10-K for the fiscal year ended March 31, 20022003 as filed with the Securities and Exchange Commission on June 28, 2002.10, 2003.
Note 2. Fiscal YearOn October 20, 2003 EA’s Board of Directors authorized a two-for-one stock split of its Class A common stock which will be distributed on or about November 17, 2003 in the form of a stock dividend for shareholders of record at the close of business on November 3, 2003. All issued and Fiscal Quarteroutstanding share and per share amounts related to EA’s Class A common stock in the accompanying Condensed Consolidated Financial Statements and Notes thereto have been restated to reflect the stock split for all periods presented.
The Company’s(2) FISCAL YEAR AND FISCAL QUARTER
EA’s fiscal year is reported on a 52/53-week period that ends on the final Saturday nearest toof March 31 in each year. The results of operations for fiscal 20032004 and fiscal 20022003 contain 52 weeks. The results of operations for the fiscal quarters ended December 31,September 30, 2003 and September 30, 2002 and 2001each contain 13 weeks.weeks ending on September 27, 2003 and September 28, 2002, respectively. For simplicity of presentation, all fiscal periods are treated as ending on a calendar month end.
(3) STOCK
Tracking Stock
On March 22, 2000, the stockholders of EA authorized the issuance of a new series of common stock, designated as Class B common stock (“Tracking Stock”). The Tracking Stock was intended to reflect the performance of the EA.com business segment. As a result of the approval of the Tracking Stock Proposal, EA’s existing common stock was re-classified as Class A common stock and was intended to reflect the performance of the EA core business segment (see discussion in Note 3. Common 8 of the Notes to Condensed Consolidated Financial Statements). With the authorization of the Class B common stock, EA transferred a portion of its consolidated assets, liabilities, revenue, expenses and cash flows to EA.com Inc., a wholly owned subsidiary of EA.
In March 2003, EA consolidated the operations of the EA.com business segment into EA’s core operations in order to increase efficiency, simplify EA’s reporting structure and more directly integrate EA’s online activities into its core console and PC business. As a result, EA has eliminated dual class reporting starting in fiscal 2004. The majority of outstanding Class B options and warrants not directly held by EA have been acquired or converted to Class A shares and warrants.
EA does not intend to issue additional Class B common stock, stock options or warrants to purchase Class B common stock. No further options are available for grant under EA’s Class B Equity Incentive Plan, and EA is currently in the process of repurchasing the remaining outstanding Class B shares acquired pursuant to the Class B Equity Incentive Plan.
6
Stock Based Compensation
EA accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (“APB”) No. 25,“Accounting for Stock Issued to Employees”and related interpretations. EA has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation”.
In fiscal 2003, EA adopted the disclosure provisions of SFAS No. 148,“Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123”,which provides alternative methods of transition for a voluntary change to the fair-value-based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the methods used on reported results.
Had compensation cost for EA’s stock option plans and employee stock purchase plans been determined based on the estimated fair value at the grant dates in accordance with the provisions of SFAS No. 123, EA’s reported net income and net earnings per share would have been the amounts indicated below. The estimated fair value of each option grant is determined on the date of grant using the Black-Scholes option-pricing model.
The following weighted-average assumptions are used for grants made under the stock plans:
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
Risk-free interest rate | 2.24 | % | 2.27 | % | 2.11 | % | 2.88 | % | ||||||||
Expected volatility | 54 | % | 71 | % | 55 | % | 71 | % | ||||||||
Expected life (in years) | 2.64 | 2.26 | 2.64 | 2.26 | ||||||||||||
Assumed dividends | None | None | None | None |
EA’s calculations are based on a multiple option valuation approach and forfeitures are recognized when they occur.
Three Months Ended | Six Months Ended | |||||||||||||||
Consolidated | September 30, | September 30, | ||||||||||||||
(In thousands) | 2003 | 2002 | 2003 | 2002 | ||||||||||||
Net income: | ||||||||||||||||
As reported | $ | 76,588 | $ | 50,234 | $ | 94,956 | $ | 57,638 | ||||||||
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects | (23,750 | ) | (20,689 | ) | (43,923 | ) | (37,468 | ) | ||||||||
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects | 25 | — | 74 | — | ||||||||||||
Pro forma | $ | 52,863 | $ | 29,545 | $ | 51,107 | $ | 20,170 | ||||||||
Earnings per share: | ||||||||||||||||
Please see Class A common stock table below for earnings per share information |
7
Three Months Ended | Six Months Ended | |||||||||||||||
Class A common stock | September 30, | September 30, | ||||||||||||||
(In thousands, except per share data) | 2003 | 2002 | 2003 | 2002 | ||||||||||||
Net income: | ||||||||||||||||
As reported- basic | $ | 76,588 | $ | 53,407 | $ | 94,956 | $ | 63,801 | ||||||||
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects | (23,750 | ) | (20,950 | ) | (43,923 | ) | (37,729 | ) | ||||||||
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects | 25 | — | 74 | — | ||||||||||||
Pro forma — basic | $ | 52,863 | $ | 32,457 | $ | 51,107 | $ | 26,072 | ||||||||
As reported — diluted | $ | 76,588 | $ | 50,234 | $ | 94,956 | $ | 57,638 | ||||||||
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects | (23,750 | ) | (21,023 | ) | (43,923 | ) | (37,802 | ) | ||||||||
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects | 25 | — | 74 | — | ||||||||||||
Pro forma — diluted | $ | 52,863 | $ | 29,211 | $ | 51,107 | $ | 19,836 | ||||||||
Earnings (loss) per share: | ||||||||||||||||
As reported — basic | $ | 0.26 | $ | 0.19 | $ | 0.32 | $ | 0.23 | ||||||||
Pro forma — basic | 0.18 | 0.12 | 0.17 | 0.09 | ||||||||||||
As reported — diluted | 0.25 | 0.17 | 0.31 | 0.20 | ||||||||||||
Pro forma — diluted | 0.17 | 0.10 | 0.17 | 0.07 |
During the three and six month periods ended September 30, 2003 and 2002, compensation cost for EA’s Class B stock option plans, based on the estimated fair value at the grant dates in accordance with the provisions of SFAS No. 123, would not have had a material impact on EA’s reported net income and net earnings per share.
At the Company’sEA’s Annual Meeting of Stockholders, held on August 1, 2002,July 31, 2003, the stockholders elected (i) to amend the 2000 Class A Equity Incentive Plan to increase by 5,500,00011,000,000 the number of shares of EA’s Class A common stock reserved for issuance under the Company’sPlan and (ii) to amend the 2000 Employee Stock Purchase Plan to increase by 300,000 the number of shares of EA’s Class A common stock reserved for issuance under the Plan.
Note 4. Goodwill and Other Intangible Assets
Effective April 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141,“Business Combinations”, which requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and acquired intangible assets meeting certain criteria to be recorded apart from goodwill. The Company evaluated its goodwill and intangibles acquired prior to June 30, 2001 using the criteria of SFAS No. 141, which resulted in $41,462,000 of other intangibles to be recorded separately from goodwill and $4,000,000 of acquired workforce intangibles being subsumed into goodwill at April 1, 2002. In addition, effective April 1, 2002, the Company adopted the provisions of SFAS No. 142,“Goodwill and Other Intangible Assets”. SFAS No. 142 requires that purchased goodwill and certain indefinite-lived intangibles no longer be amortized; rather, goodwill will be subject to at least an annual assessment for impairment by applying a fair-value-based test. SFAS No. 142 also requires, among other things, reassessment
78
ELECTRONIC ARTS INC.(4) GOODWILL AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
of the useful lives of existing recognized intangibles and the testing for impairment of existing goodwill and other indefinite-lived intangibles. The Company evaluated the estimated useful lives of existing recognized intangibles and determined that the estimated useful lives of all such assets were appropriate.
In accordance with SFAS No. 142, the Company has ceased to amortize goodwill (see goodwill information in table below). In lieu of amortization, SFAS No. 142 requires a two-step approach to testing goodwill for impairment for each reporting unit. The first step, required to be completed by September 30, 2002, tests for impairment by applying fair value-based tests at the Company’s reporting unit level. The second step (if necessary), required to be completed by March 31, 2003, measures the amount of impairment by applying fair value-based tests to individual assets and liabilities within each reporting unit. The Company completed the first step of transitional goodwill impairment testing during the quarter ended June 30, 2002 and found no indicators of impairment of its recorded goodwill. As a result, the Company has recognized no transitional impairment loss in fiscal 2003 in connection with the adoption of SFAS No. 142. The Company will complete its annual impairment test in the fourth quarter of fiscal 2003 with a measurement date of January 1 and any impairment that arises from that analysis will be accounted for in the fourth quarter of fiscal 2003. There can be no assurance that future impairment tests will not result in a charge to earnings and there is a potential for a write down of goodwill in connection with the annual impairment test.
The following table presents comparative information showing the effects that non-amortization of goodwill would have had on the Condensed Consolidated Statements of Operations for the prior three and nine months ended December 31, 2001 (in thousands, except per share amounts):
Three Months Ended | Nine Months Ended | ||||||||||||||||
December 31, | December 31, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
Reported net income | $ | 250,219 | $ | 132,292 | $ | 307,857 | $ | 54,214 | |||||||||
Goodwill amortization, net of tax | — | 1,995 | — | 6,039 | |||||||||||||
Adjusted net income | $ | 250,219 | $ | 134,287 | $ | 307,857 | $ | 60,253 | |||||||||
Reported diluted net earnings per share | $ | 1.69 | $ | 0.92 | $ | 2.10 | $ | 0.38 | |||||||||
Goodwill amortization, net of tax | — | 0.02 | — | 0.04 | |||||||||||||
Adjusted diluted net earnings per share | $ | 1.69 | $ | 0.94 | $ | 2.10 | $ | 0.42 | |||||||||
During the prior quartersix months ended September 30, 2002, the Company2003, EA recorded an additional $16,139,000$1.2 million of goodwill as a result of anEA’s acquisition of a software development company. The Company operatesSquare Co., Ltd.’s (“Square”) 30 percent interest in two business segments, EA Core and EA.com (seeElectronic Arts Square K.K. in May 2003. See Note 813 of the Notes to Condensed Consolidated Financial Statements).Statements for further discussion on the Square joint venture termination. Goodwill information for each business segment is as follows (in thousands):
Effects of | ||||||||||||||||
Goodwill as | Foreign | Goodwill as of | ||||||||||||||
of March 31, | Goodwill | Currency | September 30, | |||||||||||||
2003 | Acquired | Translation | 2003 | |||||||||||||
Goodwill | $ | 86,031 | $ | 1,182 | $ | 1,437 | $ | 88,650 | ||||||||
8
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
As of | Effects of Foreign | As of | ||||||||||||||||||
March 31, 2002 | Goodwill Acquired | Adjustments | Currency | December 31, 2002 | ||||||||||||||||
EA Core | $ | 39,335 | $ | 16,139 | $ | — | $ | (200 | ) | $ | 55,274 | |||||||||
EA.com | 29,715 | — | — | — | 29,715 | |||||||||||||||
$ | 69,050 | $ | 16,139 | $ | — | $ | (200 | ) | $ | 84,989 | ||||||||||
Other intangibles consisted of the following (in thousands):
December 31, 2002 | March 31, 2002 | |||||||||||||||||||||||||||||||
Gross | Other | Gross | Other | |||||||||||||||||||||||||||||
Carrying | Accumulated | Intangibles, | Carrying | Accumulated | Intangibles, | |||||||||||||||||||||||||||
Amount | Amortization | Other | Net | Amount | Amortization | Other | Net | |||||||||||||||||||||||||
Developed/Core Technology | $ | 28,263 | $ | (18,795 | ) | $ | — | $ | 9,468 | $ | 28,263 | $ | (15,455 | ) | $ | — | $ | 12,808 | ||||||||||||||
Tradename | 35,169 | (12,107 | ) | — | 23,062 | 35,169 | (9,854 | ) | — | 25,315 | ||||||||||||||||||||||
Subscribers and Other Intangibles | 8,694 | (6,299 | ) | (508 | ) | 1,887 | 8,694 | (5,156 | ) | (199 | ) | 3,339 | ||||||||||||||||||||
Other Intangibles | $ | 72,126 | $ | (37,201 | ) | $ | (508 | ) | $ | 34,417 | $ | 72,126 | $ | (30,465 | ) | $ | (199 | ) | $ | 41,462 | ||||||||||||
September 30, 2003 | ||||||||||||||||||||
Gross | Other | |||||||||||||||||||
Carrying | Accumulated | Intangibles, | ||||||||||||||||||
Amount | Amortization | Impairment | Other | Net | ||||||||||||||||
Developed/Core Technology | $ | 28,263 | $ | (18,886 | ) | $ | (9,377 | ) | $ | — | $ | — | ||||||||
Tradename | 35,169 | (14,249 | ) | (1,211 | ) | — | 19,709 | |||||||||||||
Subscribers and Other Intangibles | 8,694 | (6,302 | ) | (1,776 | ) | (541 | ) | 75 | ||||||||||||
Total | $ | 72,126 | $ | (39,437 | ) | $ | (12,364 | ) | $ | (541 | ) | $ | 19,784 | |||||||
March 31, 2003 | ||||||||||||||||||||
Gross | Other | |||||||||||||||||||
Carrying | Accumulated | Intangibles, | ||||||||||||||||||
Amount | Amortization | Impairment | Other | Net | ||||||||||||||||
Developed/Core Technology | $ | 28,263 | $ | (18,886 | ) | $ | (9,377 | ) | $ | — | $ | — | ||||||||
Tradename | 35,169 | (12,763 | ) | (1,211 | ) | — | 21,195 | |||||||||||||
Subscribers and Other Intangibles | 8,694 | (6,298 | ) | (1,776 | ) | (514 | ) | 106 | ||||||||||||
Total | $ | 72,126 | $ | (37,947 | ) | $ | (12,364 | ) | $ | (514 | ) | $ | 21,301 | |||||||
Amortization expense for the three and six months ended September 30, 2003 was $0.8 million and $1.5 million, respectively. Amortization expense for the three and six months ended September 30, 2002 was $2.2 million and $4.5 million, respectively. Other intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from two to twelve years.
As of December 31, 2002,September 30, 2003, future intangible asset amortization expense is estimated as follows (in thousands):
Fiscal Year Ended March 31, | ||||||||
2003 | $ | 1,997 | ||||||
2004 | 7,364 | |||||||
2004 (remaining six months) | $ | 1,245 | ||||||
2005 | 5,946 | 2,489 | ||||||
2006 | 5,517 | 2,489 | ||||||
2007 | 2,489 | 2,489 | ||||||
2008 | 2,489 | |||||||
Thereafter | 11,104 | 8,583 | ||||||
$ | 34,417 | $ | 19,784 | |||||
Note 5. Prepaid Royalties9
Prepaid royalties consist primarily of prepayments for manufacturing royalties, co-publishing and/or distribution affiliates and license fees paid to celebrities, professional sports organizations and other organizations for use of their trade name and content. 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 or effective 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 research and development expense any amounts that management deems unlikely to be realized through future product sales.
(5) PREPAID ROYALTIES, NET
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 otherOther current assets, was $41,487,000 and $65,484,000 at December 31, 2002 and March 31, 2002, respectively. Thethe long-term portion, of prepaid royalties, included in otherOther assets, was $2,885,000 and $1,164,000 at December 31, 2002 and March 31, 2002, respectively.is as follows (in thousands):
September 30, 2003 | March 31, 2003 | |||||||
Other current assets | $ | 33,877 | $ | 25,371 | ||||
Other assets | 5,288 | 7,382 | ||||||
Prepaid royalties, net | $ | 39,165 | $ | 32,753 | ||||
9(6) INVENTORIES, NET
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Note 6. Inventories,
Inventories net are stated at the lower of cost (first-in, first-out method) or market. Inventories, net at December 31, 2002September 30, 2003 and March 31, 20022003 consisted of (in thousands):
December 31, 2002 | March 31, 2002 | |||||||
Raw materials and work in process | $ | 2,612 | $ | 1,025 | ||||
Finished goods | 30,604 | 22,755 | ||||||
$ | 33,216 | $ | 23,780 | |||||
September 30, 2003 | March 31, 2003 | |||||||
Raw materials and work in process | $ | 3,632 | $ | 2,762 | ||||
Finished goods | 35,577 | 36,917 | ||||||
Inventories, net | $ | 39,209 | $ | 39,679 | ||||
Note 7. Accrued and Other Liabilities(7) ACCRUED AND OTHER LIABILITIES
Accrued and other liabilities at December 31, 2002September 30, 2003 and March 31, 20022003 consisted of (in thousands):
December 31, 2002 | March 31, 2002 | |||||||
Accrued income taxes | $ | 181,298 | $ | 94,444 | ||||
Accrued royalties | 158,423 | 77,590 | ||||||
Accrued expenses | 132,034 | 87,104 | ||||||
Accrued compensation and benefits | 97,933 | 87,985 | ||||||
Deferred revenue | 24,667 | 13,286 | ||||||
Warranty reserve | 5,429 | 4,010 | ||||||
$ | 599,784 | $ | 364,419 | |||||
September 30, 2003 | March 31, 2003 | |||||||
Accrued income taxes | $ | 154,573 | $ | 154,712 | ||||
Other accrued expenses | 95,632 | 111,878 | ||||||
Accrued compensation and benefits | 71,004 | 109,687 | ||||||
Accrued royalties | 85,176 | 77,681 | ||||||
Deferred revenue | 9,866 | 10,589 | ||||||
Accrued and other liabilities | $ | 416,251 | $ | 464,547 | ||||
Note 8. Segment Information(8) SEGMENT INFORMATION
SFAS No. 131,“Disclosures About Segments of An Enterprise And Related Information”, establishes standards for the reporting by public business enterprises of information about operating segments, 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 Companybusiness enterprise for making operational decisions and assessments of financial performance.
The Company’s chief operating decision makerEA’s Chief Operating Decision Maker is considered to be the Company’sEA’s Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenuesnet revenue by geographic region and by product lines for purposes of making operating decisions and assessing financial performance.
The Company operatesIn fiscal 2003, EA operated and reviewsreviewed its business in two business segments:
10
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Our viewIn March 2003, EA consolidated the operations of the EA.com business segment into its core business. EA considers online functionality to be integral to its existing and future products. Accordingly, beginning April 1, 2003, EA no longer manages its online products and services as a separate business segment, and has consolidated the reporting related to its online products and services into reporting for the overall development and publication of business segments may change due to changesits core products for all reporting periods ending after that date. EA believes that this better reflects the way in the underlying business facts and circumstances and the evolution of our reporting to ourwhich its Chief Operating Decision Maker. Please seeMaker reviews and manages the discussion regarding segmentbusiness and reflects the importance of the online products and services relative to the rest of the business. Concurrently, EA also eliminated separate reporting in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A).for its Class B common stock for all reporting periods ending after April 1, 2003.
