UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X]
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2001
June 30, 2002
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.
(Exact
(Exact name of registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
209 Redwood Shores Parkway
Redwood City, California 94065
(Address of principal executive offices) (Zip Code)
Delaware | | 94-2838567 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
|
209 Redwood Shores Parkway Redwood City, California (Address of principal executive offices) | | 94065 (Zip Code) |
(650) 628-1500
(Registrant's
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES X NO _____
-------
Indicate the number of shares outstanding of each of the
issuer'sissuer’s classes of common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock Par Value February 6, 2002
--------------------- --------- ----------------
Class A common stock $0.01 137,939,831
Class of Common Stock
| | Par Value
| | Outstanding at August 6, 2002
|
| Class A common stock | | $0.01 | | 139,235,558 |
ELECTRONIC ARTS INC. AND SUBSIDIARIES INDEX
Part I - I—Financial Information
| | Page
- -------------------------------- ----
|
|
| Item 1. | | Unaudited Condensed Consolidated Financial Statements | | |
|
| | | | 3 |
|
| | | | 4 |
|
| | | | 5 |
|
| | | | 7 |
|
Item 2. Management's | | | | 18 |
|
| Item 3. | | | | 47 |
|
Part II - II—Other Information
- ---------------------------
| | |
|
| Item 1. | | | | 49 |
|
| Item 4. | | | | 49 |
|
| Item 6. | | | | 49 |
|
| | 51 |
|
| | 52 |
2
PART I - I—FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars
(Dollars in thousands)
(unaudited)
December 31, March 31,
2001 2001
------------------------------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 486,842 $ 466,492
Marketable securities 7,282 10,022
Receivables, less allowances of $139,898 and $89,833, respectively 463,384 174,449
Inventories, net 24,918 15,686
Deferred income taxes 57,126 57,082
Other current assets 129,537 94,996
---------- ----------
Total current assets 1,169,089 818,727
Property and equipment, net 322,790 337,199
Long-term investments 8,400 8,400
Investments in affiliates 18,213 19,052
Goodwill and other intangibles, net 116,161 136,764
Long-term deferred income taxes 2,945 2,926
Other assets 57,775 55,850
---------- ----------
$1,695,373 $1,378,918
========== ==========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 153,699 $ 73,061
Accrued and other liabilities 367,537 266,965
---------- ----------
Total current liabilities 521,236 340,026
Minority interest in consolidated joint venture 3,592 4,545
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 137,950,866 and 134,714,464 shares; outstanding 137,670,866 and
134,714,464 shares, respectively 1,380 1,347
Class B common stock, $0.01 par value. Authorized 100,000,000 shares;
issued and outstanding 6,233,413 and 6,250,000 shares, respectively 62 63
Paid-in capital 632,930 540,354
Treasury stock, at cost; 280,000 shares at December 31, 2001 (11,922) -
Retained earnings 559,500 505,286
Accumulated other comprehensive loss (11,405) (12,703)
---------- ----------
Total stockholders' equity 1,170,545 1,034,347
---------- ----------
$1,695,373 $1,378,918
========== ==========
| | | June 30, 2002 | | | March 31, 2002 | |
| |
|
|
|
|
| ASSETS |
|
| Current assets: | | | | | | | | |
| Cash, cash equivalents and short-term investments | | $ | 826,866 | | | $ | 796,936 | |
| Marketable securities | | | 5,403 | | | | 6,869 | |
| Receivables, less allowances of $128,518 and $115,870, respectively | | | 118,347 | | | | 190,495 | |
| Inventories, net | | | 24,074 | | | | 23,780 | |
| Deferred income taxes | | | 37,710 | | | | 38,597 | |
| Other current assets | | | 117,872 | | | | 95,866 | |
| | |
|
|
| |
|
|
|
| Total current assets | | | 1,130,272 | | | | 1,152,543 | |
|
| Property and equipment, net | | | 309,892 | | | | 308,827 | |
| Investments in affiliates | | | 18,999 | | | | 19,077 | |
| Goodwill and other intangibles, net | | | 108,213 | | | | 110,512 | |
| Long-term deferred income taxes | | | 64,014 | | | | 64,065 | |
| Other assets | | | 42,475 | | | | 44,350 | |
| | |
|
|
| |
|
|
|
| | | $ | 1,673,865 | | | $ | 1,699,374 | |
| | |
|
|
| |
|
|
|
|
| LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY |
|
| Current liabilities: | | | | | | | | |
| Accounts payable | | $ | 86,326 | | | $ | 88,563 | |
| Accrued and other liabilities | | | 298,964 | | | | 364,419 | |
| | |
|
|
| |
|
|
|
| Total current liabilities | | | 385,290 | | | | 452,982 | |
|
| Minority interest in consolidated joint venture | | | 2,462 | | | | 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 139,140,406 and 138,429,269 shares, respectively | | | 1,391 | | | | 1,384 | |
| Class B common stock, $0.01 par value. Authorized 100,000,000 shares; issued and outstanding 6,233,463 and 6,233,413 shares, respectively | | | 62 | | | | 62 | |
| Paid-in capital | | | 675,960 | | | | 649,777 | |
| Retained earnings | | | 614,199 | | | | 606,795 | |
| Accumulated other comprehensive loss | | | (5,499 | ) | | | (14,724 | ) |
| | |
|
|
| |
|
|
|
| Total stockholders’ equity | | | 1,286,113 | | | | 1,243,294 | |
| | |
|
|
| |
|
|
|
| | | $ | 1,673,865 | | | $ | 1,699,374 | |
| | |
|
|
| |
|
|
|
See accompanying
notesNotes to
condensed consolidated financial statements.
3
Condensed Consolidated Financial Statements.ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In
(In thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
December 31, December 31,
2001 2000 2001 2000
--------------------------------------------------------
Net revenues $ 832,878 $ 640,319 $ 1,254,984 $ 1,015,018
Cost of goods sold 400,853 306,797 607,642 505,364
----------- ----------- ----------- -----------
Gross profit 432,025 333,522 647,342 509,654
----------- ----------- ----------- -----------
Operating expenses:
Marketing and sales 93,875 65,389 179,699 138,845
General and administrative 31,833 28,480 80,451 76,981
Research and development 97,406 109,604 285,766 278,940
Amortization of intangibles 6,359 4,681 19,309 14,051
Restructuring and asset impairment charges 14,051 -- 14,051 --
----------- ----------- ----------- -----------
Total operating expenses 243,524 208,154 579,276 508,817
----------- ----------- ----------- -----------
Operating income 188,501 125,368 68,066 837
Interest and other income, net 3,515 2,690 10,292 10,628
----------- ----------- ----------- -----------
Income before provision for income taxes
and minority interest 192,016 128,058 78,358 11,465
Provision for income taxes 59,525 39,698 24,291 3,554
----------- ----------- ----------- -----------
Income before minority interest 132,491 88,360 54,067 7,911
Minority interest in consolidated joint venture (199) (382) 147 (1,113)
----------- ----------- ----------- -----------
Net income $ 132,292 $ 87,978 $ 54,214 $ 6,798
=========== =========== =========== ===========
Class A common stock:
Net income:
Basic $ 138,998 $ 95,416 $ 72,387 $ 21,942
=========== =========== =========== ===========
Diluted $ 132,292 $ 87,978 $ 54,214 $ 6,798
=========== =========== =========== ===========
Net income per share:
Basic $ 1.01 $ 0.72 $ 0.53 $ 0.17
Diluted $ 0.92 $ 0.63 $ 0.38 $ 0.05
Number of shares used in computation:
Basic 137,103 132,339 136,457 130,716
Diluted 143,399 138,904 142,847 137,372
Class B common stock:
Net loss, net of retained interest in EA.com $ (6,706) $ (7,438) $ (18,173) $ (15,144)
=========== =========== =========== ===========
Net loss per share:
Basic $ (1.11) $ (1.24) $ (3.02) $ (2.52)
Diluted $ (1.11) $ (1.24) $ (3.02) $ (2.52)
Number of shares used in computation:
Basic 6,028 6,000 6,023 6,000
Diluted 6,028 6,000 6,023 6,000
| | | Three Months Ended June 30, | |
| | | 2002 | | | 2001 | |
| |
|
|
|
|
| Net revenues | | $ | 331,898 | | | $ | 181,950 | |
| Cost of goods sold | | | 141,365 | | | | 89,029 | |
| | |
|
|
| |
|
|
|
| Gross profit | | | 190,533 | | | | 92,921 | |
| | |
|
|
| |
|
|
|
| Operating expenses: | | | | | | | | |
| Marketing and sales | | | 65,374 | | | | 40,804 | |
| General and administrative | | | 25,663 | | | | 23,215 | |
| Research and development | | | 90,969 | | | | 90,805 | |
| Amortization of intangibles | | | 2,245 | | | | 6,475 | |
| | |
|
|
| |
|
|
|
| Total operating expenses | | | 184,251 | | | | 161,299 | |
| | |
|
|
| |
|
|
|
| Operating income (loss) | | | 6,282 | | | | (68,378 | ) |
| Interest and other income, net | | | 3,147 | | | | 2,717 | |
| | |
|
|
| |
|
|
|
| Income (loss) before provision for (benefit from) income taxes and minority interest | | | 9,429 | | | | (65,661 | ) |
| Provision for (benefit from) income taxes | | | 2,923 | | | | (20,355 | ) |
| | |
|
|
| |
|
|
|
| Income (loss) before minority interest | | | 6,506 | | | | (45,306 | ) |