Information about the Company’s business segments is presented belowEA’s operations in North America and foreign areas for the three and ninesix months ended December 31,September 30, 2003 and 2002 and 2001is presented below (in thousands):
Three Months Ended December 31, 2002 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 1,211,484 | $ | 22,242 | $ | 1,233,726 | |||||||
Cost of goods sold | 553,579 | 5,101 | 558,680 | ||||||||||
Gross profit | 657,905 | 17,141 | 675,046 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 124,744 | 14,748 | 139,492 | ||||||||||
General and administrative | 40,502 | 1,748 | 42,250 | ||||||||||
Research and development (b) | 84,351 | 28,207 | 112,558 | ||||||||||
Amortization of intangibles (c) | 927 | 1,318 | 2,245 | ||||||||||
Restructuring and asset impairment charges | 9,378 | — | 9,378 | ||||||||||
Total operating expenses | 259,902 | 46,021 | 305,923 | ||||||||||
Operating income (loss) | 398,003 | (28,880 | ) | 369,123 | |||||||||
Interest and other income (expense), net | (4,359 | ) | (80 | ) | (4,439 | ) | |||||||
Income (loss) before provision for income taxes and minority interest | 393,644 | (28,960 | ) | 364,684 | |||||||||
Provision for income taxes | 113,052 | — | 113,052 | ||||||||||
Income (loss) before minority interest | 280,592 | (28,960 | ) | 251,632 | |||||||||
Minority interest in consolidated joint venture | (1,413 | ) | — | (1,413 | ) | ||||||||
Net income (loss) before retained interest in EA.com | $ | 279,179 | $ | (28,960 | ) | $ | 250,219 | ||||||
Interest income | $ | 5,010 | $ | 3 | $ | 5,013 | |||||||
Depreciation and amortization | 12,365 | 12,591 | 24,956 | ||||||||||
Identifiable assets | 2,314,494 | 146,531 | 2,461,025 | ||||||||||
Capital expenditures | 10,965 | 119 | 11,084 |
Asia | ||||||||||||||||||||
Pacific | ||||||||||||||||||||
North | (excluding | |||||||||||||||||||
America | Europe | Japan) | Japan | Total | ||||||||||||||||
Three months ended September 30, 2003 | ||||||||||||||||||||
Net revenue from unaffiliated customers | $ | 358,184 | $ | 145,002 | $ | 17,617 | $ | 9,202 | $ | 530,005 | ||||||||||
Interest income | 6,013 | 690 | 27 | — | 6,730 | |||||||||||||||
Depreciation and amortization | 11,138 | 6,087 | 241 | 158 | 17,624 | |||||||||||||||
Total assets | 1,988,171 | 573,289 | 29,908 | 25,666 | 2,617,034 | |||||||||||||||
Capital expenditures | 12,610 | 3,621 | 324 | (52 | ) | 16,503 | ||||||||||||||
Long-lived assets | 240,050 | 137,157 | 2,244 | 2,288 | 381,739 | |||||||||||||||
Three months ended September 30, 2002 | ||||||||||||||||||||
Net revenue from unaffiliated customers | $ | 313,559 | $ | 116,654 | $ | 13,803 | $ | 9,474 | $ | 453,490 | ||||||||||
Interest income | 4,012 | 421 | 41 | 1 | 4,475 | |||||||||||||||
Depreciation and amortization | 20,793 | 3,893 | 229 | 152 | 25,067 | |||||||||||||||
Total assets | 1,402,119 | 408,419 | 24,156 | 12,391 | 1,847,085 | |||||||||||||||
Capital expenditures | 11,507 | 3,281 | 102 | 87 | 14,977 | |||||||||||||||
Long-lived assets | 287,883 | 136,301 | 1,847 | 2,509 | 428,540 | |||||||||||||||
Six months ended September 30, 2003 | ||||||||||||||||||||
Net revenue from unaffiliated customers | $ | 557,025 | $ | 272,928 | $ | 32,088 | $ | 21,345 | $ | 883,386 | ||||||||||
Interest income | 12,271 | 1,662 | 64 | — | 13,997 | |||||||||||||||
Depreciation and amortization | 20,226 | 9,831 | 477 | 313 | 30,847 | |||||||||||||||
Capital expenditures | 22,268 | 5,804 | 607 | 11 | 28,690 | |||||||||||||||
Six months ended September 30, 2002 | ||||||||||||||||||||
Net revenue from unaffiliated customers | $ | 487,138 | $ | 243,184 | $ | 28,992 | $ | 26,074 | $ | 785,388 | ||||||||||
Interest income | 8,284 | 793 | 94 | 1 | 9,172 | |||||||||||||||
Depreciation and amortization | 41,299 | 7,318 | 462 | 294 | 49,373 | |||||||||||||||
Capital expenditures | 17,833 | 5,127 | 262 | 164 | 23,386 |
11
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Three Months Ended December 31, 2001 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 810,930 | $ | 21,948 | $ | 832,878 | |||||||
Cost of goods sold | 395,261 | 5,592 | 400,853 | ||||||||||
Gross profit | 415,669 | 16,356 | 432,025 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 84,192 | 9,683 | 93,875 | ||||||||||
General and administrative | 29,116 | 2,717 | 31,833 | ||||||||||
Research and development (b) | 66,030 | 31,376 | 97,406 | ||||||||||
Amortization of intangibles (c) | 3,205 | 3,154 | 6,359 | ||||||||||
Restructuring and asset impairment charges | — | 14,051 | 14,051 | ||||||||||
Total operating expenses | 182,543 | 60,981 | 243,524 | ||||||||||
Operating income (loss) | 233,126 | (44,625 | ) | 188,501 | |||||||||
Interest and other income (expense), net | 3,597 | (82 | ) | 3,515 | |||||||||
Income (loss) before provision for income taxes and minority interest | 236,723 | (44,707 | ) | 192,016 | |||||||||
Provision for income taxes | 59,525 | — | 59,525 | ||||||||||
Income (loss) before minority interest | 177,198 | (44,707 | ) | 132,491 | |||||||||
Minority interest in consolidated joint venture | (199 | ) | — | (199 | ) | ||||||||
Net income (loss) before retained interest in EA.com | $ | 176,999 | $ | (44,707 | ) | $ | 132,292 | ||||||
Interest income | $ | 3,025 | $ | 8 | $ | 3,033 | |||||||
Depreciation and amortization | 13,438 | 14,819 | 28,257 | ||||||||||
Identifiable assets | 1,502,949 | 192,424 | 1,695,373 | ||||||||||
Capital expenditures | 8,660 | 1,685 | 10,345 |
12
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Nine Months Ended December 31, 2002 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 1,958,297 | $ | 60,817 | $ | 2,019,114 | |||||||
Cost of goods sold | 887,814 | 11,122 | 898,936 | ||||||||||
Gross profit | 1,070,483 | 49,695 | 1,120,178 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 228,473 | 31,907 | 260,380 | ||||||||||
General and administrative | 89,448 | 5,918 | 95,366 | ||||||||||
Research and development (b) | 221,716 | 79,951 | 301,667 | ||||||||||
Amortization of intangibles (c) | 2,780 | 3,956 | 6,736 | ||||||||||
Restructuring and asset impairment charges | 9,378 | — | 9,378 | ||||||||||
Total operating expenses | 551,795 | 121,732 | 673,527 | ||||||||||
Operating income (loss) | 518,688 | (72,037 | ) | 446,651 | |||||||||
Interest and other income (expense), net | 67 | (182 | ) | (115 | ) | ||||||||
Income (loss) before provision for income taxes and minority interest | 518,755 | (72,219 | ) | 446,536 | |||||||||
Provision for income taxes | 138,426 | — | 138,426 | ||||||||||
Income (loss) before minority interest | 380,329 | (72,219 | ) | 308,110 | |||||||||
Minority interest in consolidated joint venture | (253 | ) | — | (253 | ) | ||||||||
Net income (loss) before retained interest in EA.com | $ | 380,076 | $ | (72,219 | ) | $ | 307,857 | ||||||
Interest income | $ | 14,109 | $ | 76 | $ | 14,185 | |||||||
Depreciation and amortization | 36,974 | 37,355 | 74,329 | ||||||||||
Capital expenditures | 33,774 | 696 | 34,470 |
13
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Nine Months Ended December 31, 2001 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 1,201,407 | $ | 53,577 | $ | 1,254,984 | |||||||
Cost of goods sold | 595,468 | 12,174 | 607,642 | ||||||||||
Gross profit | 605,939 | 41,403 | 647,342 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 150,002 | 29,697 | 179,699 | ||||||||||
General and administrative | 72,535 | 7,916 | 80,451 | ||||||||||
Research and development (b) | 185,138 | 100,628 | 285,766 | ||||||||||
Amortization of intangibles (c) | 9,615 | 9,694 | 19,309 | ||||||||||
Restructuring and asset impairment charges | — | 14,051 | 14,051 | ||||||||||
Total operating expenses | 417,290 | 161,986 | 579,276 | ||||||||||
Operating income (loss) | 188,649 | (120,583 | ) | 68,066 | |||||||||
Interest and other income (expense), net | 10,865 | (573 | ) | 10,292 | |||||||||
Income (loss) before provision for income taxes and minority interest | 199,514 | (121,156 | ) | 78,358 | |||||||||
Provision for income taxes | 24,291 | — | 24,291 | ||||||||||
Income (loss) before minority interest | 175,223 | (121,156 | ) | 54,067 | |||||||||
Minority interest in consolidated joint venture | 147 | — | 147 | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 175,370 | $ | (121,156 | ) | $ | 54,214 | ||||||
Interest income | $ | 12,493 | $ | 43 | $ | 12,536 | |||||||
Depreciation and amortization | 38,267 | 45,284 | 83,551 | ||||||||||
Capital expenditures | 27,609 | 12,447 | 40,056 |
14
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
The Company’s operations, presented geographically, percent of total net revenue for the three and ninesix months ended December 31,September 30, 2003, respectively. EA’s sales to Wal-mart Stores represented 17 and 14 percent of total net revenue for the three and six months ended September 30, 2002, and 2001 are presented below (in thousands):
Asia | |||||||||||||||||||||||||
North | Pacific | ||||||||||||||||||||||||
America | Europe | (excluding Japan) | Japan | Eliminations | Total | ||||||||||||||||||||
Three months ended December 31, 2002 | |||||||||||||||||||||||||
Net revenues from unaffiliated customers | $ | 695,630 | $ | 470,742 | $ | 38,208 | $ | 29,146 | $ | — | $ | 1,233,726 | |||||||||||||
Intercompany revenues | (5,082 | ) | 36,726 | 3,126 | — | (34,770 | ) | — | |||||||||||||||||
Total net revenues | 690,548 | 507,468 | 41,334 | 29,146 | (34,770 | ) | 1,233,726 | ||||||||||||||||||
Operating income | 203,408 | 158,749 | 4,293 | 4,773 | (2,100 | ) | 369,123 | ||||||||||||||||||
Interest income | 4,404 | 575 | 34 | — | — | 5,013 | |||||||||||||||||||
Depreciation and amortization | 21,111 | 3,453 | 227 | 165 | — | 24,956 | |||||||||||||||||||
Identifiable assets | 1,750,576 | 626,301 | 50,398 | 33,750 | — | 2,461,025 | |||||||||||||||||||
Capital expenditures | 8,550 | 1,894 | 470 | 170 | — | 11,084 | |||||||||||||||||||
Long-lived assets | 366,503 | 183,852 | 5,239 | 5,151 | — | 560,745 | |||||||||||||||||||
Three months ended December 31, 2001 | |||||||||||||||||||||||||
Net revenues from unaffiliated customers | $ | 510,752 | $ | 279,601 | $ | 21,801 | $ | 20,724 | $ | — | $ | 832,878 | |||||||||||||
Intercompany revenues | 1,222 | 17,262 | 2,753 | 55 | (21,292 | ) | — | ||||||||||||||||||
Total net revenues | 511,974 | 296,863 | 24,554 | 20,779 | (21,292 | ) | 832,878 | ||||||||||||||||||
Operating income | 71,022 | 116,770 | 167 | 700 | (158 | ) | 188,501 | ||||||||||||||||||
Interest income | 2,742 | 254 | 37 | — | — | 3,033 | |||||||||||||||||||
Depreciation and amortization | 24,204 | 3,632 | 250 | 171 | — | 28,257 | |||||||||||||||||||
Identifiable assets | 1,202,728 | 440,991 | 29,368 | 22,286 | — | 1,695,373 | |||||||||||||||||||
Capital expenditures | 7,331 | 2,340 | 437 | 237 | — | 10,345 | |||||||||||||||||||
Long-lived assets | 351,891 | 164,079 | 4,522 | 4,406 | — | 524,898 | |||||||||||||||||||
Nine months ended December 31, 2002 | |||||||||||||||||||||||||
Net revenues from unaffiliated customers | $ | 1,182,768 | $ | 713,926 | $ | 67,200 | $ | 55,220 | $ | — | $ | 2,019,114 | |||||||||||||
Intercompany revenues | (7,998 | ) | 57,561 | 5,036 | 57 | (54,656 | ) | — | |||||||||||||||||
Total net revenues | 1,174,770 | 771,487 | 72,236 | 55,277 | (54,656 | ) | 2,019,114 | ||||||||||||||||||
Operating income | 230,976 | 211,903 | 5,002 | 693 | (1,923 | ) | 446,651 | ||||||||||||||||||
Interest income | 12,688 | 1,368 | 128 | 1 | — | 14,185 | |||||||||||||||||||
Depreciation and amortization | 62,410 | 10,771 | 689 | 459 | — | 74,329 | |||||||||||||||||||
Capital expenditures | 26,383 | 7,021 | 732 | 334 | — | 34,470 | |||||||||||||||||||
Nine months ended December 31, 2001 | |||||||||||||||||||||||||
Net revenues from unaffiliated customers | $ | 783,369 | $ | 392,615 | $ | 39,859 | $ | 39,141 | $ | — | $ | 1,254,984 | |||||||||||||
Intercompany revenues | 3,553 | 26,708 | 6,860 | 55 | (37,176 | ) | — | ||||||||||||||||||
Total net revenues | 786,922 | 419,323 | 46,719 | 39,196 | (37,176 | ) | 1,254,984 | ||||||||||||||||||
Operating income (loss) | (24,683 | ) | 92,648 | (129 | ) | (302 | ) | 532 | 68,066 | ||||||||||||||||
Interest income | 10,974 | 1,392 | 170 | — | — | 12,536 | |||||||||||||||||||
Depreciation and amortization | 72,408 | 10,044 | 616 | 483 | — | 83,551 | |||||||||||||||||||
Capital expenditures | 29,941 | 8,604 | 710 | 801 | — | 40,056 |
15
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Information about the Company’sEA’s net revenuesrevenue by product line for the three and ninesix months ended December 31,September 30, 2003 and 2002 and 2001 is presented below (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
December 31, | December 31, | |||||||||||||||||||||||||||||||
2002 | % of total | 2001 | % of total | 2002 | % of total | 2001 | % of total | |||||||||||||||||||||||||
PlayStation 2 | $ | 459,407 | 37 | % | $ | 227,554 | 27 | % | $ | 752,717 | 37 | % | $ | 369,836 | 30 | % | ||||||||||||||||
PC | 219,083 | 18 | % | 194,856 | 23 | % | 377,835 | 19 | % | 318,818 | 25 | % | ||||||||||||||||||||
Xbox | 116,836 | 9 | % | 44,629 | 5 | % | 174,466 | 9 | % | 44,629 | 4 | % | ||||||||||||||||||||
Nintendo GameCube | 111,103 | 9 | % | 30,026 | 4 | % | 153,897 | 8 | % | 30,026 | 2 | % | ||||||||||||||||||||
PlayStation | 53,066 | 4 | % | 122,940 | 15 | % | 90,495 | 4 | % | 162,129 | 13 | % | ||||||||||||||||||||
Game Boy Advance | 68,102 | 6 | % | 30,543 | 4 | % | 73,919 | 4 | % | 30,543 | 2 | % | ||||||||||||||||||||
Advertising | 9,461 | 1 | % | 10,556 | 1 | % | 28,579 | 1 | % | 25,317 | 2 | % | ||||||||||||||||||||
Game Boy Color | 22,610 | 2 | % | 24,176 | 3 | % | 25,131 | 1 | % | 28,455 | 2 | % | ||||||||||||||||||||
Online Subscriptions | 9,193 | 1 | % | 7,002 | 1 | % | 24,969 | 1 | % | 22,146 | 2 | % | ||||||||||||||||||||
License, OEM and Other | 7,396 | — | 19,813 | 2 | % | 16,349 | 1 | % | 37,464 | 3 | % | |||||||||||||||||||||
Affiliated Label | 157,469 | 13 | % | 120,783 | 15 | % | 300,757 | 15 | % | 185,621 | 15 | % | ||||||||||||||||||||
$ | 1,233,726 | 100 | % | $ | 832,878 | 100 | % | $ | 2,019,114 | 100 | % | $ | 1,254,984 | 100 | % | |||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
PlayStation® 2 | $ | 221,180 | $ | 158,712 | $ | 339,549 | $ | 293,310 | ||||||||
PC | 93,022 | 82,686 | 173,360 | 158,752 | ||||||||||||
Xbox™ | 68,691 | 37,527 | 100,212 | 57,630 | ||||||||||||
Nintendo GameCube™ | 24,553 | 27,838 | 45,707 | 42,794 | ||||||||||||
Subscription Services | 11,124 | 8,321 | 24,755 | 16,860 | ||||||||||||
Advertising, Programming, Licensing, and Other | 7,552 | 14,161 | 16,263 | 29,508 | ||||||||||||
PlayStation® | 7,562 | 24,206 | 13,313 | 37,429 | ||||||||||||
Game Boy® Advance | 3,809 | 3,679 | 6,168 | 5,817 | ||||||||||||
Co-publishing and Distribution | 92,512 | 96,360 | 164,059 | 143,288 | ||||||||||||
Total Net Revenue | $ | 530,005 | $ | 453,490 | $ | 883,386 | $ | 785,388 | ||||||||
Note 9.(9) COMPREHENSIVE INCOME
SFAS No. 130,“Reporting Comprehensive IncomeIncome”, 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 primarily includes foreign currency translation adjustments and unrealized gains (losses) on investments.
The components of comprehensive income, net of tax, for the three and ninesix months ended December 31,September 30, 2003 and 2002 and 2001 wereare summarized as follows (in thousands):
Three Months Ended | Nine Months Ended | ||||||||||||||||
December 31, | December 31, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
Net income | $ | 250,219 | $ | 132,292 | $ | 307,857 | $ | 54,214 | |||||||||
Other comprehensive income: | |||||||||||||||||
Change in unrealized appreciation (loss) on investments, net of tax expense of $165, $356, $1,636 and $434 | 153 | 1,982 | 1,317 | (1,877 | ) | ||||||||||||
Reclassification of (gain) loss realized in net income for marketable securities, net of a tax expense of ($693) and ($252) | (1,544 | ) | — | 374 | — | ||||||||||||
Foreign currency translation adjustments | 3,737 | (839 | ) | 11,509 | 3,175 | ||||||||||||
Total other comprehensive income | 2,346 | 1,143 | 13,200 | 1,298 | |||||||||||||
Total comprehensive income | $ | 252,565 | $ | 133,435 | $ | 321,057 | $ | 55,512 | |||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||
Net income | $ | 76,588 | $ | 50,234 | $ | 94,956 | $ | 57,638 | ||||||||
Other comprehensive income (loss): | ||||||||||||||||
Change in unrealized appreciation (loss) on investments, net of tax (benefit)/expense of $(793), $843, $(675) and $1,471, respectively | (1,811 | ) | 1,249 | (1,504 | ) | 1,164 | ||||||||||
Adjustment for loss (gain) realized in net income, net of tax (benefit)/expense of $0, $441, $(3) and $441, respectively | — | 1,918 | (7 | ) | 1,918 | |||||||||||
Foreign currency translation adjustments | 1,174 | (1,538 | ) | 12,875 | 7,772 | |||||||||||
Total other comprehensive income (loss) | (637 | ) | 1,629 | 11,364 | 10,854 | |||||||||||
Total comprehensive income | $ | 75,951 | $ | 51,863 | $ | 106,320 | $ | 68,492 | ||||||||
The foreign currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries.
1612
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
Note 10. Net Earnings (Loss) Per Share(10) NET EARNINGS (LOSS) PER SHARE
The following summarizes the computations of Basic Earnings Per Share (“EPS”) and Diluted EPS. Basic EPS is computed as net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock-based compensation plans including stock options, restricted stock awards, warrants and other convertible securities using the treasury stock method.
(In thousands, except per share amounts): | ||||||||||||||||
Three months ended | Six months ended | |||||||||||||||
September 30, 2003 | September 30, 2003 | |||||||||||||||
Class A common | Class A common | Class A common | Class A common | |||||||||||||
stock-Basic | stock-Diluted | stock-Basic | stock-Diluted | |||||||||||||
Net income | $ | 76,588 | $ | 76,588 | $ | 94,956 | $ | 94,956 | ||||||||
Shares used to compute net earnings per share: | ||||||||||||||||
Weighted-average common shares | 294,836 | 294,836 | 292,263 | 292,263 | ||||||||||||
Dilutive stock equivalents | — | 12,943 | — | 11,750 | ||||||||||||
Dilutive potential common shares | 294,836 | 307,779 | 292,263 | 304,013 | ||||||||||||
Net earnings per share: | ||||||||||||||||
Basic | $ | 0.26 | N/A | $ | 0.32 | N/A | ||||||||||
Diluted | N/A | $ | 0.25 | N/A | $ | 0.31 | ||||||||||
(In thousands, except per share amounts): | ||||||||||||
Three months ended September 30, 2002 | ||||||||||||
Class A common | Class A common | Class B common | ||||||||||
Stock- Basic | stock-Diluted | Stock | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 73,561 | $ | 50,234 | $ | (23,327 | ) | |||||
Net loss related to retained interest in EA.com | (20,154 | ) | — | 20,154 | ||||||||
Net income (loss) | $ | 53,407 | $ | 50,234 | $ | (3,173 | ) | |||||
Shares used to compute net earnings (loss) per share: | ||||||||||||
Weighted-average common shares | 279,686 | 279,686 | 5,547 | |||||||||
Dilutive stock equivalents | — | 13,551 | — | |||||||||
Dilutive potential common shares | 279,686 | 293,237 | 5,547 | |||||||||
Net earnings (loss) per share: | ||||||||||||
Basic | $ | 0.19 | N/A | $ | (0.57 | ) | ||||||
Diluted | N/A | $ | 0.17 | $ | (0.57 | ) | ||||||
Net income (loss) per share is computed individually13
(In thousands, except per share amounts): | ||||||||||||
Six months ended September 30, 2002 | ||||||||||||
Class A common | Class A common | Class B common | ||||||||||
Stock- Basic | stock-Diluted | Stock | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 100,897 | $ | 57,638 | $ | (43,259 | ) | |||||
Net loss related to retained interest in EA.com | (37,096 | ) | — | 37,096 | ||||||||
Net income (loss) | $ | 63,801 | $ | 57,638 | $ | (6,163 | ) | |||||
Shares used to compute net earnings (loss) per share: | ||||||||||||
Weighted-average common shares | 278,633 | 278,633 | 5,759 | |||||||||
Dilutive stock equivalents | — | 13,905 | — | |||||||||
Dilutive potential common shares | 278,633 | 292,538 | 5,759 | |||||||||
Net earnings (loss) per share: | ||||||||||||
Basic | $ | 0.23 | N/A | $ | (1.07 | ) | ||||||
Diluted | N/A | $ | 0.20 | $ | (1.07 | ) | ||||||
Excluded from the above computation of weighted-average shares for Class A Diluted EPS for the three and six months ended September 30, 2003, were options to purchase 339,000 and 574,000 shares, respectively, as the options’ exercise prices were greater than the average market price of the common stockshares during the respective periods. For the three and six months ended September 30, 2003, the weighted-average exercise prices of these options were $44.49 and $40.78 per share, respectively.
Excluded from the above computation of weighted-average shares for Class BA Diluted EPS for the three and six months ended September 30, 2002, were options to purchase 697,000 and 462,000 shares, respectively, as the options’ exercise prices were greater than the average market price of the common stock. Please seeshares during the discussion regarding segment reporting inrespective periods. For the MD&A.
(in thousands, except per share amounts): | ||||||||||||
Three months ended December 31, 2002 | ||||||||||||
Class A common | Class A common | Class B | ||||||||||
stock-Basic | stock-Diluted | common stock | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 279,179 | $ | 250,219 | $ | (28,960 | ) | |||||
Net loss related to retained interest in EA.com | (25,485 | ) | — | 25,485 | ||||||||
Net income (loss) | $ | 253,694 | $ | 250,219 | $ | (3,475 | ) | |||||
Shares used to compute net income (loss) per share: | ||||||||||||
Weighted-average common shares | 141,889 | 141,889 | 4,051 | |||||||||
Dilutive stock equivalents | — | 6,136 | — | |||||||||
Dilutive potential common shares | 141,889 | 148,025 | 4,051 | |||||||||
Net income (loss) per share: | ||||||||||||
Basic | $ | 1.79 | N/A | $ | (0.86 | ) | ||||||
Diluted | N/A | $ | 1.69 | $ | (0.86 | ) | ||||||
17
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
(in thousands, except pershare amounts): | ||||||||||||
Nine months ended December 31, 2002 | ||||||||||||
Class A common | Class A common | Class B | ||||||||||
stock-Basic | stock-Diluted | common stock | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 380,076 | $ | 307,857 | $ | (72,219 | ) | |||||
Net loss related to retained interest in EA.com | (62,581 | ) | — | 62,581 | ||||||||
Net income (loss) | $ | 317,495 | $ | 307,857 | $ | (9,638 | ) | |||||
Shares used to compute net income (loss) per share: | ||||||||||||
Weighted-average common shares | 140,193 | 140,193 | 5,247 | |||||||||
Dilutive stock equivalents | — | 6,667 | — | |||||||||
Dilutive potential common shares | 140,193 | 146,860 | 5,247 | |||||||||
Net income (loss) per share: | ||||||||||||
Basic | $ | 2.26 | N/A | $ | (1.84 | ) | ||||||
Diluted | N/A | $ | 2.10 | $ | (1.84 | ) | ||||||
(in thousands, except per share amounts): | ||||||||||||
Three months ended December 31, 2001 | ||||||||||||
Class A common | Class A common | Class B | ||||||||||
stock-Basic | stock-Diluted | common stock | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 176,999 | $ | 132,292 | $ | (44,707 | ) | |||||
Net loss related to retained interest in EA.com | (38,001 | ) | — | 38,001 | ||||||||
Net income (loss) | $ | 138,998 | $ | 132,292 | $ | (6,706 | ) | |||||
Shares used to compute net income (loss) per share: | ||||||||||||
Weighted-average common shares | 137,103 | 137,103 | 6,028 | |||||||||
Dilutive stock equivalents | — | 6,296 | — | |||||||||
Dilutive potential common shares | 137,103 | 143,399 | 6,028 | |||||||||
Net income (loss) per share: | ||||||||||||
Basic | $ | 1.01 | N/A | $ | (1.11 | ) | ||||||
Diluted | N/A | $ | 0.92 | $ | (1.11 | ) | ||||||
18
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
(in thousands, except per share amounts): | ||||||||||||
Nine months ended December 31, 2001 | ||||||||||||
Class A common | Class A common | Class B | ||||||||||
stock-Basic | stock-Diluted | common stock | ||||||||||
Net income (loss) before retained interest in EA.com | $ | 175,370 | $ | 54,214 | $ | (121,156 | ) | |||||
Net loss related to retained interest in EA.com | (102,983 | ) | — | 102,983 | ||||||||
Net income (loss) | $ | 72,387 | $ | 54,214 | $ | (18,173 | ) | |||||
Shares used to compute net income (loss) per share: | ||||||||||||
Weighted-average common shares | 136,457 | 136,457 | 6,023 | |||||||||
Dilutive stock equivalents | — | 6,390 | — | |||||||||
Dilutive potential common shares | 136,457 | 142,847 | 6,023 | |||||||||
Net income (loss) per share: | ||||||||||||
Basic | $ | 0.53 | N/A | $ | (3.02 | ) | ||||||
Diluted | N/A | $ | 0.38 | $ | (3.02 | ) | ||||||
TheFor the three and six months ended September 30, 2002, the Diluted EPS calculation for Class A common stock, includespresented above, included the potential dilution from the conversion of Class B common stock to Class A common stock in the event that anthe initial public offering for Class B common stock doesdid not occur. Net income used for the calculation of Diluted EPS for Class A common stock was $250,219,000 and $132,292,000$50.2 million for the three months ended December 31,September 30, 2002 and 2001, respectively. Net income used$57.6 million for the calculation of Diluted EPS for Class A common stock was $307,857,000 and $54,214,000 for the ninesix months ended December 31, 2002 and 2001, respectively.September 30, 2002. This net income includesincluded the remaining interest in EA.com, (100% of EA.com losses), which iswas directly attributable to outstanding Class B sharescommon stock owned by third parties, whichand would behave been included in the Class A common stock EPS calculation in the event that anthe initial public offering for Class B common stock doesdid not occur.