| Minority interest in consolidated joint venture | | | 898 | | | | 52 | |
| | |
|
|
| |
|
|
|
| Net income (loss) | | $ | 7,404 | | | $ | (45,254 | ) |
| | |
|
|
| |
|
|
|
| Class A common stock: | | | | | | | | |
| Net income (loss): | | | | | | | | |
| Basic | | $ | 10,394 | | | $ | (39,375 | ) |
| | |
|
|
| |
|
|
|
| Diluted | | $ | 7,404 | | | $ | (45,254 | ) |
| | |
|
|
| |
|
|
|
| Net income (loss) per share: | | | | | | | | |
| Basic | | $ | 0.07 | | | $ | (0.29 | ) |
| Diluted | | $ | 0.05 | | | $ | (0.33 | ) |
| Number of shares used in computation: | | | | | | | | |
| Basic | | | 138,748 | | | | 135,730 | |
| Diluted | | | 145,222 | | | | 136,382 | |
|
| Class B common stock: | | | | | | | | |
| Net loss, net of retained interest in EA.com | | $ | (2,990 | ) | | $ | (5,879 | ) |
| | |
|
|
| |
|
|
|
| Net loss per share: | | | | | | | | |
| Basic | | $ | (0.49 | ) | | $ | (0.98 | ) |
| Diluted | | $ | (0.49 | ) | | $ | (0.98 | ) |
| Number of shares used in computation: | | | | | | | | |
| Basic | | | 6,043 | | | | 6,020 | |
| Diluted | | | 6,043 | | | | 6,020 | |
See accompanying
notesNotes to
condensed consolidated financial statements.
4
Condensed Consolidated Financial Statements.ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars
(Dollars in thousands)
(unaudited)
Nine Months
Ended December 31,
2001 2000
----------------------
Operating activities:
Net income $ 54,214 $ 6,798
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Minority interest in consolidated joint venture (147) 1,113
Equity in net (gain) loss of affiliates (2,134) 452
Gain on sale of affiliate (200) (214)
Depreciation and amortization 83,551 50,272
Non-cash restructuring and asset impairment charges 6,503 --
Loss on sale of fixed assets 372 1,542
Bad debt expense 7,142 6,091
Tax benefit from exercise of stock options 16,789 15,332
Change in assets and liabilities:
Receivables (296,077) (128,488)
Inventories (9,232) 3,134
Other assets (46,892) (9,814)
Accounts payable 80,638 (29,511)
Accrued and other liabilities 95,364 83,652
Deferred income taxes (497) 966
--------- ---------
Net cash provided by (used in) operating activities (10,606) 1,325
--------- ---------
Investing activities:
Proceeds from sale of property and equipment 258 3,958
Purchase of marketable securities, net -- (2,479)
Proceeds from sale of affiliate 570 --
Capital expenditures (40,056) (104,860)
Investment in affiliates, net 2,918 662
Change in short-term investments, net (64,624) 22,443
--------- ---------
Net cash used in investing activities (100,934) (80,276)
--------- ---------
Financing activities:
Proceeds from sales of shares through employee stock
plans and other plans 75,819 60,862
Purchase of treasury shares (11,922) --
--------- ---------
Net cash provided by financing activities 63,897 60,862
--------- ---------
Translation adjustment 2,369 (3,886)
--------- ---------
Decrease in cash and cash equivalents (45,274) (21,975)
Beginning cash and cash equivalents 419,812 246,265
--------- ---------
Ending cash and cash equivalents 374,538 224,290
Short-term investments 112,304 71,087
--------- ---------
Ending cash, cash equivalents and short-term investments $ 486,842 $ 295,377
========= =========
5
| | | Three Months Ended June 30, | |
| | | 2002 | | | 2001 | |
| |
|
|
|
|
| Operating activities: | | | | | | | | |
| Net income (loss) | | $ | 7,404 | | | $ | (45,254 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | | | | |
| Minority interest in consolidated joint venture | | | (898 | ) | | | (52 | ) |
| Equity in net (income) loss of affiliates | | | (239 | ) | | | 290 | |
| Gain on sale of affiliate | | | — | | | | (200 | ) |
| Depreciation and amortization | | | 24,306 | | | | 27,355 | |
| Loss on write-down of affiliate | | | 471 | | | | — | |
| Loss on sale of fixed assets | | | 95 | | | | 221 | |
| Bad debt expense | | | 1,659 | | | | 1,144 | |
| Stock-based compensation | | | 1,154 | | | | 698 | |
| Tax benefit from exercise of stock options | | | 5,200 | | | | 14,441 | |
| Change in assets and liabilities: | | | | | | | | |
| Receivables | | | 70,489 | | | | 96,314 | |
| Inventories | | | (294 | ) | | | (334 | ) |
| Other assets | | | (34,108 | ) | | | (29,275 | ) |
| Accounts payable | | | (2,237 | ) | | | (13,893 | ) |
| Accrued and other liabilities | | | (66,669 | ) | | | (81,003 | ) |
| Deferred income taxes | | | 310 | | | | 61 | |
| | |
|
|
| |
|
|
|
| Net cash provided by (used in) operating activities | | | 6,643 | | | | (29,487 | ) |
| | |
|
|
| |
|
|
|
|
| Investing activities: | | | | | | | | |
| Proceeds from sale of property and equipment | | | 379 | | | | 165 | |
| Proceeds from sale of affiliate | | | — | | | | 570 | |
| Capital expenditures | | | (8,409 | ) | | | (15,030 | ) |
| Investment in affiliates, net | | | (154 | ) | | | 3,021 | |
| Change in short-term investments, net | | | 7,787 | | | | (16,375 | ) |
| | |
|
|
| |
|
|
|
| Net cash used in investing activities | | | (397 | ) | | | (27,649 | ) |
| | |
|
|
| |
|
|
|
|
| Financing activities: | | | | | | | | |
| Proceeds from sales of Class A shares through employee stock plans and other plans | | | 19,893 | | | | 33,262 | |
| Proceeds from sales of Class B shares through employee stock plans and other plans | | | 1 | | | | — | |
| | |
|
|
| |
|
|
|
| Net cash provided by financing activities | | | 19,894 | | | | 33,262 | |
| | |
|
|
| |
|
|
|
| Translation adjustment | | | 9,572 | | | | 1,285 | |
| | |
|
|
| |
|
|
|
| Increase (decrease) in cash and cash equivalents | | | 35,712 | | | | (22,589 | ) |
| Beginning cash and cash equivalents | | | 552,826 | | | | 419,812 | |
| | |
|
|
| |
|
|
|
| Ending cash and cash equivalents | | | 588,538 | | | | 397,223 | |
| Short-term investments | | | 238,328 | | | | 62,971 | |
| | |
|
|
| |
|
|
|
| Ending cash, cash equivalents and short-term investments | | $ | 826,866 | | | $ | 460,194 | |
| | |
|
|
| |
|
|
|
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars
(Dollars in thousands)
(unaudited)
Nine Months
Ended December 31,
2001 2000
------------------
Supplemental cash flow information:
- -----------------------------------
Cash paid during the year for income taxes $ 7,582 $10,706
======= =======
Non-cash investing activities:
- ------------------------------
Change in unrealized appreciation (depreciation) of
investments and marketable securities $(1,443) $ 9,458
======= =======
| | | Three Months Ended June 30, | |
| | | 2002
| | 2001
| |
| Supplemental cash flow information: | | | | | | | |
| Cash paid during the year for income taxes | | $ | 2,053 | | $ | 2,719 | |
| | |
|
| |
|
|
|
| Non-cash investing activities: | | | | | | | |
| Change in unrealized appreciation (loss) on investments and marketable securities | | $ | 543 | | $ | (1,883 | ) |
| | |
|
| |
|
|
|
See accompanying
notesNotes to
condensed consolidated financial statements.