Excluded from the above computation of weighted-average shares for Diluted EPS for Class A common stock were options to purchase 276,000 The remaining interest in EA.com was approximately 15 percent through August 2002, 12 percent through February 2003 and 1,333,000 shares of common stock for the three and nine months ended December 31, 2002, 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, 2002, the weighted-average exercise price of these respective options was $66.18 and $63.54 per share, respectively. Similarly, options to purchase 1,729,000 and 1,425,000 shares of common stock were excluded for the three and nine months ended December 31, 2001, 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, 2001, the weighted-average exercise price of these respective options was $57.69 and $57.59 per share, respectively.one percent through March 2003.
Due to the net loss attributable for the three and ninesix months ended December 31,September 30, 2002 on a diluted basis to Class B Stockholders,common stock, stock options have been excluded from the Diluted EPS
19
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
calculation as their inclusion would have been antidilutive. Had net income been reported for the ninethree and six months ended December 31,September 30, 2002, an additional 297,000226,000 and 422,000 shares, respectively, would have been added to diluted potential common shares for Class B common stock. Similarly, an additional 828,000 and 884,000 shares would have been added to diluted potential common shares for Class B common stock for the three and nine months ended December 31, 2001, respectively.
Note 11.(11) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
2003 Studio Restructuring and Asset Impairment Charges
EA Core
During the third quarter ended December 31, 2002, the Companyof fiscal 2003, EA closed its office located in San Francisco, California and its studio located in Seattle, Washington. The office and studio closures were a result of the Company’sEA’s strategic decision to consolidate local development efforts in Redwood City, California and Vancouver, British Columbia, Canada. The CompanyEA recorded total pre-tax charges of $9,378,000,$9.4 million, consisting of $7,310,000$7.3 million for consolidation of facilities, $1,452,000$1.5 million for the write-off impairment
14
of non-current assets and $616,000$0.6 million for workforce reductions. The facilities charge was net of a reduction in deferred rent of $533,000.$0.5 million.
The exit plans resultedAdditionally, during the fourth quarter of fiscal 2003, EA approved a plan to consolidate its Los Angeles, California, Irvine, California and Las Vegas, Nevada, studios into one major game studio in Los Angeles. These measures were taken in order to maximize efficiencies and streamline the creative development process and operations of EA’s studios. In connection with these consolidation activities, EA recorded a total pre-tax restructuring charge of $5.1 million, including $1.6 million for the shutdown of facilities related to non-cancelable lease payments for permanently vacated properties and associated costs, $2.0 million for the impairment of abandoned equipment and leasehold improvements at facilities that were permanently vacated and $1.5 million for employee severance expenses related to involuntary terminations.
Online Restructurings
Fiscal 2003 Restructuring
In March 2003, EA consolidated the operations of the EA.com business segment into its core business segment, and eliminated separate reporting for its Class B common stock for all reporting periods after fiscal 2003. During the fourth quarter of fiscal 2003, EA recorded restructuring charges of $67.0 million, consisting of $1.8 million for workforce reductionreductions, $2.3 million for consolidation of approximately 33 personnel in developmentfacilities and other administrative departments.charges, and $62.9 million for the impairment of non-current assets. The estimated costs for workforce reduction included severance charges for terminated employees, costs for certain outplacement service contracts and costs associated with the tender offer to retire employee Class B options. The consolidation of facilities included contractual rental commitments under the real estate lease for unutilized office space, offset by estimated future sub-lease income. In addition, the exit plans resulted in the write-offclosure of certain non-current fixed assets, primarily leasehold improvements.
The following table summarizes the activity in the accrued restructuring accountEA.com’s Chicago, Illinois, and Charlottesville, Virginia facilities and an adjustment for the period ended December 31, 2002 (in thousands):
Facilities | Workforce | Total | |||||||||||
Recorded in the quarter ended December 31, 2002 | $ | 7,843 | $ | 616 | $ | 8,459 | |||||||
Charges utilized in cash for the three months ended December 31, 2002 | — | (385 | ) | (385 | ) | ||||||||
Balance as of December 31, 2002 | $ | 7,843 | $ | 231 | $ | 8,074 | |||||||
The Company expectsimpairment charges on long-lived assets of $62.9 million included $24.9 million relating to customized internal-use software systems for the remaining accrued restructuring balanceEA.com infrastructure, $25.6 million for other long-lived assets and $12.4 million of $8,074,000finite-lived intangibles relating to be fully utilized by December 31, 2006.EA.com’s Kesmai and Pogo studios. The fair-value-based tests performed in accordance with EA’s annual procedures did not indicate an impairment of the recorded goodwill at the EA.com reporting unit level.
EA.com
Fiscal 2002 Restructuring
In October 2001, the CompanyEA announced a restructuring plan for EA.com.the EA.com business segment. The restructuring initiatives involved strategic decisions to discontinue certain product offerings and focus only on key online priorities that alignaligned with its fiscal 2003 operational objectives. During fiscal 2002, EA recorded restructuring charges of $20.3 million, consisting of $4.2 million for workforce reductions, $3.3 million for consolidation of facilities and other administrative charges, and $12.8 million for the write-off of non-current assets and facilities. The estimated costs for workforce reduction included severance charges for terminated employees and costs for certain outplacement service contracts. The consolidation of facilities resulted in the terminationclosure of approximately 270 positions.EA.com’s San Diego, California, studio and consolidation of its San Francisco, California, and Charlottesville, Virginia, facilities.
20Impairment charges on long-lived assets amounted to $12.8 million, including $11.2 million relating to abandoned technologies consisting of customized internal-use software systems for the EA.com infrastructure, $1.0 million of Kesmai intangibles associated with discontinued products and services and $0.6 million of goodwill charges relating to EA.com’s San Diego studio closure.
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
The following table summarizes the activity in the accrued studio and online restructuring account for the ninethree and six months ended December 31, 2002September 30, 2003 (in thousands):
Workforce | Facilities | Total | ||||||||||
Balance as of March 31, 2002 | $ | 674 | $ | 2,214 | $ | 2,888 | ||||||
Charges utilized in cash for the three months ended June 30, 2002 | (494 | ) | (243 | ) | (737 | ) | ||||||
Charges utilized in non-cash for the three months ended June 30, 2002 | — | (36 | ) | (36 | ) | |||||||
Balance as of June 30, 2002 | 180 | 1,935 | 2,115 | |||||||||
Charges utilized in cash for the three months ended September 30, 2002 | (82 | ) | (100 | ) | (182 | ) | ||||||
Balance as of September 30, 2002 | 98 | 1,835 | 1,933 | |||||||||
Charges utilized in cash for the three months ended December 31, 2002 | (93 | ) | (283 | ) | (376 | ) | ||||||
Charges utilized in non-cash for the three months ended December 31, 2002 | — | (652 | ) | (652 | ) | |||||||
Balance as of December 31, 2002 | $ | 5 | $ | 900 | $ | 905 | ||||||
The Company15
Fiscal 2003 | Fiscal 2002 | |||||||||||||||
Restructuring Plan | Restructuring Plan | |||||||||||||||
Facilities- | Facilities- | |||||||||||||||
Workforce | related | related | Total | |||||||||||||
Accrued balance as of March 31, 2003 | $ | 1,692 | $ | 8,223 | $ | 840 | $ | 10,755 | ||||||||
Charges utilized in cash | (1,452 | ) | (2,057 | ) | (103 | ) | (3,612 | ) | ||||||||
Accrued balance as of September 30, 2003 | $ | 240 | $ | 6,166 | $ | 737 | $ | 7,143 | ||||||||
EA expects the remaining EA.com accrued restructuring balance of $905,000$7.1 million to be fully utilized by December 31, 2006.
As of September 30, 2003, the estimated costs for consolidation of facilities included contractual rental commitments of $10.9 million under real estate leases for unutilized office space offset by $4.5 million of estimated future sub-lease income, costs to close or consolidate facilities, and costs to write off a portion of the assets from these facilities.
The accrued restructuring balances areaccrual is included in other accrued expenses in Note 7 of the Notes to Condensed Consolidated Financial Statements.
Note 12. Contingent Liabilities
(12) | CONTINGENT LIABILITIES |
Lease commitments
In July of 2003, EA entered into a lease agreement with Playa Vista-Water’s Edge LLC for a studio facility in Los Angeles, California, which commenced in October 2003 and expires in September 2013 with two five-year options to extend the lease term. Additionally, EA has options to purchase the property after five and ten years based on the fair market value of the property at the date of sale, a right of first offer to purchase the property upon terms offered by the landlord, and a right to share in the profits from a sale of the property. EA accounted for this arrangement as an operating lease in accordance with SFAS No. 13, “Accounting for Leases”, as amended. Existing campus facilities comprise a total of 243,000 square feet and provide space for research and development functions. The rental obligation under this agreement is $50.2 million over the initial ten-year term of the lease. EA will take possession of the property over a period of 18 months as the facilities become available for use. The above commitment is offset by sublease income of $5.8 million for the sublet to Playa Capital Company, LLC of 18,000 square feet of the Los Angeles facility, which commenced in October 2003 and expires September 2013 with options of early termination by Playa Capital Company, LLC after five years and by EA after four and five years.
Residual Value Guarantees
In February of 1995, the CompanyEA entered into a build-to-suit lease with a financial institutionKeybank National Association on the Company’sits headquarters facility in Redwood City, California, which was extended in July 2001 and expires in July 2006. The CompanyEA accounted for this arrangement as an operating lease in accordance with SFAS No. 13,“Accounting for Leases”, as amended. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. The CompanyEA has an option to purchase the property (land and facilities) for $145,000,000$145.0 million or, at the end of the lease, to arrange for (1)(i) an additional extension of the lease or (2)(ii) sale of the property to a third party with the Company retainingwhile EA retains an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000$128.9 million if the sales price is less than this amount, subject to certain provisions of the lease.
21
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)
In December 2000, the CompanyEA entered into a second build-to-suit lease with a financial institutionKeybank National Association for a five yearfive-year term from December 2000 to expand the Company’sits headquarters facilities and develop adjacent property adding approximately 310,000 square feet to its campus. Construction was completed in June 2002. The CompanyEA accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. The facilities will provide space for marketing, sales and research and development. The CompanyEA has an option to purchase the property for $127,000,000$127.0 million or, at the end of
16
the lease, to arrange for (1)(i) an extension of the lease or (2)(ii) sale of the property to a third party with the Company retainingwhile EA retains an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118,800,000$118.8 million if the sales price is less than this amount, subject to certain provisions of the lease.
Director Indemnity Agreements
The Company has entered into an indemnification agreement withEA believes the membersestimated fair value of its Board of Directors to indemnify its Directors to the extent permitted by law against any and all liabilities, costs, expenses, amounts paidboth properties under these operating leases are in settlement and damages incurred by the Directors as a result of any lawsuit, or any judicial, administrative or investigative proceeding in which the Directors are sued as a resultexcess of their service as members of the Board of Directors of the Company.respective guaranteed residual values based in part on an independent third party appraisal.
Please seeSee the Liquidity and Capital Resources section of the MD&AManagement’s Discussion and Analysis of Financial Condition and Results of Operations for a schedule of the Company’sEA’s contractual obligations and commitments.
Note 13. Investments(13) SQUARE JOINT VENTURE
In May 1998, EA and Square, a leading developer and publisher of entertainment software in Affiliates
Japan, completed the formation of two new joint ventures in North America and Japan. In accordanceNorth America, the companies formed Square Electronic Arts, LLC (“Square EA”), which had exclusive publishing rights in North America for future interactive entertainment titles created by Square. Additionally, EA had the exclusive right to distribute in North America products published by this joint venture. EA contributed $3.0 million and owned a 30 percent minority interest in this joint venture while Square owned 70 percent. This joint venture was accounted for under the equity method. The joint venture agreements with SFAS No. 144,“Accounting for the Impairment or DisposalSquare expired as of Long-Lived Assets”, management evaluates purchased intangible assets and long-lived assets to determine if events or changesMarch 31, 2003. EA’s distribution of Square products in circumstances indicate an other-than-temporary impairment in value. The Company has cost investments in affiliates. BasedNorth America terminated on several factors, such as the financial performance of the affiliate, the Company's decision to no longer acquire or continue investing in these affiliates, the limited cash flow from future business arrangements and other information available during the quarter ended December 31, 2002, the Company determined that some of its investments in affiliates were permanently impaired and recorded a permanent impairmentJune 30, 2003. On May 30, 2003 Square acquired EA’s remaining 30 percent ownership interest in the amountjoint venture for $8.5 million and EA’s investment was removed from the Condensed Consolidated Balance Sheet.
In Japan, the companies established Electronic Arts Square K.K. (“EA Square KK”) in 1998, which localized and published in Japan EA’s properties originally created in North America and Europe, as well as developed and published original videogames in Japan. EA contributed cash and had a 70 percent majority ownership interest, while Square contributed cash and owned 30 percent. Accordingly, the assets, liabilities and results of $10,119,000. This permanent impairment was recordedoperations for EA Square KK were included in interestEA’s Condensed Consolidated Balance Sheets and other income (expense) on the Condensed Consolidated Statements of Operations.
Note 14. Subsequent Events
Studio RestructuringOperations since June 1, 1998, the date of formation. Square’s 30 percent interest in EA Square KK has been reflected as “Minority interest in consolidated joint venture” on EA’s Condensed Consolidated Balance Sheet as of March 31, 2003, and Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2002.
In May 2003, EA acquired Square’s 30 percent ownership interest in EA Square KK for approximately $2.5 million in cash. As a result of the fourth quarteracquisition, EA Square KK has become a wholly owned subsidiary of fiscal 2003,EA and has been renamed Electronic Arts K.K. The acquisition was accounted for as a step acquisition purchase and the Company will beginexcess purchase price over fair value of the consolidation of its Los Angeles, Irvinenet tangible assets acquired, $1.2 million, was allocated to goodwill.
(14) | AMERICA ONLINE, INC. (“AOL”) AGREEMENT |
In November 1999, Electronic Arts Inc., EA.com and Las Vegas studiosAOL entered into a major centralized studiofive-year $81.0 million carriage fee agreement (the “Prior Agreement”) which gave EA.com the exclusive right to provide online games and interactive entertainment content on the “Games” channels/areas of certain AOL online services and gain access to and sell its products to AOL subscribers and to users of AOL properties. This agreement provided for carriage fees, advertising commitments, advertising revenue sharing and other fees.
During the three months ended June 30, 2003, EA and AOL terminated the Prior Agreement and entered into a new two-year agreement (the “New Agreement”) under which EA will continue to provide its current online game content services, and launch new online game content and services, on the “Games” channels/areas of certain AOL online services in Los Angeles. These measuresexchange for a programming fee from AOL.
Below is a discussion of the Prior Agreement and the changes in EA’s relationship with AOL that are being taken to maximize efficiencies and streamlinereflected in the creative development process and operations of our studios.New Agreement.
2217
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)Carriage
Shelf RegistrationThe Prior Agreement provided for EA’s payment of a total of $81.0 million in carriage fees to AOL over the term of the Prior Agreement.
On January 29,Of this amount, $36.0 million was paid upon signing the Prior Agreement with the remainder due in four equal annual installments of $11.25 million beginning with the first anniversary of the initial payment. EA made carriage payments to AOL of $11.25 million in each of the fiscal years 2003, 2002 and 2001. Due to the termination of the Prior Agreement in June 2003, EA is no longer required to make the last $11.25 million carriage payment. There was no carriage fee expense for the three and six months ended September 30, 2003. Carriage fee expense for the three and six months ended September 30, 2002 was $4.5 million and $8.9 million, respectively.
Carriage fee amounts paid under the Prior Agreement were capitalized as a prepaid asset as payments were made to AOL. Until April 1, 2003, the Company filedtotal carriage fee of $81.0 million that was provided for in the Prior Agreement was being expensed using the straight-line method over the remaining life of the Prior Agreement subsequent to EA.com’s site launch in October 2000. As the carriage fee was expensed, EA applied the portion that had been paid against the prepaid asset and recorded the remaining amount as a “shelf” registration statementliability. Amortization expense was classified as “Marketing and sales” expense in EA’s Condensed Consolidated Statements of Operations. The prepaid asset and liability balances were classified as “Other assets” and “Accrued and other liabilities”, respectively, on Form S-3 withEA’s Condensed Consolidated Balance Sheets.
Under the U.S. Securities and Exchange Commission which will allowNew Agreement, in July 2003, AOL refunded $18.0 million in carriage fees that EA had previously paid to AOL under the Company to sell up to $2 billion in equity or debt securities.
Note 15. Impact of Recently Issued Accounting Standards
In June 2001,Prior Agreement. This refund was applied against the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143,“Accounting for Asset Retirement Obligations”. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assetsprepaid balance and the associatedremaining asset, retirement costs. This statement applies to legal obligations associated with$6.4 million, is being amortized over the retirement of long-lived assets that result from the acquisition, construction, development or normal useterm of the asset. SFAS No. 143 is effectiveNew Agreement as a reduction to revenue.
Programming Fee
The New Agreement provides for fiscal years beginning after June 15, 2002. We do not expectpayments by AOL to EA of $27.5 million over the adoptiontwo-year term of SFAS No.143the New Agreement as a programming fee. $20.8 million of this $27.5 million pertains to have a material impactexisting online games content and services that EA currently provides on the Company’s consolidated financial position“Games” channels/areas of the AOL properties, and is being recognized as revenue ratably over the term of the New Agreement. The remaining $6.7 million pertains to new online games content and services to be delivered during the term of the New Agreement. This portion of the programming fee will be recognized as revenue as the required new content and services are delivered. During the three and six months ended September 30, 2003, $2.4 million and $4.9 million have been recognized as programming fee revenue, respectively.
Advertising Commitment
Under the Prior Agreement, EA also made a commitment to spend $15.0 million in offline media advertisements prior to March 31, 2005 consisting of:
Under the Prior Agreement, EA was free to purchase this advertising from any television, radio, print or results of operations.
In April 2002, the FASB issued SFAS No. 145,“Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS No. 145 rescinds SFAS No. 4,“Reporting Gains and Lossesoutdoor media property that it chose, not necessarily from Extinguishment of Debt”, as amended by SFAS No. 64,“Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. The adoption of SFAS No. 145any AOL-affiliated media property. EA did not have a material impact onpurchase any advertisements from AOL, though it purchased some qualifying advertising from AOL affiliates. Through March 31, 2003, EA expensed the Company’s consolidated financial statements.advertising as it was incurred. These costs were classified as “Marketing and sales” expense in EA’s Condensed Consolidated Statements of Operations. As of March 31, 2003, EA had spent approximately $4.3 million against this commitment.
In June 2002,Upon the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3,“Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)”. The Company currently accounts for and reports exit and disposal activities under the provisions of EITF No. 94-3. The Company will adopt the provisions of SFAS No. 146 for all exit and disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of SFAS No. 146 to have a material impact on its consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires a guarantor to (i) include disclosure of certain obligations, and (ii) if applicable, at the inceptiontermination of the guarantee, recognize a liabilityPrior Agreement, this advertising commitment was extinguished, and there is no similar commitment provided for the fair value of other certain obligations undertaken in issuing a guarantee. The disclosure provisions of the Interpretation are effective for financial statements of interim or annual reports that end after December 15, 2002 and the Company has adopted those requirements in its condensed consolidated financial statements included in Note 12 of the Notes to Condensed Consolidated Financial Statements and in the Liquidity and Capital Resources section of the MD&A of this Form 10-Q. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002, irrespectiveNew Agreement.
2318
ELECTRONIC ARTS INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)(continued)Advertising Revenue and Revenue Sharing
Advertising revenue is derived principally from the sale of banner and in-game advertisements. Banner and in-game advertising is typically generated from contracts in which either EA or AOL provides a minimum number of impressions over the term of the guarantor’s year-end. agreed-upon commitment. Revenue is recognized as the impressions are delivered, provided that no significant obligations remain and collection of the related receivable is probable. Under the Prior Agreement, advertising revenue generated on the AOL Games Channel was recorded net of the applicable revenue share owed to AOL.
The CompanyPrior Agreement required that AOL pay EA 50 percent of all revenue collected by AOL from the sale of advertisements on EA’s online games sites, until advertising revenue reached $16.0 million in a year (measured from October 1 through the following September 30). Thereafter, the Prior Agreement provided that AOL would pay EA 70 percent of all advertising revenue collected by AOL from the sale of advertisements on EA’s game sites. Under the New Agreement, AOL is currently assessingentitled to retain all advertising revenue collected by AOL from the impactsale of adoptingadvertisements on EA’s games sites on the initial recognitionAOL properties, until net advertising revenue reaches $20.0 million in the twelve months ended March 31, 2004, and initial measurement requirementsuntil net advertising revenue reaches $35.0 million for the remainder of FIN 45 onthe term of the New Agreement. After advertising revenue exceeds these thresholds, AOL is required to pay EA 50 percent of the additional net advertising revenue.
Other Fee Arrangements
Under the Prior Agreement, EA was also required to pay AOL a percentage of its consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148,“Accountingsubscription, e-commerce and anchor tenancy revenue that exceeded certain amounts. These costs were expensed as incurred and were classified as “Cost of goods sold” in EA’s Condensed Consolidated Statement of Operations. EA does not net these costs against revenue because it maintains responsibility for Stock-Based Compensation — Transitionproviding e-commerce products and Disclosure — an Amendment of FASB Statement No. 123”. SFAS No. 148 amends FASB Statement No. 123,“Accounting for Stock-Based Compensation”, to provide alternative methods of transition for an entity that voluntarily changessubscription services directly to the fair-value-based method of accounting for stock-based employee compensation. It also amendsconsumer and retains the disclosure provisions of that statement to require prominent disclosure about the effects on reported net income and earnings per share and the entity’s accounting policy decisions with respect to stock-based employee compensation. Certain of the disclosure requirements are required for all companies, regardless of whether the fair value method or intrinsic value method is used to account for stock-based employee compensation arrangements. The Company continues to accountprimary inventory risk for its employee incentive stock option plans usingproducts and games service.
Under the intrinsic value methodNew Agreement, EA is required to pay AOL a percentage of its revenue derived from game service subscriptions, e-commerce, downloadable games and prize games that EA makes available on the AOL online services. EA accounts for these amounts in accordance with the recognition and measurement principles of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees.” The amendments to SFAS 123 will be effective for financial statements for fiscal years ended after December 15, 2002 and for interim periods beginning after December 15, 2002. The Company will adopt the disclosure provisions of this statement in its fourth quarter of fiscal year 2003.a similar manner as described above.
(15) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, ““Consolidation of Variable Interest Entities”Entities” (“FIN 46”). This interpretation of Accounting Research Bulletin No. 51, ““Consolidated Financial Statements,” addresses consolidation by business enterprises of variable interest entities. Under current practice, two enterprises generally have been included in consolidated financial statements because one enterprise controls the other through voting interests. FIN 46 defines the concept of “variable interests” and requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities(“VIEs”) that either: (i) do not effectively disperse risks amonghave sufficient equity investment at risk to permit the parties involved.entity to finance its activities without additional subordinated financial support, or (ii) are owned by equity investors who lack an essential characteristic of a controlling financial interest. This interpretation applies immediately to variable interest entitiesVIEs created after January 31, 2003. ItWith regard to VIE’s already in existence prior to February 1, 2003, the implementation of FIN 46 has been delayed and currently applies into the first fiscal year or interim period beginning after JuneDecember 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. If it is reasonably possible that an enterprise will consolidate or disclose information about a variable interest entity when FIN 46 becomes effective, the enterprise shall disclose information about those entitiesrequires disclosure of VIEs in all financial statements issued after January 31, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment2003, if it is reasonably possible that as of the date on whichtransition date: (i) EA will be the primary beneficiary of an existing VIE that will require consolidation, or (ii) EA will hold a significant variable interest in, or have significant involvement with, an existing VIE. EA does not believe that it is first appliedhas any entities that will require disclosure or by restating previously issued financial statements for one or more years withnew consolidation as a cumulative-effect adjustment asresult of adopting the beginning of the first year restated. Based on the recent releaseprovisions of FIN 46, the Company has not completed its assessment as to whether or not the adoption of FIN 46 will have a material impact on its consolidated financial statements.46.