6
Condensed Consolidated Financial Statements.ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Basis of Presentation
The condensed consolidated financial statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. Certain amounts have been reclassified to conform to the fiscal 20022003 presentation.
These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Electronic Arts Inc. (the "Company"“Company”) Annual Report on Form 10-K for the fiscal year ended March 31, 20012002 as filed with the Securities and Exchange Commission ("Commission"(“SEC”) on June 29, 2001.
28, 2002.
Note 2. Fiscal Year and Fiscal Quarter
The Company'sCompany’s fiscal year is reported on a 52/53-week period that ends on the Saturday nearest to March 31 in each year. The results of operations for fiscal 2003 and fiscal 2002 will contain 52 weeks. The results of operations for the fiscal 2001 contained
53 weeks. Accordingly, the results of operations for the first three quarters of
fiscalended June 30, 2002 and the first three quarters of fiscalJune 30, 2001 contain 39 weeks and 40
weeks, respectively.13 weeks. For claritysimplicity of presentation, all fiscal periods are treated as ending on a calendar month end.
Note 3. Tracking Stock
On March 22, 2000, the shareholders of Electronic Arts authorized the issuance
of a new series of common stock, designated as Class B common stock ("Tracking
Stock"). The Tracking Stock is intended to reflect the performance of Electronic
Arts' online and e-Commerce division ("EA.com"). As a result of the approval of
the Tracking Stock Proposal, Electronic Arts' existing common stock has been
re-classified as Class A common stock and that stock reflects the performance of
Electronic Arts' other businesses ("EA Core").
Note 4. Common Stock
At the
Company'sCompany’s Annual Meeting of Stockholders, held on August 1,
2001,2002, the stockholders elected to amend the 2000 Class A Equity Incentive Plan to increase by
6,000,0005,500,000 the number of shares of the
Company'sCompany’s Class A common stock reserved for issuance under the Plan.
7
Note 4. Goodwill and Other Intangible Assets
Effective April 1, 2002, the Company adopted the full 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 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
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
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 approximately $69,050,000 of goodwill. 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 impairment testing during the current quarter and found no instances of impairment of its recorded goodwill. Accordingly, provided there are no future indicators of impairment, the second testing step is not necessary during fiscal 2003.
The Company operates in two principal business segments globally, EA Core and EA.com (see Note 8 of the Notes to Condensed Consolidated Financial Statements). As of March 31, 2002, the Company allocated goodwill in the amount of $39,335,000 to EA Core and $29,715,000 to EA.com. There were no changes to these allocations as of June 30, 2002.
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 three months ended June 30, 2001 (in thousands, except per share amounts):
|
|
|
|
|
| | | Three Months Ended June 30, | |
| |
|
|
| | | 2002 | | 2001 | |
| |
|
|
|
|
| Reported net income (loss) | | $ | 7,404 | | $ | (45,254 | ) |
| Goodwill amortization, net of tax | | | — | | | 2,022 | |
| |
|
|
|
|
| Adjusted net income (loss) | | $ | 7,404 | | $ | (43,232 | ) |
| |
|
|
|
|
|
| Reported diluted net earnings (loss) per share | | $ | 0.05 | | $ | (0.33 | ) |
| Goodwill amortization, net of tax | | | — | | | 0.01 | |
| |
|
|
|
|
| Adjusted diluted net earnings (loss) per share | | $ | 0.05 | | $ | (0.32 | ) |
| |
|
|
|
|
For the three months ended June 30, 2002, no goodwill or other intangibles were acquired, impaired or disposed of. Other intangibles consisted of the following (in thousands):
|
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|
|
|
|
|
|
| | | June 30, 2002 | | | | | | | March 31, 2002 |
| |
|
|
|
| | |
|
|
| | | Gross Carrying Amount | | Accumulated Amortization | | | Other | | | Other Intangibles, Net | | | | Gross Carrying Amount | | Accumulated Amortization | | | Other | | | Other Intangibles, Net |
| |
|
|
|
|
|
|
|
| | |
|
|
|
|
|
|
|
|