2419
Item 2. Management’s Discussion and Analysis Ofof Financial Condition and Results Ofof Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking. We use words such as anticipates, believes, expects, intends, future“anticipates”, “believes”, “expects”, “intends”, “future” and similar expressions to help identify forward-looking statements. These forward-looking statements are subject to business and economic risk and management’s expectations, and are inherently uncertain and difficult to predict. Our actual results could differ materially from management’s expectations due to such risks. 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 include, but are not limited to, those discussed in this report below under the heading “Risk Factors” at pages 55 to 61,, as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 20022003 as filed with the Securities and Exchange Commission (SEC)(“SEC”) on June 28, 200210, 2003 and in other documents filed with the SEC.
Critical Accounting PoliciesCRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis ofOur Condensed Consolidated Financial Condition and Results of Operations discusses our consolidated financial statements. Our financial statementsStatements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statementsCondensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, and revenuesrevenue and expenses during the reporting period. The policies discussed below are considered by management to be critical because they are not only important to the portrayal of our financial condition and results of operations but also because application and interpretation of these policies requires both judgment and estimates ofon matters that are inherently uncertain and unknown. As a result, actual results may differ materially from our estimates.
Sales allowances and bad debt reserves
We principally derive revenuesrevenue from sales of our packaged goods product, subscriptions of online service, sales of packaged goods through our online storeinteractive software games designed for play on videogame consoles (such as the PlayStation 2, Xbox and website advertising.Nintendo GameCube), PCs and hand-held game machines (such as the Nintendo Game Boy Advance). Product revenue is recognized net of sales allowances. We also have stock-balancing programs for our personal computerPC products, which allow for the exchange of personal computerPC products by resellers under certain circumstances. We may decide to provide price protection under certain circumstances for both our personal computer and video gamevideogame system products afterproducts. In making this determination we analyze:evaluate: inventory remaining in the channel, the rate of inventory sell-through in the channel, and our remaining inventory on hand. It is our policygeneral practice to exchange products or give credits, rather than give cash refunds.
We estimate potential future product returns, price protection and stock-balancing programs related to current period product revenue. We analyze historical returns, current sell-through of distributor and retailer inventory of our products, current trends in the video gamevideogame market and the overall economy, changes in customer demand and acceptance of our products and other related factors when evaluating the adequacy of the sales returns and price protection allowances. In addition, management monitors and manages the volume of our sales to retailers and distributors
25
and their inventories, as substantial overstocking in the distribution channel can result in high returns or the requirement for substantial price protection requirements in subsequent periods. In the past, actual returns have not generally exceeded our reserves. However, actual returns and price protections may materially exceed our estimates as unsold products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing products. For example, the risk of product returns for our products on mature platforms may increase as new hardware platforms, such asthe Xbox, Nintendo GameCube and PlayStation 2 become more popular.consoles pass the midpoint of their lifecycle and an increasing number and aggregate amount of competitive products heighten pricing and competitive pressures. While management believes it can make reliable estimates forregarding these matters, these estimates are inherently subjective. Accordingly, if weour estimates changed, our assumptions and estimates, our returns reserves would change, which would impact the net revenue we report. For example, if actual returns were significantly greater than the reserves we have established, theour actual results would decrease our reported net revenue. Conversely, if actual returns were significantly less than our reserves, this would increase our reported net revenue.
20
Similarly, significant judgment is required to estimate our allowance for doubtful accounts in any accounting period. OurWe determine our allowance for doubtful accounts is determined by evaluating customer credit-worthinesscreditworthiness in the context of current economic trends. Depending upon the overall economic climate and the financial condition of our customers, the amount and timing of our bad debt expense could change significantly.
We also have no way of accurately forecastingcannot predict customer bankruptcies or an inability of any of our customers to meet their financial obligations to us. Therefore, our estimates could differ materially from actual results.
Our gross accounts receivable balance was $815,680,000 and our allowance for product returns, pricing allowances and doubtful accounts was $206,651,000 as of December 31, 2002. As of March 31, 2002, our gross accounts receivable balance was $306,365,000 and our allowance for product returns, pricing allowances and doubtful accounts was $115,870,000.
Prepaid royalties
Prepaid royalties consist primarily of prepayments for manufacturing royalties, advances paid to our co-publishing and/or distribution affiliates and license fees paid to celebrities, professional sports organizations and other organizations for our use of their trade namenames and content. 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 or effective royalty rate as cost of goods sold based on actual net product sales. We evaluate the future realization of prepaid royalties quarterly and charge to research and development expense anydetermine amounts that we deem unlikely to be realized through product sales. WeAny impairments determined before the launch of a product are charged to research and development expense. Impairments determined post launch are charged to cost of goods sold. In either case, we rely on forecasted revenue to evaluate the future realization of prepaid royalties. If actual revenues,revenue, or revised sales forecasts, fallfalls below the initial forecasted sales, the charge to research and development expensetaken may be larger than anticipated in any given quarter. Once theIf a charge has been taken prior to research and development expense,the product launch, that amount will not be expensed in future quarters when the product has shipped. The current portion of prepaid royalties, included in other current assets, was $41,487,000 at December 31, 2002 and $65,484,000 at March 31, 2002. The long-term portion of prepaid royalties, included in other assets, was $2,885,000 at December 31, 2002 and $1,164,000 at March 31, 2002.
26
Valuation of long-lived assets including goodwill and other intangible assets
We evaluate both purchased intangible assets and other long-lived assets in order to determine if events or changes in circumstances indicate an other-than-temporarya potential impairment in value.value exists. This evaluation requires us to estimate, among other things, the remaining useful lives along with future estimates of cash flows of the business. All require the use of judgment and estimates. Our actual results could differ materially from our current estimates. Please see our Risk Factors section for a discussion of risks and uncertainties that may affect our future results.
Under current accounting standards, we make judgments about the remaining useful lives of purchased intangible assets and other long-lived assets whenever events or changes in circumstances indicate an other-than-temporarya potential impairment in the remaining value of the assets recorded on our balance sheet. In order to determine if an other-than-temporarya potential impairment has occurred, management makes various assumptions about the future value of the asset, by evaluating future business prospects and estimated cash flows. Please refer to the Operations by Segment discussion of the Management’s Discussion and Analysis of Financial Condition and Results of Operations for discussions of EA Core and EA.com. For our EA Core division, ourOur future net cash flows are primarily dependent on the sale of products for play on proprietary videovideogame consoles, hand-held game platforms.machines and PC’s (“platforms”). The success of our products is affected by theour ability to accurately predict which platforms and which products we develop will be successful. Also, our revenuesrevenue and earnings are dependent on our ability to meet our product release schedules. For our EA.com division, the future net cash flows are dependent on the success of online games. Offering games solely for online play is a substantial departure from our traditional business of selling packaged software games. The EA.com business is not yet mature or profitable, therefore evaluating its business and prospects is more difficult than would be the case for a more mature business. For example, on December 17, 2002 we launchedThe Sims OnlineTM. While we cannot yet accurately predict the ultimate success of this product, sales of this game have not met our expectations and may negatively impact our ability to generate positive cash flows at EA.com. Due to product sales shortfalls, and other factors described in our Risk Factors, we may not realize the future net cash flows necessary to recover our long-lived assets, which may result in an impairment charge being recorded in the future.
On April 1, 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142,“Goodwill and Other Intangible Assets”. As a result of adopting this standard, we will continue to amortize finite-lived intangibles, but will no longer amortize certain other intangible assets, most notably goodwill and acquired workforce. In lieu of amortization, SFAS No. 142 requires a two-step approach to testing goodwill for impairment for each reporting unit. The first step, required to be completed by During the six-month periods ended September 30, 2003 or September 30, 2002 tests forno impairment by applying fair value-based tests at the Company’s reporting unit level. The second step (if necessary), required to be completed by March 31, 2003, measures the amount of impairment by applying fair value-based tests to individual assets and liabilities within each reporting unit. We completed the first step of transitional goodwill impairment testing during the first quarter of fiscal 2003 and found no indicators of impairment of ourcharges were recorded goodwill. As a result, we have recognized no transitional impairment loss in fiscal 2003 in connection with the adoption of SFAS No. 142. We will complete the annual impairment test in the fourth quarter of fiscal 2003 with a measurement date of January 1 and any impairment that arises from that analysis will be accounted for in the fourth quarter of 2003. There can be no assurance that future impairment tests will not result in a charge to earnings and there is a potential for a write down of goodwill in connection with the annual impairment test. Following adoption of SFAS No. 142, we continue to evaluate whether any event has occurred which might indicate that the carrying value of an intangible asset is not recoverable.on long-lived assets.
27
Income taxes
In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. As part of the process of preparing our consolidated financial statements,Condensed Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our current tax exposures in each jurisdiction including the impact, if any, of additional taxes resulting from tax examinations as well asand making judgments regarding the recoverability of deferred tax assets. ToA valuation allowance is established to the extent recovery of deferred tax assets is not likely based on our estimation of future taxable income in each jurisdiction, a valuation allowance is established.jurisdiction. Tax exposures can involve complex issues and may require an extended period to resolve. To determine the quarterly tax rate, we are required to estimate full-year income and the related income tax expense in each jurisdiction. The estimated effective tax rate is adjusted for the tax related to significant unusual items. Changes in the geographic mix or estimated level of annual pre-tax income can affect the overall effective tax rate.
21
RESULTS OF OPERATIONS
RevenuesRevenue
We principally derive revenues primarilyrevenue from shipmentssales of entertainmentpackaged interactive software which includes EA Studio productsgames designed for dedicated entertainment systems (that we call “video game systems” or “consoles” such as PlayStation®, PlayStation® 2, XboxTM and Nintendo GameCubeTM, and handheld systems such as Game Boy® Advance), EA Studio personal computer products (PC), Co-Publishing products that are co-published and distributed by us, and Affiliated Label (AL) products that are published by third parties and distributed by us.play on videogame platforms. We also derive revenuesadditional revenue from licensing of EA Studio products and AL products through hardware companies (or OEM), selling subscriptions onto some of our online game service,games, selling advertisements on our online web pages, and selling our packaged goods through our online store.store, receiving programming fees for integrated online content and by allowing other companies to manufacture and sell our products in conjunction with other products.
Geographically, our net revenuesrevenue for the three and ninesix months ended December 31,September 30, 2003 and 2002 and 2001 break down as followsis presented below (in thousands):
December 31, | December 31, | |||||||||||||||
2002 | 2001 | Increase | % change | |||||||||||||
Net Revenues for the Three Months Ended: | ||||||||||||||||
North America | $ | 695,630 | $ | 510,752 | $ | 184,878 | 36.2 | % | ||||||||
Europe | 470,742 | 279,601 | 191,141 | 68.4 | % | |||||||||||
Asia Pacific | 38,208 | 21,801 | 16,407 | 75.3 | % | |||||||||||
Japan | 29,146 | 20,724 | 8,422 | 40.6 | % | |||||||||||
International | 538,096 | 322,126 | 215,970 | 67.0 | % | |||||||||||
Consolidated Net Revenues | $ | 1,233,726 | $ | 832,878 | $ | 400,848 | 48.1 | % | ||||||||
December 31, | December 31, | |||||||||||||||
2002 | 2001 | Increase | % change | |||||||||||||
Net Revenues for the Nine Months Ended: | ||||||||||||||||
North America | $ | 1,182,768 | $ | 783,369 | $ | 399,399 | 51.0 | % | ||||||||
Europe | 713,926 | 392,615 | 321,311 | 81.8 | % | |||||||||||
Asia Pacific | 67,200 | 39,859 | 27,341 | 68.6 | % | |||||||||||
Japan | 55,220 | 39,141 | 16,079 | 41.1 | % | |||||||||||
International | 836,346 | 471,615 | 364,731 | 77.3 | % | |||||||||||
Consolidated Net Revenues | $ | 2,019,114 | $ | 1,254,984 | $ | 764,130 | 60.9 | % | ||||||||
Net Revenue for the Three | September 30, | September 30, | Increase/ | |||||||||||||
Months Ended | 2003 | 2002 | (Decrease) | % change | ||||||||||||
North America | $ | 358,184 | $ | 313,559 | $ | 44,625 | 14 | % | ||||||||
Europe | 145,002 | 116,654 | 28,348 | 24 | % | |||||||||||
Asia Pacific | 17,617 | 13,803 | 3,814 | 28 | % | |||||||||||
Japan | 9,202 | 9,474 | (272 | ) | (3 | %) | ||||||||||
International | 171,821 | 139,931 | 31,890 | 23 | % | |||||||||||
Consolidated Net Revenue | $ | 530,005 | $ | 453,490 | $ | 76,515 | 17 | % | ||||||||
Net Revenue for the Six | September 30, | September 30, | Increase/ | |||||||||||||
Months Ended | 2003 | 2002 | (Decrease) | % change | ||||||||||||
North America | $ | 557,025 | $ | 487,138 | $ | 69,887 | 14 | % | ||||||||
Europe | 272,928 | 243,184 | 29,744 | 12 | % | |||||||||||
Asia Pacific | 32,088 | 28,992 | 3,096 | 11 | % | |||||||||||
Japan | 21,345 | 26,074 | (4,729 | ) | (18 | %) | ||||||||||
International | 326,361 | 298,250 | 28,111 | 9 | % | |||||||||||
Consolidated Net Revenue | $ | 883,386 | $ | 785,388 | $ | 97,998 | 12 | % | ||||||||
28Net Revenue
Net Revenues
Net Revenuesrevenue for the three months ended December 31, 2002September 30, 2003 increased by 4817 percent as compared to the three months ended December 31, 2001. The increasesame period in the prior fiscal year. Foreign exchange rates (primarily the Euro and the Pound Sterling) strengthened reported net revenue by approximately $14.3 million or 3.0 percent in the current quarter. Strong sales of our PlayStation 2, Xbox and PC platform products were partially offset by a decline in net revenuesrevenue from PlayStation products as we transition away from that platform. In addition, based on reported amounts, the net revenue increase was driven by the following:
• | |||
Net Revenues for the nine months ended December 31, 2002increased by 61 percent as compared to the nine months ended December 31, 2001. The increase in net revenues was driven by the following:
• | Strong | ||
2922
• | |||
Net revenue for the six months ended September 30, 2003 increased by 12 percent as compared to the same period in the prior fiscal year. Foreign exchange rates (primarily the Euro and the Pound Sterling) strengthened reported net revenue by approximately $35.5 million or 4.5 percent in the current period. Based on reported amounts, the net revenue increase was driven by the following:
• | Strong sales of our PlayStation 2, Xbox and PC products for an aggregate increase of $103.4 million. The increase was driven primarily byNBA STREET Vol. 2, Def Jam VENDETTA, Tiger Woods PGA TOUR 2004, Madden NFL 2004andThe Simsfranchise products. These increases were partially offset by strong net revenue in the six months ended September 30, 2002 for2002 FIFA World Cupand theMedal of Honorfranchise products. |
• | Net |
North America
For the three months ended September 30, 2003, net revenue from sales in North America increased by 14 percent as compared to the three months ended September 30, 2002. Based upon reported amounts, the net revenue increase was driven by the following:
• | Strong sales of our Playstation 2 and Xbox products for an aggregate increase of $81.5 million. The increase was primarily due to strong EA Sports title net revenue onMadden, Tiger Woods PGA TOUR, NHL,andNCAA Footballfranchise products. |
• | PC net revenue increase of 15 percent to |
• | Partially offset by a 55 percent decrease in net revenue from co-publishing and distribution products to $20.2 million from $44.7 million in the same period of the prior fiscal year. The | ||
North America
For the threesix months ended December 31, 2002, revenuesSeptember 30, 2003, net revenue from sales in North America increased by 3614 percent as compared to $695,630,000versus $510,752,000 in the same period of the prior fiscal year. Growth in North Americansix months ended September 30, 2002. The net revenue increase was driven by:by the following:
• | |||
• |
• | Also partially offset by a 26 percent decrease in net revenue from co-publishing and distribution products to $44.4 million versus $59.7 million in the six months ended September 30, 2002. The decrease was due in large part to net revenue in the six months ended September 30, 2002 forKingdom HeartsandBuffy the |
23
Vampire Slayer, partially offset by net revenue in the same period of the |
International
Europe
For the three months ended September 30, 2003, net revenue from sales in Europe increased by 24 percent as compared to the three months ended September 30, 2002. Foreign exchange rates strengthened reported European net revenue by approximately $11.7 million or 10 percent. Based upon reported amounts, the net revenue increase was driven by the following:
• | Co-publishing and distribution product sales increased by $20.4 million, or 48 percent, primarily due to net revenue fromSoul Calibur IIandFreedom Fighters,partially offset by decreases in the current |
• | Playstation 2, Xbox and PC product sales increased by $11.8 million, or 31 percent, primarily due to the additional titles available on the Xbox console and strong current fiscal year net revenue onEA SPORTS Rugby 2004,Command & Conquer: Generals,andTiger Woods PGA TOURfranchise products, as well asLord of the Rings: The Two Towers, partially offset by strong sales in the same period of the prior fiscal | ||
For the nine months ended December 31, 2002, revenues in North America increased by 51 percent to $1,182,768,000versus $783,369,000 in the same period of the prior fiscal year. Growth in North American revenue was driven by:
• | |||
30
International
Europe
For the threesix months ended December 31, 2002,September 30, 2003, net revenuesrevenue from sales in Europe increased by 6812 percent as compared to $470,742,000versus $279,601,000 a year ago. Netthe six months ended September 30, 2002. Foreign exchange rates strengthened reported European net revenue growth in Europeby approximately $30.8 million or 13 percent. Based upon reported amounts, the increase was driven by:by the following:
• | |||
For the nine months ended December 31, 2002, net revenues in Europe increased by 82 percent to $713,926,000versus $392,615,000 a year ago. Net revenue growth in Europe was driven by:
• | |||
Asia Pacific
For the three months ended December 31, 2002, net revenues in Asia Pacific increased by 75 percent to $38,208,000versus $21,801,000 a year ago. Growth in net revenues in Asia Pacific was driven by strong sales of PlayStation 2 and Xbox titles.
For the nine months ended December 31, 2002, net revenues in Asia Pacific increased by 69 percent to $67,200,000versus $39,859,000 a year ago. Growth in net revenues in Asia Pacific was driven by strong sales of PlayStation 2 titles, most notablyThe Lord of the Rings, The Two TowersandMedal of Honor: Frontlineand Affiliated Label titles.
Japan
For the three months ended December 31, 2002, net revenues in Japan increased by 41 percent to $29,146,000versus $20,724,000 a year ago. Growth in net revenues in Japan was driven by strong sales of Affiliated Label and PlayStation 2 titles.
For the nine months ended December 31, 2002, net revenues in Japan increased by 41 percent to $55,220,000versus $39,141,000 a year ago. Growth in net revenues in Japan was driven by strong sales of titles associated with the PlayStation 2, most notably2002 FIFA World CupandProject FIFA World Cup, and Affiliated Label titles.
31
Information about our worldwide net revenues by product line for the three and nine months ended December 31, 2002 and 2001 is presented below (in thousands):
December 31, | December 31, | Increase/ | ||||||||||||||
2002 | 2001 | (Decrease) | % change | |||||||||||||
Net Revenues for the Three Months Ended: | ||||||||||||||||
PlayStation 2 | $ | 459,407 | $ | 227,554 | $ | 231,853 | 101.9 | % | ||||||||
PC | 219,083 | 194,856 | 24,227 | 12.4 | % | |||||||||||
Xbox | 116,836 | 44,629 | 72,207 | 161.8 | % | |||||||||||
Nintendo GameCube | 111,103 | 30,026 | 81,077 | 270.0 | % | |||||||||||
PlayStation | 53,066 | 122,940 | (69,874 | ) | (56.8 | %) | ||||||||||
Game Boy Advance | 68,102 | 30,543 | 37,559 | 123.0 | % | |||||||||||
Advertising | 9,461 | 10,556 | (1,095 | ) | (10.4 | %) | ||||||||||
Game Boy Color | 22,610 | 24,176 | (1,566 | ) | (6.5 | %) | ||||||||||
Online Subscriptions | 9,193 | 7,002 | 2,191 | 31.3 | % | |||||||||||
License, OEM and Other | 7,396 | 19,813 | (12,417 | ) | (62.7 | %) | ||||||||||
1,076,257 | 712,095 | 364,162 | 51.1 | % | ||||||||||||
Affiliated Label | 157,469 | 120,783 | 36,686 | 30.4 | % | |||||||||||
Consolidated Net Revenues | $ | 1,233,726 | $ | 832,878 | $ | 400,848 | 48.1 | % | ||||||||
December 31, | December 31, | Increase/ | ||||||||||||||
2002 | 2001 | (Decrease) | % change | |||||||||||||
Net Revenues for the Nine Months Ended: | ||||||||||||||||
PlayStation 2 | $ | 752,717 | $ | 369,836 | $ | 382,881 | 103.5 | % | ||||||||
PC | 377,835 | 318,818 | 59,017 | 18.5 | % | |||||||||||
Xbox | 174,466 | 44,629 | 129,837 | 290.9 | % | |||||||||||
Nintendo GameCube | 153,897 | 30,026 | 123,871 | 412.5 | % | |||||||||||
PlayStation | 90,495 | 162,129 | (71,634 | ) | (44.2 | %) | ||||||||||
Game Boy Advance | 73,919 | 30,543 | 43,376 | 142.0 | % | |||||||||||
Advertising | 28,579 | 25,317 | 3,262 | 12.9 | % | |||||||||||
Game Boy Color | 25,131 | 28,455 | (3,324 | ) | (11.7 | %) | ||||||||||
Online Subscriptions | 24,969 | 22,146 | 2,823 | 12.7 | % | |||||||||||
License, OEM and Other | 16,349 | 37,464 | (21,115 | ) | (56.4 | %) | ||||||||||
1,718,357 | 1,069,363 | 648,994 | 60.7 | % | ||||||||||||
Affiliated Label | 300,757 | 185,621 | 115,136 | 62.0 | % | |||||||||||
Consolidated Net Revenues | $ | 2,019,114 | $ | 1,254,984 | $ | 764,130 | 60.9 | % | ||||||||
32
PlayStation 2 Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 459,407 | 37.2 | % | $ | 227,554 | 27.3 | % | 101.9 | % | ||||||||||
Nine Months Ended | $ | 752,717 | 37.3 | % | $ | 369,836 | 29.5 | % | 103.5 | % | ||||||||||
Net revenues increased for the three months ended December 31, 2002 by 102 percent to $459,407,000versus $227,554,000 a year ago. The increase was primarily due to the following:
• | |||
Net revenues increased for the nine months ended December 31, 2002104 percent to $752,717,000versus $369,836,000 for the comparable period in 2001. The increase was$6.7 million primarily due to our transition away from this platform.
Asia Pacific
For the three months ended September 30, 2003, net revenue from sales in the Asia Pacific region, excluding Japan, increased by 28 percent to $17.6 million versus $13.8 million for the three months ended September 30, 2002. Foreign exchange rates strengthened reported Asia Pacific net revenue by approximately $2.4 million or 18 percent. Based upon reported amounts, the net revenue increase was driven by the following:
• | |||
We expect net revenues from PlayStation 2 products to continue to grow in fiscal 2003, but as net revenues for these products increase, we expect our growth rates to decrease. We expect that premium titles will continue to hold their current price points, however we expect lower price points for non-premium titles.
Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America as of April 2000, as amended, we are authorized to develop and distribute DVD-based software products compatible with the PlayStation 2. Pursuant to this agreement, we engage Sony to supply PlayStation 2 CD’s and DVDs for distribution by us. Accordingly, we have limited ability to control our supply of PlayStation 2 CD and DVD products or the timing of their delivery.
33
Personal Computer Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 219,083 | 17.8 | % | $ | 194,856 | 23.4 | % | 12.4 | % | ||||||||||
Nine Months Ended | $ | 377,835 | 18.7 | % | $ | 318,818 | 25.4 | % | 18.5 | % | ||||||||||
Net revenues increased for the three months ended December 31, 2002 by 12 percent to $219,083,000versus $194,856,000 a year ago. The increase was primarily due to the following:
Net revenues increased for the nine months ended December 31, 2002 by 19 percent to $377,835,000versus $318,818,000 for the comparable period in 2001. The increase was primarily due to the following:
Due to the strong sales ofThe Simsproducts in fiscal 2002, we expect revenues from PC products to be up only slightly in fiscal 2003.
Xbox Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 116,836 | 9.5 | % | $ | 44,629 | 5.4 | % | 161.8 | % | ||||||||||
Nine Months Ended | $ | 174,466 | 8.6 | % | $ | 44,629 | 3.6 | % | 290.9 | % | ||||||||||
Net revenues increased for the three months ended December 31, 2002by 162 percent to $116,836,000 versus $44,629,000 a year ago. The increase was primarily due to the following:
34
Net revenues increased for the nine months ended December 31, 2002by 291 percent to $174,466,000 versus $44,629,000 for the comparable period in 2001. The increase was primarily due to the following:
We expect net revenues from Xbox products to continue to grow in fiscal 2003, but as net revenues for these products increase, we expect our growth rates to decrease. We expect that premium titles will continue to hold their current price points, however we expect lower price points for non-premium titles.
Nintendo GameCube Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 111,103 | 9.0 | % | $ | 30,026 | 3.6 | % | 270.0 | % | ||||||||||
Nine Months Ended | $ | 153,897 | 7.6 | % | $ | 30,026 | 2.4 | % | 412.5 | % | ||||||||||
Net revenues increased for the three months ended December 31, 2002by 270 percent to $111,103,000 versus $30,026,000 a year ago. The increase was primarily due to the following:
Net revenues increased for the nine months ended December 31, 2002by 413 percent to $153,897,000 versus $30,026,000 for the comparable period in 2001. The increase was primarily due to the following:
3524
• | |||
For the six months ended September 30, 2003, net revenue from sales in the Asia Pacific region, excluding Japan, increased by 11 percent to $32.1 million versus $29.0 million for the six months ended September 30, 2002. Foreign exchange rates strengthened reported Asia Pacific net revenue by approximately $3.9 million or 14 percent. Based upon reported amounts, the net revenue increase was driven by the following:
• |
• | Co-publishing and distribution product sales, which increased by $1.1 million, or 13 percent, primarily due to net revenue fromSoul Calibur II. |
Japan
For the three months ended September 30, 2003, net revenue from sales in Japan decreased by 3 percent to $9.2 million from $9.5 million. Foreign exchange rates strengthened reported net revenue in Japan by approximately $0.1 million or 1 percent. Based upon reported amounts, the net revenue decrease was driven by the following:
• | Co-publishing and distribution product sales, which decreased by $1.4 million, or 26 percent, primarily due to strong prior year net revenue in the three months ended September 30, 2002 fromEver17,Tenkatouitsu 4andGundam Net Op,partially offset by the current |
We expect
• | Partially offset by PlayStation 2 and PC product sales, which increased $0.9 million primarily due to stronger sales from key products, includingF1 Career Challenge, SimCity 4andDef Jam VENDETTA. |
For the six months ended September 30, 2003, net revenuesrevenue from sales in Japan decreased by 18 percent to $21.3 million versus $26.1 million for the six months ended September 30, 2002. Foreign exchange rates strengthened reported net revenue in Japan by approximately $0.8 million or 3 percent. Based upon reported amounts, the net revenue decrease was driven by the following:
• | PlayStation 2 product sales, which decreased $6.9 million, primarily due to reduced sales onFIFAfranchise products, partially offset byThe Sims, MVP BaseballandNBA STREET Vol. 2. |
• | Offset partially by co-publishing and distribution product sales, which increased by $2.2 million, or 31 percent, primarily due to net revenue fromMax PayneandMemo Off Mix. |
Revenue by Product Line
Our worldwide net revenue by product line for the three and six months ended September 30, 2003 and 2002 is summarized below (in thousands):
25
Net Revenue for the Three | September 30, | September 30, | Increase/ | |||||||||||||
Months Ended | 2003 | 2002 | (Decrease) | % change | ||||||||||||
PlayStation 2 | $ | 221,180 | $ | 158,712 | $ | 62,468 | 39.4 | % | ||||||||
PC | 93,022 | 82,686 | 10,336 | 12.5 | % | |||||||||||
Xbox | 68,691 | 37,527 | 31,164 | 83.0 | % | |||||||||||
Nintendo GameCube | 24,553 | 27,838 | (3,285 | ) | (11.8 | %) | ||||||||||
Subscription Services | 11,124 | 8,321 | 2,803 | 33.7 | % | |||||||||||
Advertising, Programming, Licensing, and Other | 7,552 | 14,161 | (6,609 | ) | (46.7 | %) | ||||||||||
PlayStation | 7,562 | 24,206 | (16,644 | ) | (68.8 | %) | ||||||||||
Game Boy Advance | 3,809 | 3,679 | 130 | 3.5 | % | |||||||||||
437,493 | 357,130 | 80,363 | 22.5 | % | ||||||||||||
Co-publishing and Distribution | 92,512 | 96,360 | (3,848 | ) | (4.0 | %) | ||||||||||
Total Net Revenue | $ | 530,005 | $ | 453,490 | $ | 76,515 | 16.9 | % | ||||||||
Net Revenue for the Six | September 30, | September 30, | Increase/ | |||||||||||||
Months Ended | 2003 | 2002 | (Decrease) | % change | ||||||||||||
PlayStation 2 | $ | 339,549 | $ | 293,310 | $ | 46,239 | 15.8 | % | ||||||||
PC | 173,360 | 158,752 | 14,608 | 9.2 | % | |||||||||||
Xbox | 100,212 | 57,630 | 42,582 | 73.9 | % | |||||||||||
Nintendo GameCube | 45,707 | 42,794 | 2,913 | 6.8 | % | |||||||||||
Subscription Services | 24,755 | 16,860 | 7,895 | 46.8 | % | |||||||||||
Advertising, Programming, Licensing, and Other | 16,263 | 29,508 | (13,245 | ) | (44.9 | %) | ||||||||||
PlayStation | 13,313 | 37,429 | (24,116 | ) | (64.4 | %) | ||||||||||
Game Boy Advance | 6,168 | 5,817 | 351 | 6.0 | % | |||||||||||
719,327 | 642,100 | 77,227 | 12.0 | % | ||||||||||||
Co-publishing and Distribution | 164,059 | 143,288 | 20,771 | 14.5 | % | |||||||||||
Total Net Revenue | $ | 883,386 | $ | 785,388 | $ | 97,998 | 12.5 | % | ||||||||
PlayStation 2 Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 221,180 | 41.7 | % | $ | 158,712 | 35.0 | % | 39.4 | % | ||||||||||
Six months ended | $ | 339,549 | 38.4 | % | $ | 293,310 | 37.3 | % | 15.8 | % | ||||||||||
For the three months ended September 30, 2003, net revenue from PlayStation 2 products increased by 39 percent to $221.2 million versus $158.7 million for the three months ended September 30, 2002. The increase was primarily due to strong sales ofMaddenandTiger Woods PGA TOURfranchise products in the current quarter.This increase was partially offset by lower net revenue from theMedal of Honorfranchise compared to the same period in the prior fiscal year.
For the six months ended September 30, 2003, net revenue from PlayStation 2 products increased by 16 percent to $339.5 million versus $293.3 million for the six months ended September 30, 2002. The increase was primarily due to current fiscal year sales of hit titlesDef Jam VENDETTA, The Sims, and franchise products includingNBA STREET, Madden, Tiger Woods PGA TOUR, andNHL. This increase was partially offset by lower net revenue fromMedal of Honor Frontlinecompared to the same period in the prior fiscal year.
26
Personal Computer Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 93,022 | 17.6 | % | $ | 82,686 | 18.2 | % | 12.5 | % | ||||||||||
Six months ended | $ | 173,360 | 19.6 | % | $ | 158,752 | 20.2 | % | 9.2 | % | ||||||||||
For the three months ended September 30, 2003, net revenue from products for the PC increased by 13 percent to $93.0 million versus $82.7 million in the three months ended September 30, 2002. The increase was primarily due to strong sales of hit franchise products includingSimCityfranchise products, (particularlySimCity 4 DeluxeandSimCity 4 Rush Hour) andCommand & Conquer,Medal of HonorandNHLfranchise products. This was partially offset by a decrease in net revenue onThe Simsfranchise products. Ten titles were released in the current fiscal quarter versus three in the same period in the prior fiscal year.
For the six months ended September 30, 2003, net revenue from products for the PC increased by 9 percent to $173.4 million versus $158.8 million in the six months ended September 30, 2002. The increase was primarily due to stronger current year net revenue of products fromCommand & Conquer,SimCityandMedal of Honorfranchise products, partially offset by lower net revenue from prior fiscal year hit title2002 FIFA World Cup. Current fiscal year releases includedThe Sims Superstar,The Sims Double Deluxe,SimCity 4 Deluxe, andSimCity 4 Rush Hour. Other prior fiscal year releases continued to generate strong sales, particularlyThe Sims DeluxeandThe Sims Unleashed. Twelve titles were released in the six months ended September 30, 2003 versus five titles released in the same period of the prior fiscal year.
Xbox Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of | September 30, | % of | |||||||||||||||||
2003 | net revenue | 2002 | net revenue | % change | ||||||||||||||||
Three months ended | $ | 68,691 | 13.0 | % | $ | 37,527 | 8.3 | % | 83.0 | % | ||||||||||
Six months ended | $ | 100,212 | 11.3 | % | $ | 57,630 | 7.3 | % | 73.9 | % | ||||||||||
For the three months ended September 30, 2003, net revenue of Xbox products increased by 83 percent to $68.7 million versus $37.5 million in the three months ended September 30, 2002. The increase was primarily due to the higher installed base of Xbox consoles as well as the sales ofTiger Woods PGA TOUR,MaddenandNHLfranchise products. Other significant titles contributing to the increase wereMedal of Honor Frontline,FIFA 2003andNBA STREET Vol. 2. Five titles were released in the current fiscal quarter versus three in the same period in the prior fiscal year.
For the six months ended September 30, 2003, net revenue of Xbox products increased by 74 percent to $100.2 million versus $57.6 million in the six months ended September 30, 2002. The increase was primarily due toNBA STREET Vol. 2,The SimsandMedal of Honor Frontline, and strong sales ofTiger Woods PGA TOUR,MaddenandNHLfranchise products. This increase was partially offset by lower net revenue for prior fiscal year hit title2002 FIFA World Cup. Seven titles were released in the six months ended September 30, 2003 versus five in the same period in the prior fiscal year.
Nintendo GameCube Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 24,553 | 4.6 | % | $ | 27,838 | 6.1 | % | (11.8 | %) | ||||||||||
Six months ended | $ | 45,707 | 5.2 | % | $ | 42,794 | 5.4 | % | 6.8 | % | ||||||||||
For the three months ended September 30, 2003, net revenue from Nintendo GameCube products decreased by 12 percent to continue to grow in fiscal 2003, but as net revenues for these products increase, we expect our growth rates to decrease. We expect that premium titles will continue to hold their current price points, however we expect lower price points for non-premium titles.
Under the terms of a licensing agreement entered into with Nintendo of America (effective as of November 1, 2001), we are authorized to develop and distribute proprietary optical format disk products compatible with the Nintendo GameCube. Pursuant to this agreement, we engage Nintendo to supply Nintendo GameCube proprietary optical format disk products for distribution by us. Accordingly, we have limited ability to control our supply of Nintendo GameCube proprietary optical format disk products or the timing of their delivery.
PlayStation Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 53,066 | 4.3 | % | $ | 122,940 | 14.8 | % | (56.8 | %) | ||||||||||
Nine Months Ended | $ | 90,495 | 4.5 | % | $ | 162,129 | 12.9 | % | (44.2 | %) | ||||||||||
The decrease in PlayStation net revenues$24.6 million versus $27.8 million for the three and nine months ended September 30, 2002. The decrease was
27
primarily due to strong sales ofFreekstyleandNASCAR ThunderTM 2003 in the prior year quarter, partially offset by current quarter sales ofTiger Woods PGA TOUR 2004.
For the six months ended September 30, 2003, net revenue from Nintendo GameCube products increased by 7 percent to $45.7 million versus $42.8 million for the six months ended September 30, 2002. The slight increase was attributable to significant new releases in the current year includingNBA STREET Vol. 2andDef Jam VENDETTA, partially offset by lower net revenue onJames Bond 007 in...Agent Under Fire. Seven titles were released in the six months ended September 30, 2003 versus six in the same period in the prior fiscal year.
Subscription Services Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 11,124 | 2.1 | % | $ | 8,321 | 1.8 | % | 33.7 | % | ||||||||||
Six months ended | $ | 24,755 | 2.8 | % | $ | 16,860 | 2.1 | % | 46.8 | % | ||||||||||
For the three months ended September 30, 2003, net revenue from subscription fees for our online games increased 34 percent to $11.1 million compared to $8.3 million for the three months ended September 30, 2002 primarily due to subscription net revenue fromThe Sims OnlineandEarth & Beyond,partially offset by a decrease in subscription net revenue fromMotor City Online(which was discontinued during the three months ended September 30, 2003).
For the six months ended September 30, 2003, net revenue from subscription fees for our online games increased 47 percent to $24.8 million compared to $16.9 million for the six months ended September 30, 2002. This increase was primarily due toThe Sims Online, which was launched in December 31, 2002, and higher subscription net revenue fromEarth & Beyond.
Advertising, Programming, Licensing and Other Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 7,552 | 1.4 | % | $ | 14,161 | 3.1 | % | (46.7 | %) | ||||||||||
Six months ended | $ | 16,263 | 1.8 | % | $ | 29,508 | 3.8 | % | (44.9 | %) | ||||||||||
For the three months ended September 30, 2003, net revenue from advertising, programming, licensing and other decreased 47 percent to $7.6 million versus $14.2 million in the three months ended September 30, 2002. The decrease was primarily due to the discontinuance (as of April 1, 2003) of advertising revenue received from AOL, partially offset by AOL programming fees initiated during the quarter ended June 30, 2003. In addition, Game Boy Color net revenue decreased in the current quarter compared to the same periods lastperiod in the prior fiscal year primarily due to lower net revenue from ourHarry Potter franchise products.
For the six months ended September 30, 2003, net revenue from advertising, programming, licensing and other decreased 45 percent to $16.3 million versus $29.5 million for the six months ended September 30, 2002. The decrease was primarily due to the discontinuance (as of April 1, 2003) of advertising revenue received from AOL, partially offset by AOL programming fees initiated during the quarter ended June 30, 2003. In addition, Game Boy Color net revenue decreased in the six months ended September 30, 2003 versus the same period in the prior fiscal year primarily due to lower net revenue for ourHarry Potterfranchise products.
PlayStation Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 7,562 | 1.4 | % | $ | 24,206 | 5.3 | % | (68.8 | %) | ||||||||||
Six months ended | $ | 13,313 | 1.5 | % | $ | 37,429 | 4.8 | % | (64.4 | %) | ||||||||||
28
For the three months ended September 30, 2003, net revenue from PlayStation products decreased 69 percent to $7.6 million versus $24.2 million for the three months ended September 30, 2002. As we expected, the decrease in net revenue from sales of PlayStation products for the three months ended September 30, 2003 was attributable to the market transition to nextnewer generation console systems. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline throughout the remainder of fiscal 2004.
For the six months ended September 30, 2003, net revenue from PlayStation products decreased 64 percent to $13.3 million versus $37.4 million for the six months ended September 30, 2002. As we expected, the decrease in net revenue was attributable to the market transition to newer generation console systems. Two new titles were released in the six months ended September 30, 2003 versus three titles in the same period in the prior fiscal 2003.year. Titles and franchises that generated lower net revenue in the six months ended September 30, 2003 include2002 FIFA World CupandMadden,Medal of HonorandNASCAR franchise products.
Game Boy Advance Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 3,809 | 0.7 | % | $ | 3,679 | 0.8 | % | 3.5 | % | ||||||||||
Six months ended | $ | 6,168 | 0.7 | % | $ | 5,817 | 0.7 | % | 6.0 | % | ||||||||||
Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994, as amended, we are authorized to develop and distribute CD-based software products compatible with the PlayStation. Pursuant to this agreement, we engage Sony to supply its 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.
Game Boy Advance Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 68,102 | 5.5 | % | $ | 30,543 | 3.7 | % | 123.0 | % | ||||||||||
Nine Months Ended | $ | 73,919 | 3.7 | % | $ | 30,543 | 2.4 | % | 142.0 | % | ||||||||||
Net revenues increased forFor the three months ended December 31, 2002by 123September 30, 2003, net revenue from Game Boy Advance increased 4 percent to $68,102,000$3.8 million versus $30,543,000$3.7 million in the three months ended September 30, 2002. Net revenue from Game Boy Advance products increased slightly due to strong sales of ourLord of the Ringsfranchise products, partially offset by lower net revenue from ourHarry Potterfranchise products. Twelve titles were available in the three months ended September 30, 2003 versus seven in the same period in the prior fiscal year.
For the six months ended September 30, 2003, net revenue from Game Boy Advance increased 6 percent to $6.2 million versus $5.8 million for the six months ended September 30, 2002. This slight increase in net revenue in the current fiscal year was primarily attributable to strong sales ofJames Bond 007: Nightfire, partially offset by lower net revenue on ourHarry Potterfranchise products.
Co-publishing and Distribution Net Revenue(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 92,512 | 17.5 | % | $ | 96,360 | 21.2 | % | (4.0 | %) | ||||||||||
Six months ended | $ | 164,059 | 18.6 | % | $ | 143,288 | 18.2 | % | 14.5 | % | ||||||||||
For the three months ended September 30, 2003, net revenue from co-publishing products and distribution products decreased 4 percent to $92.5 million compared to $96.4 million in the three months ended September 30, 2002. This decrease was primarily due to strong sales in the three months ended September 30, 2002, ofKingdom Hearts,Buffy the Vampire Slayer,Resident EvilandFinal Fantasy Xpartially offset by a net revenue increase in the same period of the current fiscal year ago. Thefrom current fiscal year releases,Soul Calibur IIandFreedom Fighters.
For the six months ended September 30, 2003, net revenue from co-publishing products and distribution products increased 15 percent to $164.1 million compared to $143.3 million in the six months ended September 30, 2002. This increase was primarily due to the following:
36
Net revenues increased for the nine months ended December 31, 2002by 142 percent to $73,919,000 versus $30,543,000 a year ago. The increase was primarily due to the following:
Game Boy Color Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 22,610 | 1.8 | % | $ | 24,176 | 2.9 | % | (6.5 | %) | ||||||||||
Nine Months Ended | $ | 25,131 | 1.2 | % | $ | 28,455 | 2.3 | % | (11.7 | %) | ||||||||||
Net revenues for Game Boy Color decreased six percent for the three months ended December 31, 2002 compared to the same period last year. Net revenues for Game Boy Color decreased 12 percent during the nine months ended December 31, 2002 compared to the same period last year primarily due to the release of the hit title last year,strong net revenue fromHarry Potter and the Sorceror’s Stone,Soul Calibur IIas well as,The World is Not EnoughFreedom Fighters,Aliens Natural SelectionandMadden NFL 2002Devil May Cry 2, versus only one new title released in the current period,Harry Potter and the Chamber of Secrets.
Advertising Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 9,461 | 0.8 | % | $ | 10,556 | 1.3 | % | (10.4 | %) | ||||||||||
Nine Months Ended | $ | 28,579 | 1.4 | % | $ | 25,317 | 2.0 | % | 12.9 | % | ||||||||||
Advertising revenues decreased for the three months ended December 31, 2002 compared to the same period last year primarily due to lower advertising revenues generated from AOL and co-branded AOL properties along with a decrease in anchor tenancy banners.
Advertising revenues increased for the nine months ended December 31, 2002 compared to the same period last year primarily due to higher advertising revenues generated from AOL and co-branded AOL properties. This increase was partially offset by lower advertising revenues generatednet revenue from EA.com and Pogo websites and a decrease in anchor tenancy banners. AOL is our exclusive advertising representative for advertising sold through AOL related links. We have been advised by AOL to expect significant declines in future advertising-related revenue. We expect advertising revenues to decline in future quarters.
License, OEM and Other Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 7,396 | 0.6 | % | $ | 19,813 | 2.4 | % | (62.7 | %) | ||||||||||
Nine Months Ended | $ | 16,349 | 0.8 | % | $ | 37,464 | 3.0 | % | (56.4 | %) | ||||||||||
The decrease in license, OEM and other net revenues for the three and nine months ended December 31, 2002 was primarily attributable to lower Nintendo 64 net revenues due to the platform transition to next-generation consoles. Nintendo 64 net revenues decreased 100 percent
37
for the three months ended December 31, 2002 and 97 percent for the nine months ended December 31, 2002. We do not intend to release any new Nintendo 64 products in fiscal 2003.
Online Subscription Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 9,193 | 0.7 | % | $ | 7,002 | 0.8 | % | 31.3 | % | ||||||||||
Nine Months Ended | $ | 24,969 | 1.2 | % | $ | 22,146 | 1.8 | % | 12.7 | % | ||||||||||
Net revenues for online subscriptions increased 31 percent for the three months ended December 31, 2002 and 13 percent for the nine months ended December 31, 2002 compared to the same periods last year primarily due to higher subscription revenues fromMotor City OnlineandEarth & Beyond,as well as the launch ofThe Sims Onlinein December 2002. These increases were partially offset by our Platinum and Sports subscription offerings which we discontinued in November 2001. The increase for the nine months ended December 31, 2002 was also partially offset by a decrease in subscription revenues fromUltima Online. Securing and maintaining subscriptions to such products will be critical to the success of EA.com both in the current fiscal year and for the long term.
The success ofThe Sims Onlineis important to the financial success of EA.com. WhileThe Sims Onlineonly shipped in December 2002 and it is premature to judge its commercial success, early results have been below our expectations.
We have also indicated that EA.com will not reach profitability, as originally expected, in the quarter ending March 31, 2003, and long-term profitability of this business segment cannot be assured. We may determine that further cost reductions are necessary.
Affiliated Label Product Net Revenues | ||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | |||||||||||||||
Three Months Ended | $ | 157,469 | 12.8 | % | $ | 120,783 | 14.5 | % | 30.4 | % | ||||||||||
Nine Months Ended | $ | 300,757 | 14.9 | % | $ | 185,621 | 14.8 | % | 62.0 | % | ||||||||||
AL net revenues increased 30 percent to $157,469,000 for the three months ended December 31, 2002 compared to $120,783,000 in the same period last year primarily due to strong sales ofKingdom Hearts, under a distribution arrangement with Square EA, andAnno 1503.The growth in the current quarter was also due to sales from co-publishing deals with Krome Studios and LEGO Interactive.
AL net revenues increased 62 percent to $300,757,000 for the nine months ended December 31, 2002 compared to $185,621,000 in the same period last year primarily due to strong sales of hit titlesKingdom HeartsandBattlefield 1942Final Fantasy X, under a co-publishing arrangement with Digital Illusions. The increase was also due to products released under co-publishing deals with Krome Studios and LEGO Interactive during the current year..
38
Operations by Segment
We operate in two business segments:
EA.com represents Electronic Arts’ online and e-Commerce businesses. EA.com’s business includes subscription revenues collected for Internet game play on our websites, website advertising, sales of packaged goods for Internet-only based games and sales of Electronic Arts games sold through the EA.com web store. The Condensed Consolidated Statements of Operations includes all revenues and costs directly attributable to EA.com, including charges for shared facilities, functions and services. Certain costs and expenses are subjective and allocations are based on management’s estimates.
Our view and reporting of business segments may change due to changes in the underlying business facts and circumstances and the evolution of our reporting to our Chief Operating Decision Maker.
Information about our operations by segment for the three and nine months ended December 31, 2002 and 2001 is presented below (in thousands):
Three Months Ended December 31, 2002 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 1,211,484 | $ | 22,242 | $ | 1,233,726 | |||||||
Cost of goods sold | 553,579 | 5,101 | 558,680 | ||||||||||
Gross profit | 657,905 | 17,141 | 675,046 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 124,744 | 14,748 | 139,492 | ||||||||||
General and administrative | 40,502 | 1,748 | 42,250 | ||||||||||
Research and development (b) | 84,351 | 28,207 | 112,558 | ||||||||||
Amortization of intangibles (c) | 927 | 1,318 | 2,245 | ||||||||||
Restructuring and asset impairment charges | 9,378 | — | 9,378 | ||||||||||
Total operating expenses | 259,902 | 46,021 | 305,923 | ||||||||||
Operating income (loss) | 398,003 | (28,880 | ) | 369,123 | |||||||||
Interest and other income (expense), net | (4,359 | ) | (80 | ) | (4,439 | ) | |||||||
Income (loss) before provision for income taxes and minority interest | 393,644 | (28,960 | ) | 364,684 | |||||||||
Provision for income taxes | 113,052 | — | 113,052 | ||||||||||
Income (loss) before minority interest | 280,592 | (28,960 | ) | 251,632 | |||||||||
Minority interest in consolidated joint venture | (1,413 | ) | — | (1,413 | ) | ||||||||
Net income (loss) before retained interest in EA.com | 279,179 | (28,960 | ) | 250,219 | |||||||||
Net loss related to retained interest in EA.com | (25,485 | ) | 25,485 | — | |||||||||
Net income (loss) | $ | 253,694 | $ | (3,475 | ) | $ | 250,219 | ||||||
39
Three Months Ended December 31, 2001 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 810,930 | $ | 21,948 | $ | 832,878 | |||||||
Cost of goods sold | 395,261 | 5,592 | 400,853 | ||||||||||
Gross profit | 415,669 | 16,356 | 432,025 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 84,192 | 9,683 | 93,875 | ||||||||||
General and administrative | 29,116 | 2,717 | 31,833 | ||||||||||
Research and development (b) | 66,030 | 31,376 | 97,406 | ||||||||||
Amortization of intangibles (c) | 3,205 | 3,154 | 6,359 | ||||||||||
Restructuring and asset impairment charges | — | 14,051 | 14,051 | ||||||||||
Total operating expenses | 182,543 | 60,981 | 243,524 | ||||||||||
Operating income (loss) | 233,126 | (44,625 | ) | 188,501 | |||||||||
Interest and other income (expense), net | 3,597 | (82 | ) | 3,515 | |||||||||
Income (loss) before provision for income taxes and minority interest | 236,723 | (44,707 | ) | 192,016 | |||||||||
Provision for income taxes | 59,525 | — | 59,525 | ||||||||||
Income (loss) before minority interest | 177,198 | (44,707 | ) | 132,491 | |||||||||
Minority interest in consolidated joint venture | (199 | ) | — | (199 | ) | ||||||||
Net income (loss) before retained interest in EA.com | 176,999 | (44,707 | ) | 132,292 | |||||||||
Net loss related to retained interest in EA.com | (38,001 | ) | 38,001 | — | |||||||||
Net income (loss) | $ | 138,998 | $ | (6,706 | ) | $ | 132,292 | ||||||
Nine Months Ended December 31, 2002 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 1,958,297 | $ | 60,817 | $ | 2,019,114 | |||||||
Cost of goods sold | 887,814 | 11,122 | 898,936 | ||||||||||
Gross profit | 1,070,483 | 49,695 | 1,120,178 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 228,473 | 31,907 | 260,380 | ||||||||||
General and administrative | 89,448 | 5,918 | 95,366 | ||||||||||
Research and development (b) | 221,716 | 79,951 | 301,667 | ||||||||||
Amortization of intangibles (c) | 2,780 | 3,956 | 6,736 | ||||||||||
Restructuring and asset impairment charges | 9,378 | — | 9,378 | ||||||||||
Total operating expenses | 551,795 | 121,732 | 673,527 | ||||||||||
Operating income (loss) | 518,688 | (72,037 | ) | 446,651 | |||||||||
Interest and other income (expense), net | 67 | (182 | ) | (115 | ) | ||||||||
Income (loss) before provision for income taxes and minority interest | 518,755 | (72,219 | ) | 446,536 | |||||||||
Provision for income taxes | 138,426 | — | 138,426 | ||||||||||
Income (loss) before minority interest | 380,329 | (72,219 | ) | 308,110 | |||||||||
Minority interest in consolidated joint venture | (253 | ) | — | (253 | ) | ||||||||
Net income (loss) before retained interest in EA.com | 380,076 | (72,219 | ) | 307,857 | |||||||||
Net loss related to retained interest in EA.com | (62,581 | ) | 62,581 | — | |||||||||
Net income (loss) | $ | 317,495 | $ | (9,638 | ) | $ | 307,857 | ||||||
40
Nine Months Ended December 31, 2001 | |||||||||||||
EA Core | |||||||||||||
(excl. EA.com) | EA.com | Electronic Arts | |||||||||||
Net revenues | $ | 1,201,407 | $ | 53,577 | $ | 1,254,984 | |||||||
Cost of goods sold | 595,468 | 12,174 | 607,642 | ||||||||||
Gross profit | 605,939 | 41,403 | 647,342 | ||||||||||
Operating expenses: | |||||||||||||
Marketing and sales (a) | 150,002 | 29,697 | 179,699 | ||||||||||
General and administrative | 72,535 | 7,916 | 80,451 | ||||||||||
Research and development (b) | 185,138 | 100,628 | 285,766 | ||||||||||
Amortization of intangibles (c) | 9,615 | 9,694 | 19,309 | ||||||||||
Restructuring and asset impairment charges | — | 14,051 | 14,051 | ||||||||||
Total operating expenses | 417,290 | 161,986 | 579,276 | ||||||||||
Operating income (loss) | 188,649 | (120,583 | ) | 68,066 | |||||||||
Interest and other income (expense), net | 10,865 | (573 | ) | 10,292 | |||||||||
Income (loss) before provision for income taxes and minority interest | 199,514 | (121,156 | ) | 78,358 | |||||||||
Provision for income taxes | 24,291 | — | 24,291 | ||||||||||
Income (loss) before minority interest | 175,223 | (121,156 | ) | 54,067 | |||||||||
Minority interest in consolidated joint venture | 147 | — | 147 | ||||||||||
Net income (loss) before retained interest in EA.com | 175,370 | (121,156 | ) | 54,214 | |||||||||
Net loss related to retained interest in EA.com | (102,983 | ) | 102,983 | — | |||||||||
Net income (loss) | $ | 72,387 | $ | (18,173 | ) | $ | 54,214 | ||||||
41
Costs and Expenses, Interest and Other Income, Net, and Income Taxes and Net Income (Loss) for both EA Core and EA.com Segments
Cost of Goods Sold.Cost of goods sold for our packaged goods businessdisk-based and cartridge-based products consists of actual product costs, royalties expense for celebrities, professional sports and other organizations and independent software
29
developers, manufacturing royalties, net of volume discounts, expense for defective products, write-off of post-launch prepaid royalty costs, and operations expense. Cost of goods sold for our online product subscription business consists primarily of data center and bandwidth costs associated with hosting our websites, credit card fees and royalties for use of EA and third party properties. Cost of goods sold for our website advertising business consists primarily of ad serving costs.
Marketing and Sales.Marketing and sales expenses consist of personnel-related costs, advertising, and marketing and promotional expenses.expenses, net of co-op advertising expense reimbursements. In addition, marketing and sales includesexpense in fiscal year 2003 included the amortization of the “carriage” fees payable for the distribution of our online games on AOL, carriage fee (“Carriage Fee”), which began with the launch of EA.com in October 2000. The Carriage Fee is being amortized straight-line over the five-year term of the AOL agreement entered into in November 1999.we are no longer required to pay.
General and Administrative.General and administrative expenses consist of personnel and related expenses of executive and administrative staff, fees for professional services such as legal and accounting, and allowances for bad debts.
Research and Development.Research and development expenses consist of expenses incurred by our production studios for personnel-related costs, consulting, equipment depreciation, customer relationship management expenses associated with Electronic Arts’our products and online games and write-offsany impairments of prepaid royalties. EA.com has researchroyalties for pre-launch products. Research and development expenses for our online business include expenses incurred by Electronic Arts’our studios consisting of direct development costs and related overhead costs in connection with the development and production of EA.comour online games. Research and development expenses also include network development and support costs directly incurred by EA.com. Network development and support costs consist of expenses associated with development of website content, depreciation on server equipment to support online games, network infrastructure direct expenses, software licenses and maintenance, and network and management overhead.
Cost of Goods Sold | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 558,680 | 45.3 | % | $ | 400,853 | 48.1 | % | 39.4 | % | |||||||||||
Nine Months Ended | $ | 898,936 | 44.5 | % | $ | 607,642 | 48.4 | % | 47.9 | % | |||||||||||
Cost of Goods Sold(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 213,762 | 40.3 | % | $ | 200,867 | 44.3 | % | 6.4 | % | ||||||||||
Six months ended | $ | 363,725 | 41.2 | % | $ | 343,321 | 43.7 | % | 5.9 | % | ||||||||||
CostFor the three months ended September 30, 2003, cost of goods sold as a percentage of revenuesnet revenue decreased by 4.0 percentage points to 40.3 percent from 44.3 percent for the three months ended December 31,September 30, 2002 as compared to the same periods last year primarily due to:
• | ||
42
• | Higher | |
• | ||
Cost30
For the six months ended September 30, 2003, cost of goods sold as a percentage of revenuesnet revenue decreased for the nine months ended December 31, 2002 as comparedby 2.5 percentage points to the same period last year primarily due to:
Marketing and Sales | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 139,492 | 11.2 | % | $ | 93,875 | 11.3 | % | 48.6 | % | |||||||||||
Nine Months Ended | $ | 260,380 | 13.0 | % | $ | 179,699 | 14.3 | % | 44.9 | % | |||||||||||
Marketing and sales expenses for the three months ended December 31, 2002 increased in absolute dollars by 4941.2 percent primarily attributable to:
43
As a percentage of revenue, marketing and sales expenses were relatively consistent at 11.3 percent of revenue in the year ago quarter versus 11.2 percent of revenue in the current period.
Marketing and sales expenses increased in absolute dollars by 45from 43.7 percent for the ninesix months ended December 31, 2002 primarily attributed to:
As a percentage of revenue, marketing and sales expenses declined from 14.3 percent of revenue in the prior nine-month period ended December 31, 2001 to 13.0 percent of revenue in the current nine-month period ended December 31, 2002.
General and Administrative | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 42,250 | 3.5 | % | $ | 31,833 | 3.8 | % | 32.7 | % | |||||||||||
Nine Months Ended | $ | 95,366 | 4.7 | % | $ | 80,451 | 6.4 | % | 18.5 | % | |||||||||||
General and administrative expenses for the three months ended December 31, 2002 increased in absolute dollars by 33 percent primarily due to:
As a percentage of revenue, general and administrative expenses declined from 3.8 percent of revenue in the year ago quarter to 3.5 percent of revenue in the current period.
General and administrative expenses increased in absolute dollars by 19 percent for the nine months ended December 31,September 30, 2002 primarily due to:
• | ||
As a percentage of revenue, general and administrative expenses declined from 6.4 percent of revenue in the prior nine-month period ended December 31, 2001 to 4.7 percent of revenue in the current nine-month period ended December 31, 2002.
44
Research and Development | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 112,558 | 9.1 | % | $ | 97,406 | 11.7 | % | 15.6 | % | |||||||||||
Nine Months Ended | $ | 301,667 | 14.9 | % | $ | 285,766 | 22.8 | % | 5.6 | % | |||||||||||
Research and development expenses increased for the three months ended December 31, 2002 in absolute dollars by 16 percent primarily due to:
• | Higher | |
• |
Marketing and Sales(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 64,041 | 12.1 | % | $ | 55,514 | 12.2 | % | 15.4 | % | ||||||||||
Six months ended | $ | 123,125 | 13.9 | % | $ | 120,888 | 15.4 | % | 1.9 | % | ||||||||||
As a percentage of revenue, researchFor the three months ended September 30, 2003, marketing and development expenses declined from 11.7 percent of revenue in the year ago quarter to 9.1 percent of revenue in the current period.
Research and developmentsales expenses increased in absolute dollars by 615.4 percent foras compared to the ninethree months ended December 31,September 30, 2002 primarily due to:
• | ||
As
Amortization of Intangibles | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 2,245 | 0.2 | % | $ | 6,359 | 0.8 | % | (64.7 | %) | |||||||||||
Nine Months Ended | $ | 6,736 | 0.3 | % | $ | 19,309 | 1.6 | % | (65.1 | %) | |||||||||||
For the three and ninesix months ended December 31,September 30, 2003, marketing and sales expenses increased by 1.9 percent as compared to the six months ended September 30, 2002 amortizationprimarily due to:
General and Administrative(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 36,032 | 6.8 | % | $ | 27,453 | 6.1 | % | 31.2 | % | ||||||||||
Six months ended | $ | 66,792 | 7.6 | % | $ | 53,116 | 6.8 | % | 25.7 | % | ||||||||||
4531
For the three and nine months ended December 31, 2001, amortizationSeptember 30, 2003, general and administrative expenses increased by 31.2 percent as compared to the three months ended September 30, 2002 due to:
For the six months ended September 30, 2003, general and administrative expenses increased by 25.7 percent as compared to the six months ended September 30, 2002 due to:
Research and Development(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 113,493 | 21.4 | % | $ | 96,164 | 21.2 | % | 18.0 | % | ||||||||||
Six months ended | $ | 204,615 | 23.2 | % | $ | 186,044 | 23.7 | % | 10.0 | % | ||||||||||
For the three months ended September 30, 2003, research and development expenses increased by 18.0 percent as compared to the three months ended September 30, 2002 due to:
For the six months ended September 30, 2003, research and development expenses increased by 10.0 percent as compared to the six months ended September 30, 2002 due to:
The increase in research and development spending is expected to continue in fiscal 2004 due to an increase in development spending for current generation console products including the PlayStation 2, Xbox and Nintendo GameCube, as well as extending our investment in the PC and future platforms.
Amortization of Intangibles(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 810 | 0.2 | % | $ | 2,246 | 0.5 | % | (63.9 | %) | ||||||||||
Six months ended | $ | 1,490 | 0.2 | % | $ | 4,491 | 0.6 | % | (66.8 | %) | ||||||||||
Amortization of intangibles relates primarilydecreased $1.4 million and $3.0 million for the three and six months ended September 30, 2003 compared to amortization of purchased goodwill and intangibles from acquisitions of Westwood, Pogo, Kesmai, DreamWorks, ABC Software and other acquisitions.
the same periods in the prior year. The decrease in amortization for the three months ended December 31, 2002both periods was due primarily to the impairment of certain identifiablefinite-lived intangible assets related to Westwood and DreamWorks being fully amortizedrecognized in the prior fiscal 2002, as well as the result of adopting SFAS No. 142 which required, among other things, the discontinuance of goodwill amortization. As of April 1, 2002, we have ceased to amortize approximately $69,050,000 of goodwill. year.
32
Interest and Other Income, Net(In thousands) | ||||||||||||||||||||
September 30, | % of net | September 30, | % of net | |||||||||||||||||
2003 | revenue | 2002 | revenue | % change | ||||||||||||||||
Three months ended | $ | 9,130 | 1.7 | % | $ | 1,177 | 0.3 | % | 675.7 | % | ||||||||||
Six months ended | $ | 13,979 | 1.6 | % | $ | 4,324 | 0.6 | % | 223.3 | % | ||||||||||
For the three months ended December 31, 2001, amortization of goodwill totaled $2,891,000. As a percentage of revenue, amortization of intangibles expense declinedSeptember 30, 2003, interest and other income, net, increased from 0.8 percent of revenue in the year ago quarter to 0.2 percent of revenue in the current period.
The decrease in amortization for the nine months ended December 31, 2002 was due to certain identifiable intangible assets related to Westwood and DreamWorks being fully amortized in fiscal 2002, as well as the result of adopting SFAS No. 142. For the nine months ended December 31, 2001, amortization of goodwill totaled $8,752,000. As a percentage of revenue, amortization of intangibles expense declined from 1.6 percent of revenue in the prior nine-month period ended December 31, 2001 to 0.3 percent of revenue in the current nine-month period ended December 31, 2002.
In addition, during the three months ended December 31, 2001, we recorded intangible impairment charges of $1,641,000 relating to EA.com’s restructuring.
Restructuring and Asset Impairment Charges | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 9,378 | 0.8 | % | $ | 14,051 | 1.7 | % | (33.3 | %) | |||||||||||
Nine Months Ended | $ | 9,378 | 0.5 | % | $ | 14,051 | 1.1 | % | (33.3 | %) | |||||||||||
During the quarter ended December 31, 2002, the Company closed its office located in San Francisco, California and its studio located in Seattle, Washington. The office and studio closures were
The exit plans resultedlosses on foreign exchange hedge contracts in a workforce reduction of approximately 33 personnel in development and administrative departments. The estimated costs for consolidation of facilities included contractual rental commitments under the real estate lease for unutilized office space, offset by estimated future sub-lease income. In addition, the exit plans resulted in the write-off of certain non-current fixed assets, primarily leasehold improvements.
In October 2001, we announced a restructuring plan for EA.com to reduce EA.com’s workforce and consolidate facilities. The restructuring initiatives involved strategic decisions to discontinue certain product offerings and focus only on key online priorities that align with its fiscal 2003
46
operational objectives. The restructuring and asset impairment charge of $14,051,000 incurred in the third quarter of fiscal 2002 is comprised of charges of approximately $3,763,000 for workforce reduction, $3,785,000 for consolidation of facilities and other administrative charges and $6,503,000 for the write-off of non-current assets. The workforce reduction resulted in the termination of approximately 240 positions in the third quarter of fiscal 2002. At December 31, 2002, there was $905,000 remaining of the EA.com accrued restructuring balance. We expect this remaining balance to be fully utilized by December 31, 2006. (See Note 11 of the Notes to Condensed Consolidated Financial Statements).
Interest and Other Income (Expense), Net | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | (4,439 | ) | (0.3 | %) | $ | 3,515 | 0.5 | % | (226.3 | %) | ||||||||||
Nine Months Ended | $ | (115 | ) | (0.0 | %) | $ | 10,292 | 0.8 | % | (101.1 | %) | ||||||||||
Interest and other income (expense), net, for the three months ended December 31, 2002 decreased from the same period inof the prior fiscal year primarily due tofor an aggregate increase of $4.7 million.
For the six months ended September 30, 2003, interest and other income, (expense), net, declinedincreased from 0.5 percentthe six months ended September 30, 2002 primarily due to:
Interest and other income (expense), net,nineEuro and British Pound as of September 30, 2003 compared to losses on foreign exchange hedge contracts in the six months ended December 31,September 30, 2002 decreased from the same period in the prior year primarily due to a permanent impairmentfor an aggregate increase of investments in affiliates of $10,590,000 and losses on sales of marketable securities of $273,000 in fiscal 2003. As a percentage of revenue, interest and other income (expense), net, declined from 0.8 percent of revenue in the prior nine-month period ended December 31, 2001 to 0.0 percent of revenue in the current nine-month period ended December 31, 2002. Income Taxes (in thousands) December 31, 2002 Effective tax rate December 31, 2001 Effective tax rate % change Three Months Ended $ 113,052 31.0 % $ 59,525 31.0 % 89.9 % Nine Months Ended $ 138,426 31.0 % $ 24,291 31.0 % 469.9 % Income Taxes(In thousands) September 30, Effective September 30, Effective 2003 tax rate 2002 tax rate % change Three months ended $ 34,409 31.0 % $ 22,451 31.0 % 53.3 % Six months ended $ 42,662 31.0 % $ 25,374 31.0 % 68.1 %
Our effective tax rate was 31%31 percent for the three and ninesix months ended December 31, 2002September 30, 2003 and 2001.
Net Income | |||||||||||||||||||||
(in thousands) | December 31, 2002 | % of net revenues | December 31, 2001 | % of net revenues | % change | ||||||||||||||||
Three Months Ended | $ | 250,219 | 20.3 | % | $ | 132,292 | 15.9 | % | 89.1 | % | |||||||||||
Nine Months Ended | $ | 307,857 | 15.2 | % | $ | 54,214 | 4.3 | % | 467.9 | % | |||||||||||
In absolute dollars, reported net income increased for2002. The effective tax rate is the three months ended December 31, 2002 primarily related to:
47
Although expenses rose on an absolute basis versus the comparable period, net income as a percentage of sales increased to 20.3 percent versus 15.9 percent as expenses grew at a slower rate than did our revenues.
In absolute dollars, reported net income increased for the nine months ended December 31, 2002 primarily related to:
Although expenses rose on an absolute basis versus the comparable period, net income as a percentage of sales increased to 15.2 percent versus 4.3 percent as expenses grew at a slower rate than did our revenues.
We have indicated that the EA.com segment will not reach profitability in the quarter ending March 31, 2003. For fiscal 2003, we expect full year losses for EA.com as a result of higherthe mix of income earned in various tax jurisdictions that apply a broad range of tax rates. The effective tax rate may change period-to-period based on nonrecurring events, as well as recurring factors including the geographical mix of income before taxes, the timing and amount of foreign dividends, and state and local taxes. Future effective tax rates could be adversely affected if earnings are lower than anticipated marketing spend, delays in launching key products resultingcountries where we have lower statutory rates, by unfavorable changes in fewer subscriberstax laws and lower-than-expected advertising revenues. For fiscal 2004,regulations or by adverse rulings in tax related litigation. In addition, we are committedsubject to minimizing the lossescontinuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for our online business and expect to see some improvement in net loss year over year.income taxes.
48
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2002,September 30, 2003, our working capital was $1,182,683,000$1.65 billion compared to $699,561,000$1.34 billion at March 31, 2002.2003. Cash, cash equivalents and short-term investments increased by approximately $368,390,000$146.6 million during the ninefirst six months ended December 31, 2002.of fiscal 2004. We generated $283,510,000 of cash from operations, $109,877,000$139.9 million of cash through the sale of equity securities under our stock plans and $28.2 million of cash provided by operations, which was partially offset by $34,470,000$28.7 million of cash used infor capital expenditures during the ninesix months ended December 31, 2002.September 30, 2003.
Reserves for bad debts and sales allowances increased from $115,870,000 at March 31, 2002 to $206,651,000 at December 31, 2002. Reserves have been charged for returnsAs 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.
OurSeptember 30, 2003, our principal source of liquidity is $1,165,326,000$1.7 billion in cash, cash equivalents and short-term investments at December 31, 2002. Management believesand $0.8 million in marketable equity securities. We believe the existing cash, cash equivalents, short-term investments, marketable equity securities and cash generated from operations will be sufficient to meet cash and investment requirements for at least the next 12 months. However,A portion of our cash is generated from operations domiciled in foreign tax jurisdictions (approximately $329.4 million) that is designated as permanently invested in
33
the respective tax jurisdiction. While we do not currently believe there is a need to repatriate these funds to the United States in the short term, if these funds are required for our operations in the United States, we would be required to accrue and pay additional taxes to repatriate these funds.
Our ability to maintain sufficient liquidity could be affected by various risks and uncertainties including, but not limited to, those related to customer demand and acceptance of our titles on new platforms and new title versions of our titles on existing platforms, our ability to collect our accounts receivable as they become due, successfully achieving our product release schedules and attaining our forecasted sales objectives, the impact of competition, the economic conditions in the domestic and international markets, seasonality in operating results, risks of product returns and the other risks listed in the “Risk Factors” section.
EA.com
IncludedOur gross accounts receivable balance was $329.6 million and $246.7 million as of September 30, 2003 and March 31, 2003, respectively. Reserves for product returns, pricing allowances and doubtful accounts decreased 23 percent from $164.6 million at March 31, 2003 to $126.8 million at September 30, 2003. The decrease in the amounts above isoverall reserves as of September 30, 2003 was due to the followinghigh volume of return and price protection credits processed in the first six months of fiscal year 2004, for products sold in prior periods. Although the EA.com business:
49
Under the AOL agreement entered into in November 1999, EA.com is required to pay $81,000,000 to AOL over the lifeabsolute dollar amounts of the five-year agreement. Of this amount, $36,000,000 was paid upon signing the agreement with the remainder due in four equal annual installments beginning with the first anniversarysales return and price protection reserves have decreased as of the initial payment. EA.com paid AOL $11,250,000 in each of the fiscal years 2001, 2002 and 2003.
Future liquidity needs of EA.com will be met by Electronic Arts as Electronic Arts intends to continue to fund the cash requirements of EA.com for the foreseeable future.
Other Commitments
Advertising Commitments
We made a commitment to spend $15,000,000 in offline media advertisements promoting our online games, including those on the AOL service, priorSeptember 30, 2003, both have remained relatively constant compared to March 31, 2005. As2003 as a percentage of December 31, 2002, we have spent approximately $4,322,000 against this commitment.trailing nine months net revenue. We believe these reserves are adequate based on historical experience and our current estimate of potential returns and allowances.
In addition, under an agreement amended on August 30, 2002, we made a commitment to spend $17,000,000 in advertising with News America Corporation and its affiliates through the period ended December 31, 2006. As of December 31, 2002, we have fulfilled approximately $7,303,000 of this commitment. See “News America Corporation Exchange” below.Commitments
Lease Commitments
We lease certain of our current facilities and certain equipment under non-cancelable capital and operating lease agreements. We are required to pay property taxes, insurance and normal maintenance costs for certain of our facilities and will be required to pay any increases over the base year of these expenses on the remainder of our facilities.
In February 1995, we entered into a build-to-suit lease with a financial institutionKeybank National Association on our headquarters facility in Redwood City, California, which was extended in July 2001 and expires in July 2006. We accounted for this arrangement as an operating lease in accordance with SFASStatement of Finance Accounting Standards (“SFAS”) No. 13,“Accounting for LeasesLeases””, as amended. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. We have an option to purchase the property (land and facilities) for $145,000,000$145.0 million or, at the end of the lease, to arrange for (1)(i) an additional extension of the lease or (2)(ii) sale of the property to a third party with us retainingwhile we retain an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000$128.9 million if the sales price is less than this amount, subject to certain provisions of the lease.
In December 2000, we entered into a second build-to-suit lease with a financial institutionKeybank National Association for a five yearfive-year term frombeginning December 2000 to expand our Redwood City, California headquarters facilities and develop adjacent property adding approximately 310,000 square feet to our campus. Construction was completed in June 2002. We accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. The facilities will provide space for marketing, sales and research and development. We have an option to purchase the property for $127,000,000$127.0 million or, at the end of the lease, to arrange for (1)(i) an extension of the lease, or (2)(ii) sale of the property to a third party with us retainingwhile we retain an obligation to the owner for the difference between the sale price and the
50
guaranteed residual value of up to $118,800,000$118.8 million if the sales price is less than this amount, subject to certain provisions of the lease. We believe the estimated fair value of the properties under the operating leases are in excess of the guaranteed residual values based in part on a independent third party appraisal.
In July of 2003, we entered into a lease agreement with Playa Vista-Water’s Edge LLC for a studio facility in Los Angeles, California, which commenced in October 2003 and expires in September 2013 with two five-year options to extend the lease term. Additionally, we have options to purchase the property after five and ten years based on the fair market value of the property at the date of sale, a right of first offer to purchase the property upon terms offered by the landlord, and a right to share in the profits from a sale of the property. We have accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. Existing campus facilities comprise a total of 243,000 square feet and provide space for research and development functions. Our rental obligation under
34
this agreement is $50.2 million over the initial ten-year term of the lease. We will take possession of the property over a period of 18 months as the facilities become available for use. The above commitment is offset by sublease income of $5.8 million for the sublet to Playa Capital Company, LLC of 18,000 square feet of the Los Angeles facility, which commenced in October 2003 and expires September 2013 with options of early termination by Playa Capital Company, LLC after five years and by EA after four and five years. The contractual obligations table below has been updated for this lease based on our gross lease commitment.
Lease rates are based upon the Commercial Paper Rate. The twothree lease agreements described above require us to maintain certain financial covenants related to consolidated net worth, fixed charge coverage ratio, total consolidated debt to total consolidated capital and quick ratio, all of which we were in compliance with as of December 31, 2002.September 30, 2003.
Letters of Credit
In connection with our purchases of Nintendo GameCube optical disks 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 optical disks. For purchases of Nintendo GameCube optical disks for distribution in Japan and Europe, Nintendo typically requires us to make cash deposits.
In July 2002, we provided an irrevocable standby letter of credit to Nintendo of Europe. The standby letter of credit guarantees performance of our obligations to pay Nintendo of Europe for trade payables of up to 8,000,00018.0 million Euros. The standby letter of credit expires in July 2005. At December 31, 2002,As of September 30, 2003, we had $319,000 of payables$7.8 million payable to Nintendo of Europe covered by this standby letter of credit.
In August 2003, we provided an irrevocable standby letter of credit to 300 California Associates II, LLC in replacement of our security deposit for office space. The standby letter of credit guarantees performance of our obligations to pay our lease commitment up to $1.1 million. The standby letter of credit expires in December 2006. As of September 30, 2003, we had no payable on this standby letter of credit.
Development, Celebrity, League and Content Licenses: Payments and Commitments
The products publishedproduced by EA Studiosour studios are designed and created by our in-houseemployee designers, and artists, software programmers and by independentnon-employee software developers (“independent artists”). We typically payadvance development funds to the independent artists during development of our games, usually in installment payments made upon the completion of specified development milestones. These payments are considered advances against subsequent royalties based on the sales of the specific products, as defined inproducts. These terms are typically set forth-in written agreements entered into with the related independent artist agreements. Advance payments on these royalties are paid to independent artists upon meeting deliverables as detailed in the contractual agreements.artists. In addition, we have certain celebrity, league and content license contracts that contain minimum guarantee payments and marketing commitments that are not dependent on any deliverables. Celebrities and organizations with whom we have contracts include: FIFA (soccer), NASCAR (stock car racing), John Madden (professional football), National Basketball Association, PGA TOUR (golf), Tiger Woods (golf), National Hockey League and NHLPA (Hockey), Warner Bros. (Harry Potter)Potter and Superman), MGM/Danjaq (James Bond), The Saul Zaentz Company d/b/a Tolkien EnterprisesNew Line Productions (The Lord of Thethe Rings), National Football League and Players Inc. (Professional Football) Collegiate Licensing Company (March Madness(collegiate football and NCAA Football)basketball), ISC -Major track company,(stock car racing), Major League Baseball Properties, MLB Players Association (baseball) and Island Def Jam.Jam (wrestling). These developer and content license commitments represent the sum of (i) the cash payments due under non-royalty-bearing licenses and services agreements, and (ii) the minimum payments and advances against royalties due under royalty-bearing licenses and services agreements. These minimum guarantee payments and marketing commitments are included in the following table.
35
The following table below.
Summary ofsummarizes our minimum contractual obligations and commercial commitments as of December 31, 2002September 30, 2003 (in thousands):
Contractual Obligations | Commercial Commitments | |||||||||||||||||||||||||||||||
Developer/ | ||||||||||||||||||||||||||||||||
Fiscal Year Ended | Licensee | Bank and Other | ||||||||||||||||||||||||||||||
March 31, | Leases | Advertising | Commitments | AOL | Marketing | Guarantees | Letters of Credit | Total | ||||||||||||||||||||||||
2003 | $ | 4,083 | $ | 2,678 | $ | 8,862 | $ | — | $ | 2,554 | $ | 1,667 | $ | 319 | $ | 20,163 | ||||||||||||||||
2004 | 13,054 | 3,697 | 25,407 | 11,250 | 14,401 | 171 | — | 67,980 | ||||||||||||||||||||||||
2005 | 9,397 | 8,000 | 21,408 | — | 6,582 | 171 | — | 45,558 | ||||||||||||||||||||||||
2006 | 8,853 | 3,000 | 16,781 | — | 4,572 | 171 | — | 33,377 | ||||||||||||||||||||||||
2007 | 8,149 | 3,000 | 3,141 | — | 3,571 | 170 | — | 18,031 | ||||||||||||||||||||||||
Thereafter | 11,609 | — | — | — | 3,571 | 170 | — | 15,350 | ||||||||||||||||||||||||
$ | 55,145 | $ | 20,375 | $ | 75,599 | $ | 11,250 | $ | 35,251 | $ | 2,520 | $ | 319 | $ | 200,459 | |||||||||||||||||
Commercial | ||||||||||||||||||||||||||||
Contractual Obligations | Commitments | |||||||||||||||||||||||||||
Fiscal Year | Developer/ | Bank and | Letters | |||||||||||||||||||||||||
Ended | Licensee | Other | of | |||||||||||||||||||||||||
March 31, | Leases | Advertising | Commitments | Marketing | Guarantees | Credit | Total | |||||||||||||||||||||
2004 (remaining six months) | $ | 12,392 | $ | — | $ | 16,711 | $ | 27,300 | $ | 220 | $ | 7,759 | $ | 64,382 | ||||||||||||||
2005 | 24,499 | 747 | 37,611 | 14,109 | 234 | — | 77,200 | |||||||||||||||||||||
2006 | 25,817 | 3,000 | 32,053 | 9,692 | 234 | — | 70,796 | |||||||||||||||||||||
2007 | 19,064 | 3,000 | 11,276 | 9,692 | 204 | — | 43,236 | |||||||||||||||||||||
2008 | 15,966 | — | 13,116 | 9,692 | 203 | — | 38,977 | |||||||||||||||||||||
Thereafter | 43,820 | — | 14,521 | 16,952 | 203 | — | 75,496 | |||||||||||||||||||||
Total | $ | 141,558 | $ | 6,747 | $ | 125,288 | $ | 87,437 | $ | 1,298 | $ | 7,759 | $ | 370,087 | ||||||||||||||
51The lease commitments disclosed above exclude commitments included in our restructuring activities for contractual rental commitments of $10.9 million under real estate leases for unutilized office space, offset by $4.5 million of estimated future sub-lease income. These amounts were expensed in the periods of the related restructuring and are included in our accrued liabilities reported on our Condensed Consolidated Balance Sheet as of September 30, 2003. (See Note 11 in Notes to Condensed Consolidated Financial Statements.)
Transactions with Related Parties
Square EA
In May 1998,Executive Officer Compensation
On June 24, 2002, we entered into a joint venture with Square Co., Ltd. (“Square”), a leading developerhired Warren Jenson as our Executive Vice President and publisherChief Financial and Administrative Officer and agreed to loan Mr. Jenson $4.0 million, to be forgiven over four years based on his continuing employment. Two million dollars of entertainment software in Japan. In North America, the companies formed Square Electronic Arts, LLC (“Square EA”), which has exclusive publishing rights in North America for future interactive entertainment titles created by Square. Additionally, we havenote will be forgiven after two years employment, and the exclusive right to distribute in North America products published by this joint venture. We own a 30% minority interest in this joint venture while Square owns 70%. This joint ventureremainder forgiven after four years. The entire balance of the loan is accounted for under the equity method. Our joint venture and distribution agreements with Square will expireoutstanding as of March 31,September 30, 2003. We are discussing with Square the possibility of continuing to distribute Square products in North America on a limited, title-by-title basis. Even if those discussions are successful, our revenue from distributing Square titles in North America may be reduced going forward. If these discussions are not successful, this revenue stream will be lost.
We generated $38,895,000 and $72,501,000 in net revenues from sales of Square EA products during the three and nine months ended December 31, 2002. We generated $39,583,000 and $54,685,000 in net revenues from sales of Square EA products during the three and nine months ended December 31, 2001.
Indebtedness of Management
As of December 31, 2002, we had loans outstanding to executive officers in the amount of $4,104,000. All loans were in effect prior to the enactment of the Sarbanes-Oxley Act of 2002. As of February 2, 2003, all loans to executive officers made in connection with their purchase of restricted Class B common stock, totaling $854,000, were repaid in full.
News America Corporation Exchange
On February 7, 2000, we acquired Kesmai from News America Corporation (“News Corp”) in exchange for $22,500,000 in cash and approximately 206,000 shares of our existing common stock valued at $8,650,000. Under the original agreements, we agreed to spend $12,500,000 through the period ended June 1, 2002 in advertising with News Corp or any of its affiliates. In addition, under these agreements if certain conditions were met, including that a qualified public offering of Class B common stock did not occur within twenty-four months of News Corp’s purchase of such shares and all of the Class B outstanding shares had been converted to Class A common stock, then (1) News Corp would have the right to (i) exchange Class B common stock for approximately 206,000 shares of Class A common stock, and (ii) receive cash from us in the amount of $9,650,000, and (2) we would agree to spend an additional $11,675,000 in advertising with News Corp and its affiliates.
On August 30, 2002, we entered into a new agreement with News Corp under which (i) News Corp exchanged its 2,000,000 shares of Class B common stock for 206,454 shares of Class A common stock and (ii) we paid News Corp $1,000,000 in cash and committed to spend an additional $17,000,000 in advertising with News Corp and its affiliates through the period ended December 31, 2006. All of our other obligations to News Corp under the original agreements were terminated.
52
Impact of Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We do not expect the adoption of SFAS No. 143 to have a material impact on our consolidated financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS No. 145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, as amended by SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. The adoption of SFAS No. 145 did not have a material impact on our consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)”. We currently account for and report exit and disposal activities under the provisions of EITF No. 94-3. We will adopt the provisions of SFAS No. 146 for all exit and disposal activities that are initiated after December 31, 2002. We do not expect the adoption of SFAS No. 146 to have a material impact on our consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires a guarantor to (i) include disclosure of certain obligations, and (ii) if applicable, at the inception of the guarantee, recognize a liability for the fair value of other certain obligations undertaken in issuing a guarantee. The disclosure provisions of the Interpretation are effective for financial statements of interim or annual reports that end after December 15, 2002 and we have adopted those requirements in our condensed consolidated financial statements included in Note 12 of the Notes to Condensed Consolidated Financial Statements and in the Liquidity and Capital Resources section of the MD&A of this Form 10-Q. However, the provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002, irrespective of the guarantor’s year-end. We are currently assessing the impact of adopting the initial recognition and initial measurement requirements of FIN 45 on our consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123”. SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for an entity that voluntarily changes to the fair-value-based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of that statement to require prominent disclosure about the effects on reported net income and earnings per share and the entity’s accounting policy decisions with respect to stock-based employee compensation. Certain of the disclosure requirements are required for all companies, regardless of whether the fair value method or intrinsic value method is used to
53
account for stock-based employee compensation arrangements. We continue to account for our employee incentive stock option plans using the intrinsic value method in accordance with the recognition and measurement principles of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees.”The amendments to SFAS 123 will be effective for financial statements for fiscal years ended after December 15, 2002 and for interim periods beginning after December 15, 2002. We will adopt the disclosure provisions of this statement in our fourth quarter of fiscal year 2003.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” addresses consolidation by business enterprises of variable interest entities. Under current practice, two enterprises generally have been included in consolidated financial statements because one enterprise controls the other through voting interests. FIN 46 defines the concept of “variable interests” and requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities(“VIEs”) that either: (i) do not effectively disperse risks amonghave sufficient equity investment at risk to permit the parties involved.entity to finance its activities without additional subordinated financial support, or (ii) are owned by equity investors who lack an essential characteristic of a controlling financial interest. This interpretation applies immediately to variable interest entitiesVIEs created after January 31, 2003. ItWith regard to VIE’s already in existence prior to February 1, 2003, the implementation of this FASB has been delayed and currently applies into the first fiscal year or interim period beginning after JuneDecember 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. If it is reasonably possible that an enterprise will consolidate or disclose information about a variable interest entity when FIN 46 becomes effective, the enterprise shall disclose information about those entitiesrequires disclosure of VIEs in all financial statements issued after January 31, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment2003, if it is reasonably possible that as of the date on which it is first appliedtransition date: (i) the company will be the primary beneficiary of an existing VIE that will require consolidation, or by restating previously issued financial statements for one(ii) the company will hold a significant variable interest in, or more yearshave significant involvement with, an existing VIE. We do not believe that we will have any entities that require disclosure or new consolidation as a cumulative-effect adjustment asresult of adopting the beginning of the first year restated. Based on the recent releaseprovisions of FIN 46, we have not completed our assessment as to whether or not the adoption of FIN 46 will have a material impact on our consolidated financial statements.46.
5436
RISK FACTORS
Electronic Arts’Our business is subject to many risks and uncertainties, which may affect our future financial performance. Some of those importantThese risks and uncertainties whichare discussed below. There may causebe additional risks and uncertainties not currently known to us or that we currently do not believe are material. If any of the events or circumstances described below occurs, our operating results to vary or which may materiallybusiness and adversely affect our operating results are as follows:
Risk Factors Relating to Our Core Business
New Video Game Platforms Create Additional Technicalfinancial performance could be harmed and Business Model Uncertainties
A majoritythe market value of our revenues are derivedsecurities could decline.
The success of our business is highly dependent on being able to predict which new videogame platforms will be successful, and on the market acceptance and timely release of those platforms.
We derive most of our revenue from the sale of products for play on proprietary video gamevideogame platforms of third parties, such as theSony’s PlayStation 2. TheTherefore, the success of our products is significantly affecteddriven in large part by acceptancethe success of the new video gamevideogame 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 continuesuccessful in the marketplace. We must make product development decisions and commit significant resources well in advance of the anticipated introduction of a new platform. A new platform for older hardware platforms thatwhich we are developing products may be delayed, may not succeed or 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 longershorter life cycle than expected, our revenue growth may be adversely affected.
For example,anticipated. If the Sega Dreamcast console launched in Japan in early 1999 and in the United States in September of 1999. We didplatforms for which we are developing products are not develop products for this platform. Had this platform achievedreleased when anticipated or do not attain wide market acceptance, our revenue growth will suffer.
Our platform licensors set the royalty rates and other fees that we must pay to publish games for their platforms, and therefore have significant influence on our costs. If one or more of the platform licensors adopt a different fee structure for future game consoles, our profitability may suffer.
In the next few years, we expect our platform licensors to introduce new game machines into the market. In order to publish products for a new game machine, we must take a license from the platform licensor which gives the platform licensor the opportunity to set the fee structure that we must pay in order to publish games for that platform. Similarly, the platform licensors have retained the flexibility to change their fee structures for online gameplay and features for their consoles. The control that platform licensors have over the fee structures for their future platforms and online access makes it difficult for us to predict our costs and profitability in the medium to long term. Because publishing products for videogame consoles is the largest portion of our business, any increase in fee structures would have been adversely affected. Similarly,a significant negative impact on our business model and profitability.
If we do not accurately predict the importance to consumers of online game play for different console products, our sales may be limited in the future.
Sony and Microsoft have introduced online game play for their respective PlayStation 2 and Xbox consoles. We anticipate that Nintendo will do so for its Nintendo GameCube console. We have agreed to support online game features for our Sony PlayStation 2 products but do not currently offer similar capability for our Xbox products. We currently cannot predict how important these features are developing(or will be) to consumers, or whether, and to what extent, our support for online game features will affect our sales of console products. For example, if consumers consider online play capability to be a “must have” component of games for the Xbox, our sales of products for the Xbox would decline significantly.
Our business is both seasonal and Nintendo GameCube.cyclical. If these platforms do not achieve wide commercial acceptance,we, or our revenue growthplatform licensors, fail to deliver products at the right times, our sales will be adversely impacted.suffer.
Our Business Is Both Seasonal and Cyclical
Our business is highly seasonal, with the highest levels of consumer demand, and a significant percentage of our revenuesrevenue, occurring in the December quarter. In fiscal 2002, these seasonal trends were magnified by generalThe timing of hardware platform introduction is often tied to the year-end holiday season and is not within our control. If we miss this key selling period, due to product delays or delayed introduction of a new platform for which we have developed products, our sales will suffer disproportionately. Our industry factors, including the platform transition, the fall 2001 launches of the Xbox and Nintendo GameCube in North America and the economic slowdown in the United States and other territories. Our business is also cyclical; video gamecyclical. Videogame platforms have historically had a life cycle of four to six years, and decline as more advanced platforms are being introduced.years. As one group of platforms is reaching the end of its cycle and new platforms are emerging, buying patternsconsumers often defer game software purchases until the new platforms are available, causing sales to decline. This decline may change. Purchasesnot be offset by increased sales of products for the new platform. For example, the market for products for Sony’s older platforms may slow at a faster rate than salesPlayStation game console has declined significantly since the launch of new platforms. There canthe PlayStation 2 platform.
37
Our business is intensely competitive and increasingly “hit” driven. If we do not continue to deliver “hit” products, our success will be no guarantee that the current platform cycle will mirror past cycles in length or in terms of consumer behavior.limited.
Our Business is Intensely Competitive and Increasingly “Hit” Driven
Competition in our industry is intense, in all areas. Weand new products are regularly facing strong competition by our competitors on a product-by-product and brand-by-brand basis.introduced. During calendar year 2002, approximately 22 percent of the sales of videogames in North America consisted of only 20 “hit” products out of thousands published. These “hit” titles are increasingly expensive to produce. If our competitors develop more successful products, or if we do not continue to develop consistently high-quality and popular products, our revenuesrevenue will decline.
If we are unable to maintain or acquire licenses to intellectual property, we will publish fewer hit titles and our revenue will decline. Competition for these licenses may make them more expensive, and increase our costs.
Many of our products are based on or incorporate intellectual property owned by others. For example, ourEA SPORTSproducts include intellectual property licenses from the major sports leagues and players associations. Similarly, many of our hitEA Gamesfranchises, such asJames Bond, Harry PotterandLord of the Rings, are based on key film and literary licenses. Competition for these licenses is intense. If we are unable to maintain these licenses and obtain additional licenses with significant commercial value, we will be adversely affected.unable to increase our revenue in the future. Competition for these licenses may also drive up the advances, guarantees and royalties that must be paid to the licensor, which could significantly increase our costs.
ImpactIf patent claims continue to be asserted against us, we may be unable to sustain our current business models or profits.
Many patents have been issued that may apply to widely used game technologies. Additionally, infringement claims under many recently issued patents are now being asserted against Internet implementations of e-Commerceexisting games. Several such claims have been asserted against us. Such claims can harm our business. We incur substantial expenses in evaluating and Online Gamesdefending 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.
Other intellectual property claims may increase our product costs or require us to cease selling affected products.
Many of our products include extremely realistic graphical images, and we expect that as technology continues to advance, images will become even more realistic. Some of the images and other content are based on real-world examples that may inadvertently infringe upon the intellectual property rights of others. Although we believe that we make reasonable efforts to ensure that our products do not violate the intellectual property rights of others, it is possible that third parties still may claim infringement. From time to time, we receive communications from third parties regarding such claims. Existing or future infringement claims against us, whether valid or not, may be time consuming and expensive to defend. Such claims or litigations could require us to stop selling the affected products, redesign those products to avoid infringement, or obtain a license, all of which would be costly and harm our business.
Our Business Is Not Known
Whilebusiness, our products and our distribution are subject to increasing regulation in key territories of content, consumer privacy and online delivery. If we do not currently derive significant revenues from online sales ofsuccessfully respond to these regulations, our packaged products, online distributionbusiness may become a more significant channel for distribution of our products in the future. How online distribution ultimately affects the more traditional retail distribution, at which we have historically had success, and over what time period, is uncertain. We also expect the number and popularity of online games to increase and become a significant factor in the interactive games businesssuffer.
55
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 of Content, Consumer Privacy and Online Delivery in Key Territories
Legislation is continually being introduced whichthat may affect both the content of our products and their distribution. For example, privacy ruleslaws in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory while of coursealthough the Internet recognizes no geographical boundaries. Other countries, such as Germany, have adopted laws regulating content both in packaged goods and those transmitted over the Internet that are stricter than current United States laws. In the United States, the federal and several state governments are considering content restrictions on products such as those made by usours, as well as restrictions on distribution of such products. Any one or more of these factors could harm our business.
Risk Factors Relating to Our Online 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, includingbusiness by limiting the current fiscal year. We expect EA.com to continue to incur losses at least through the current fiscal year. EA.com will be required to maintain the significant support, service and product enhancement demands of online users, andproducts 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 beare able to sustain it over a period of time. We may determine that further cost reductions are necessary.offer to our customers and by requiring additional differentiation between products for different territories to address varying regulations. This additional product differentiation would be costly.
Our Agreements with America Online May Not Prove Successful to the Development of EA.com’s Business
We have a series of agreements with America Online (“AOL”) for the offering of our games for online play. These agreements require that we make substantial guaranteed payments to AOL and that we commit our resources to the pursuit of the online game opportunity. We cannot be assured that the substantial costs associated with the AOL agreements will be justified by the revenues generated from that relationship. In addition, restrictions included in the AOL agreements limiting other channels we may develop for offering online games may limit our ability to diversify our online distribution strategies. The success for us of the AOL agreements will also be a result of AOL’s performance under the agreements, a factor over which we will have very little control.
We Have 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 have employed various revenue models, including subscription fees, ''pay to play fees’’ and advertising. We have limited experience with developing optimal pricing strategies for online games. For example, our productMajesticand ourPlatinum offering, which contained certain browser-based entertainment games, were launched with a monthly subscription pricing model and obtained only limited commercial success. Accordingly, we did not realize our projected cash flows and discontinued these offerings. Similarly, we continue to evaluate the content, marketing programs and pricing strategy forThe Sims Onlinewhich launched in December 2002.
5638
Development of EA.com’s Business Continues to Require Significant Capital, and We Cannot Be Assured That It Will Be Available
EA.com willIf we do not be successful if it does not continue to receive substantial financing. Electronic Arts has agreed to provide a limited amount of funding to EA.com, but this financing alone may not be sufficient. Any additional funding that is obtained from Electronic Arts may either be treated as a debt arrangement or alternatively may increase Electronic Arts’ retained interest in EA.com and correspondingly decrease the interest of the holders of outstanding shares of Class B common stock. To date, nearly all funding (except warrants and cash from revenues) has been provided by Electronic Arts. We cannot provide assurance that Electronic Arts will be able to recover its investment in EA.com.
To Become and Remain Competitive, EA.com Must Continually Develop New Content. This Is Inherently Risky and Expensive.
EA.com’s success depends onconsistently meet our ability to develop new products and services for the EA.com site. Our agreement with AOL requires us to develop new games for the EA.com site. We cannot assure you that products will be developed on time, in a cost-effective manner, or that they will be commercially successful. The release ofThe Sims Online,for which we currently generate subscription revenue, was delayed due to longer than anticipatedproduct development schedules. Similarly, the online productMajesticachieved only limited commercial success due in part to the length of time it took to download the online software component. Accordingly, we discontinuedMajesticon May 1, 2002.
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.
Our Revenues Have Been Heavily Dependent on a Single Product and Would Be Adversely Affected if That Product’s Popularity Were To Decline; Our Future Success Depends on the Success ofThe Sims Online
In the near term, EA.com’s subscription revenues to date have consisted primarily of revenues from sales of our online productUltima 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 competing products could cause revenues fromUltima Onlineto decline. In addition, popularity ofUltima Onlinecould decline over time simply because of consumer preference for new game experiences.
Going forward, the success ofThe Sims Onlineis critical to the success of EA.com. WhileThe Sims Onlineonly shipped in December 2002 and it is premature to judge its commercial success, early results have been below our expectations.
We Continue to Invest in Research and Development and Network Technology and Operations for EA.com, and We Cannot Be Assured That We Will Achieve Revenues That Support This Level of Spending
We have invested heavily, and expect to continue to invest, in research and development and network technology and operations for our website and online games. While we have reduced the overall level of spending for EA.com,schedules, we will continue to investexperience fluctuations in the technologies, tools and network infrastructure that are necessary for us to support our key product,The Sims Online. Accordingly, there
57
are no assurances that the revenues from this product will exceed the associated costs in order for EA.com to achieve profitability. If we cannot increase revenues to profitable levels, the value of EA.com will be impaired. In order to develop the game offerings that we envision for our online operations it will continue to be necessary to engage in significant developmental efforts both to adapt existing Electronic Arts 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.
We Derive a Portion Of Our Revenue From Advertisements and Advertising Services, Which Revenues Tend to be Cyclical and Dependent on the Economic Prospects Of Advertisers and Direct Marketers and the Economy in General. A Continued Decrease in Expenditures By Advertisers and Direct Marketers Or a Continued Downturn in the Economy Could Cause Our Revenues to Decline Significantly in any Given Period
We derive, and expect to continue to derive for the foreseeable future, a portion of our revenue from products and services we provide to advertisers, direct marketers and agencies, advertising sold through our agreement with AOL and from advertisements we deliver to Web sites. Expenditures by advertisers tend to be cyclical, reflecting overall economic conditions as well as budgeting and buying patterns. The overall market for advertising, including Internet advertising, has been characterized in recent quarters by increasing softness of demand, lower prices for advertisements, the reduction or cancellation of advertising contracts, an increased risk of uncollectible receivables from customers and the reduction of marketing and advertising budgets, especially for online advertising and by Internet-related companies. As a result of these reductions, advertising spending across traditional media, as well as the Internet, has decreased. We have seen a decline in our advertising revenues in the current quarter compared to the same period a year ago. We expect further declines to occur in the near term.
We Are Heavily Dependent on a Few Internet Infrastructure Service Providers to Host and Manage Our Servers at Co-Location Facilities and Our Operating Results May Be Adversely Affected if We Must Change Service Providers
We are dependent on a few third-party Internet infrastructure service providers to host and manage the majority of our servers that support our online games. The performance of these service providers is outside of our control. Many Internet infrastructure service providers require substantial financial resources to build, maintain and manage co-location facilities. Many of these service providers have experienced significant financial difficulties during the recent economic downturn. To the extent that industry, economic, financial or competitive factors influence the level of performance that we receive from service providers we currently use for co-location space (bandwidth and rack), we may need to re-locate our servers to another co-location facility which would increase our expenses and may result in delays or reduced shipments of our online products, thereby adversely impacting our operating results.
General Risk Factors
Product Development Schedules Are Frequently Unreliable and Make Predicting Quarterly Results Difficult
Product development schedules, particularly for new hardware platforms, high-end multimedia personal computers, or PCs and the Internet, 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,EMPEROR: Battle for DuneforWe have in the PC, which was expected to ship in fiscal 2001 was not released until the first quarter of fiscal 2002 due to development delays. Also,James Bond 007 in...Agent Under Firefor the PS2, which was expected to ship in fiscal 2001, released in October of fiscal 2002 due to development delays. Likewise,The Sims Onlinepast experienced development delays and was released later than planned.The
58
Sims Onlinewas launched in December 2002.for several of our products. Failure to meet anticipated production or “go live” schedules may adversely impactcause a shortfall in our revenuesrevenue and profitability and cause our actualoperating results to be materially different than any financial guidance given byfrom expectations. Delays that prevent release of our products during peak selling seasons may reduce lifetime sales of those products.
Technology changes rapidly in our business, and if we fail to anticipate new technologies, the Company.quality, timeliness and competitiveness of our products will suffer.
Rapid technology changes in our industry require us to anticipate, (sometimessometimes years in advance)advance, which technologies our products must take advantage of in order to make them competitive in the market at the time they are released. Therefore, we usually start our product development with a range of technical development goals that we hope to be able to achieve. We may not be able to achieve these goals, or our competition may be able to achieve them more quickly than we can. In either case, our products may be technologically inferior to competitive products, or less appealing to consumers, or both. If we cannot achieve our technology goals within the original development schedule of our products, then we may delay products until these technology goals can be achieved, (whichwhich may adversely affect our revenuesdelay or reduce revenue and increase our development expenses).expenses. Alternatively, we may increase the resources employed in research and development in an attempt to accelerate our development of new technologies, (eithereither to preserve our product launch schedule or to keep up with our competition),competition, which willwould increase our development expenses.
We May Not Be Able To AttractIf we do not continue to attract and Retain the Personnel Necessary forretain key personnel, we will be unable to effectively conduct our Businessesbusiness.
The market for technical, creative, marketing and other personnel essential to the development and marketing of our products and management of our businesses is extremely competitive. In the last fiscal year, notwithstanding the downturn of the economy generally, competitive recruiting efforts aimed at Electronic Arts’our employees and executives continued. Electronic Arts’For example, in fiscal 2003, a team of employees that developed one of our hitMedal of Honorproducts left the company to develop products for a competitor. Our leading position within the interactive entertainment industry makes us a prime target for recruiting of executives and key creative talent. In addition, the cost of real estate in the San Francisco Bay area – the location of our headquarters and one of our largest studios – remains relatively high, 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.
Our Platform Licensors Are Our Chief Competitorsplatform licensors are our chief competitors and Frequently Controlfrequently control the Manufacturingmanufacturing of and/or Access To Our Video Game Productsaccess to our videogame products. If they do not approve our products, we will be unable to ship to our customers.
Our agreements with hardware licensors which(such as Sony for the PlayStation 2, Microsoft for the Xbox and Nintendo for the Nintendo GameCube), who are also our chief competitors, typically give significant control to the licensor over the approval and manufacturing of our products. This factproducts, which 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,While we experienced delays in obtaining approvals for and manufacturing of PlayStation products which caused delays in shipping those products. Thebelieve that our relationships with our hardware licensors are currently good, the potential for additional delay or refusal to approve or manufacture our products continues with our platform licensors.exists. Such occurrences would harm our business and adversely affect our financial performance. Additionally, we have not negotiated a final publishing agreement with Nintendo for the Nintendo GameCube platform for territories outside of the Western Hemisphere, and although we are currently operating under an understanding with Nintendo, we cannot be assured that the final terms of the formal agreements for Europe and/or Asia will be favorable.
In addition, as online capabilities for videogame platforms emerge, our platform licensors will control our ability to provide online game capabilities for our console platform products.products and will in large part establish the financial terms on which these services are offered to consumers. Currently, both Microsoft and Sony provide, or have announced plans to provide online capabilities for Xbox and PlayStation 2 products, respectively. In each case, compatibility code and the consent of the licensor are
39
required for us to include online capabilities in our products. In addition, the business model for Microsoft’s and Sony’s online businesses for their videogame products may compete with our EA.comonline business. As these capabilities become more significant, the failure or refusal of our licensors to approve
59
our products, or the successful deployment by these licensors of services competitive to EA.com,ours, may harm our business.
Proliferation and Assertion of Patents Poses Serious RisksOur international net revenue is subject to our Businesscurrency fluctuations.
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. Such claims can harm our business. For example, in June of 2002 we were sued for alleged infringement of a patent which the plaintiff claims generally describes the distribution of a software program on CD-ROMs to users containing a link capability (e.g., hyperlinks) to additional information stored on a remote server. 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.
Foreign Sales and Currency Fluctuations
For the ninesix months ended December 31, 2002,September 30, 2003 international net revenuesrevenue comprised 41%37 percent of total consolidated net revenues.revenue. For the fiscal year ended March 31, 2002,2003, international net revenuesrevenue comprised 37%42 percent of total consolidated net revenues.revenue. We expect foreign sales to continue to account for a significant and growing portion of our revenues.revenue. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies, which may fluctuate.fluctuate against the dollar. While we utilize foreign exchange contracts to hedge against foreign currency fluctuations,exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies, we cannot control translation issues.
Increased DifficultiesOur reported financial results could be affected if significant changes in Forecasting Resultscurrent accounting principles are adopted.
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. At launch, Sony shipped only half of the number of PlayStation 2 units to retail in North America than it had originally planned, and it shipped significantly fewer units than planned at launch in Europe as well. Shortages were announced as being caused by shortages of components for manufacturing. Due to these shortages, our results of operations for fiscal 2001 were adversely affected. Consequently, if Sony, Microsoft or Nintendo do not ship the number of units planned for the PlayStation 2, the Xbox and Nintendo GameCube, our sales of products for these platforms may be adversely affected in fiscal 2004.
The Current Legislative and Regulatory Environment Affecting Accounting Principles Generally Accepted in the United States of America is Uncertain and Volatile, and Significant Changes in Current Principles Could Affect Our Financial Statements Going Forward
Recent actions and public comments from the SEC have focused on the integrity of financial reporting generally. Similarly, Congress has considered a variety of bills that could affect certain accounting principles. In addition, theThe FASB and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, such as accounting for stock options, some of which represent a significant change from current industry practices. While we believe thatChanges in our financial statements haveaccounting for stock options could materially increase our reported expenses.
Our stock price has been prepared in accordance with accounting principles generally accepted in the United States of America, we cannot predict the impact of the adoption of any such proposals on our financial statements going forward.volatile and may continue to fluctuate significantly.
60
Fluctuations in Stock Price
Industry and financial analysts provide investors with estimates of our future production and financial performance. We also give guidance as to our expectations for future performance. We may not meet those expectations. This may create an immediate and significant adverse effect on the trading price of our common stock. 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. 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.
The majority of our sales are made to a relatively small number of key customers. If these customers reduce their purchases of our products or become unable to pay for them, our business could be harmed.
In addition, fluctuations may be duethe U.S. in fiscal 2003, over 66 percent of our sales were made to uncertaintiessix key customers. In Europe, our top ten customers accounted for over 40 percent of our sales in that territory in fiscal 2003. Worldwide, we had sales to one customer, Wal-Mart Stores, Inc., which represented 12 percent of net revenue in fiscal 2003. Though our products are available to consumers through a variety of retailers, the concentration of our sales in one, or a few, large customers could lead to short-term disruption in our sales if one or more of these customers significantly reduced their purchases or ceased to carry our products, and could make us more vulnerable to collection risk if one or more of these large customers became unable pay for our products. Additionally, our receivables from these large customers increase significantly in the securities markets in general. For example, duringlast quarter of the fiscalcalendar year ended March 31, 2002,as they stock up for the price per shareholiday selling season. Also, having such a large portion of our Class A common stock ranged from $42.40 to $66.01 and $51.48 to $72.14 during the nine months ended December 31, 2002.net revenue concentrated in a few customers reduces our negotiating leverage with these customers.
World Events
The terrorist attacks of September 11, 2001 in the United States, the subsequent US military action, the continuing concerns over potential additional terrorist attacks against US interests and citizens and the current potential for war with Iraq pose serious uncertainties in our business. Consumer spending, consumer preferences in entertainment, and the securities markets and the economy generally may be affected on an ongoing and unpredictable basis by these events, all of which may make prediction of our results more difficult.
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.
6140
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. Our foreign exchange contracts are accounted for as derivatives whereby the gains and losses on these contracts are reflected in the Condensed Consolidated StatementStatements of Operations. Gains and losses on open contracts at the end of each accounting period resulting from changes in the forward rate are recognized in earnings and are designed to offset gains and losses on the underlying foreign currency denominated assets and liabilities. At December 31, 2002,September 30, 2003, we had foreign exchange contracts, all with maturities of less than one month, to purchase and sell approximately $508,133,000$144.8 million in foreign currencies, primarily British Pounds, European Currency Units (“Euros”), AustralianEuros, Japanese Yen, Canadian Dollars and other currencies. Of this amount, $127.0 million represents contracts to sell foreign currency in exchange for U.S. dollars and $17.8 million represents contracts to sell foreign currency in exchange for British Pounds.
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 following table below provides information about our foreign currency forward exchange contracts at December 31, 2002.September 30, 2003. 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.
Weighted-Average | Fair Value | ||||||||||||
Contract Amount | Contract Rate | Gain/(Loss) | |||||||||||
(In thousands) | (In thousands) | ||||||||||||
Foreign currency to be sold under contract: | |||||||||||||
British Pound | $ | 193,734 | 1.5945 | $ | (411 | ) | |||||||
Euro | 178,781 | 1.0263 | (1,741 | ) | |||||||||
Swedish Krona | 20,269 | 0.1126 | (184 | ) | |||||||||
Australian Dollar | 19,176 | 0.5640 | 61 | ||||||||||
Japanese Yen | 10,896 | 0.0083 | (120 | ) | |||||||||
Norwegian Krone | 8,525 | 0.1398 | (139 | ) | |||||||||
Canadian Dollar | 8,382 | 0.6448 | 56 | ||||||||||
Danish Krone | 6,909 | 0.1382 | (76 | ) | |||||||||
Swiss Franc | 5,592 | 0.6990 | (117 | ) | |||||||||
South African Rand | 4,260 | 0.1092 | (93 | ) | |||||||||
New Zealand Dollar | 1,032 | 0.5160 | (3 | ) | |||||||||
Brazilian Real | 422 | 0.2814 | 3 | ||||||||||
Total | $ | 457,978 | $ | (2,764 | ) | ||||||||
62
Foreign currency to be purchased under contract: | |||||||||||||
British Pound | $ | 50,155 | 1.6003 | $ | (601 | ) | |||||||
Total | $ | 50,155 | $ | (601 | ) | ||||||||
Grand total | $ | 508,133 | $ | (3,365 | ) | ||||||||
Weighted- | ||||||||||||
Average | ||||||||||||
Contract | Contract | |||||||||||
Amount | Rate | Fair Value | ||||||||||
Foreign currency to be sold under contract: | ||||||||||||
British Pound | $ | 90,851 | 1.6518 | $ | (237 | ) | ||||||
Euro | 16,064 | 1.1475 | (17 | ) | ||||||||
Japanese Yen | 14,738 | 0.0090 | 79 | |||||||||
Canadian Dollar | 9,957 | 0.7375 | (37 | ) | ||||||||
Swedish Krona | 5,497 | 0.1278 | (44 | ) | ||||||||
South African Rand | 4,025 | 0.1388 | (33 | ) | ||||||||
Danish Krone | 2,021 | 0.1554 | 9 | |||||||||
Norwegian Krone | 1,693 | 0.1411 | (15 | ) | ||||||||
Total | $ | 144,846 | $ | (295 | ) | |||||||
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.
41
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 maintainingThough we maintain sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity. maturity, currently, the majority of our short-term investments are callable by the issuer. As there can be no assurance as to how long these investments will be held, classification of these securities as short-term investments is based on call date.
At December 31, 2002,September 30, 2003, our cash equivalents and short-term investments included debt securities, typically government agency bonds and money market funds, of $986,616,000.$1.4 billion. 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 (in thousands) and related weighted average interest rates of our investment portfolio at December 31, 2002:
Average Interest Rate | Cost | Fair Value | |||||||||||
(Dollars in thousands) | |||||||||||||
Cash equivalents | |||||||||||||
Variable rate | 1.43 | % | $ | 587,358 | $ | 587,358 | |||||||
Short-term investments | |||||||||||||
Fixed rate | 3.28 | % | $ | 387,029 | $ | 390,858 | |||||||
Variable rate | 6.35 | % | $ | 8,400 | $ | 8,400 | |||||||
Average | ||||||||||||
Interest Rate | Cost | Fair Value | ||||||||||
Cash equivalents | ||||||||||||
Fixed rate | 1.86 | % | $ | 503,701 | $ | 503,873 | ||||||
Variable rate | 1.18 | % | $ | 496,251 | $ | 496,241 | ||||||
Short-term investments | ||||||||||||
Fixed rate | 2.16 | % | $ | 295,658 | $ | 295,262 | ||||||
Fixed-step rate | 1.53 | % | $ | 85,293 | $ | 84,387 |
Maturity dates for short-term investments range from 58 months to 3635 months with call dates ranging from 03 months to 118 months.
6342
Item 4. Controls and Procedures |
64Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s (the “SEC”) rules and forms. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Because we have designed our system of controls based on certain assumptions about the likelihood of future events, which we believe are reasonable, our system of controls may not achieve its desired purpose under all possible future conditions. Further, the design of our system of controls reflects reasonable resource constraints - the benefits of controls must be considered relative to their costs. Accordingly, even effective disclosure controls and procedures can only provide reasonable, not absolute, assurance of achieving our control objectives.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures, have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective and designed to ensure that material information required to be disclosed in the reports that we file or submit under the Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding the required disclosure.
CHANGES IN INTERNAL CONTROLS
During out last fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. However, in the last several months, in response to the certification requirements of the Sarbanes-Oxley Act and new SEC Regulations, we have enhanced our internal controls and disclosure systems, through various measures including: detailing certain internal accounting policies; establishing a formal disclosure committee for the preparation of all periodic SEC reports; and requiring certifications from various trial balance controllers and other financial personnel responsible for our financial statements.
43
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 |
None. |
Item 6. | Exhibits and Reports on Form 8-K | |
(a) |
Exhibit | ||
Number | Title | |
10.29 | ||
10.30 | Agreement Re: Right of First Offer to Purchase and | |
10.31 | Profit Participation Agreement by and between Playa Vista-Waters Edge, LLC and Electronic Arts Inc., dated July 31, 2003. | |
10.32 | Sublease Agreement by and between Electronic Arts Inc. and Playa Capital Company, LLC, dated July 31, 2003. | |
31.1 | Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (a) of the Exchange Act. | |
31.2 | Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (a) of the Exchange Act. | |
Additional exhibits accompanying this report: | ||
32.1 | Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (b) of the Exchange Act and 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (b) of the Exchange Act and 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(b) | Reports on Form 8-K: | |
On |
6544
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/ | ||||
66
CERTIFICATIONS
I, Lawrence F. Probst III, certify that:
WARREN C. JENSON | |||||
November 7, 2003 | |||||
67
I, Warren C. Jenson, certify that:
Chief Financial and Administrative Officer |
6845
ELECTRONIC ARTS INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002SEPTEMBER 30, 2003
EXHIBIT INDEX
EXHIBIT | ||
NUMBER | EXHIBIT TITLE | |
10.29 | ||
10.30 | Agreement Re: Right of First Offer to Purchase and | |
10.31 | Profit Participation Agreement by and between Playa Vista-Waters Edge, LLC and Electronic Arts Inc., dated July 31, 2003. | |
10.32 | Sublease Agreement by and between Electronic Arts, Inc. and Playa Capital Company, LLC, dated July 31, 2003. |
31.1 | Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (a) of the Exchange Act. | |
31.2 | Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (a) of the Exchange Act. | |
Additional exhibits accompanying this report: | ||
32.1 | Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (b) of the Exchange Act and 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (b) of the Exchange Act and 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
6946