| Developed/Core Technology | | $ | 28,263 | | $ | (16,568 | ) | | $ | — | | | $ | 11,695 | | | | $ | 28,263 | | $ | (15,455 | ) | | $ | — | | | $ | 12,808 |
| Tradename | | | 35,169 | | | (10,605 | ) | | | — | | | | 24,564 | | | | | 35,169 | | | (9,854 | ) | | | — | | | | 25,315 |
| Members (Subscribers) and Other Intangibles | | | 8,694 | | | (5,537 | ) | | | (253 | ) | | | 2,904 | | | | | 8,694 | | | (5,156 | ) | | | (199 | ) | | | 3,339 |
| |
|
|
|
|
|
|
|
| | |
|
|
|
|
|
|
|
|
| Other Intangibles | | $ | 72,126 | | $ | (32,710 | ) | | $ | (253 | ) | | $ | 39,163 | | | | $ | 72,126 | | $ | (30,465 | ) | | $ | (199 | ) | | $ | 41,462 |
| |
|
|
|
|
|
|
|
| | |
|
|
|
|
|
|
|
|
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
As of June 30, 2002, future intangible asset amortization expense is estimated as follows (in thousands):
|
|
|
| Fiscal Year Ended March 31, | | |
|
|
|
| 2003 | | $ | 6,487 |
| 2004 | | | 7,364 |
| 2005 | | | 5,946 |
| 2006 | | | 5,517 |
| 2007 | | | 2,489 |
| Thereafter | | | 10,993 |
|
|
|
| | | $ | 38,796 |
|
|
|
Note 5. Treasury Stock
In September 2001, the Board of Directors approved a plan to purchase up to two
million shares of the Company's Class A common stock. For the nine months ended
December 31, 2001, the Company repurchased 280,000 shares for approximately
$11,922,000 under the program. None of these shares were reissued as of December
31, 2001.
Note 6. Prepaid Royalties
Prepaid royalties consist primarily of prepayments for manufacturing royalties, original equipment manufacturer (OEM) feesco-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 the Statement of Operationsresearch and development expense any amounts that management deems unlikely to be realized through product sales. Royalty advances are classified as current and non-current assets based upon estimated net product sales for the following year. The current portion of prepaid royalties, included in other current assets, was $68,545,000$69,020,000 and $46,264,000$65,484,000 at December 31, 2001June 30, 2002 and March 31, 2001,2002, respectively. The long-term portion of prepaid royalties, included in other assets, was $11,363,000$1,715,000 and $9,664,000$1,164,000 at December 31, 2001June 30, 2002 and March 31, 2001,2002, respectively.
Note 7.6. Inventories
Inventories are stated at the lower of cost or market. Inventories at
December
31, 2001June 30, 2002 and March 31,
20012002 consisted of (in thousands):
===============================================================================
December 31, 2001 March 31, 2001
- -------------------------------------------------------------------------------
Raw materials and work in process $ 3,216 $ 976
Finished goods 21,702 14,710
- -------------------------------------------------------------------------------
$ 24,918 $ 15,686
===============================================================================
8
|
|
|
|
|
| | | June 30, 2002 | | March 31, 2002 |
|
|
|
|
|
| Raw materials and work in process | | $ | 1,757 | | $ | 1,025 |
| Finished goods | | | 22,317 | | | 22,755 |
|
|
|
|
|
| | | $ | 24,074 | | $ | 23,780 |
|
|
|
|
|
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Note 8.7. Accrued and Other Liabilities
Accrued and other liabilities at December 31, 2001June 30, 2002 and March 31, 20012002 consisted of (in thousands):
==============================================================================
December 31, 2001 March 31, 2001
- ------------------------------------------------------------------------------
Accrued royalties $ 115,860 $ 55,997
Accrued compensation and benefits 81,306 75,603
Accrued expenses 77,756 67,957
Accrued income taxes 64,114 42,371
Deferred revenue 15,527 16,967
Warranty reserve 12,974 8,070
- ------------------------------------------------------------------------------
$ 367,537 $ 266,965
==============================================================================
|
|
|
|
|
| | | June 30, 2002 | | March 31, 2002 |
|
|
|
|
|
| Accrued income taxes | | $ | 93,347 | | $ | 94,444 |
| Accrued expenses | | | 78,555 | | | 87,104 |
| Accrued royalties | | | 57,840 | | | 77,590 |
| Accrued compensation and benefits | | | 51,708 | | | 87,985 |
| Deferred revenue | | | 15,053 | | | 13,286 |
| Warranty reserve | | | 2,461 | | | 4,010 |
|
|
|
|
|
| | | $ | 298,964 | | $ | 364,419 |
|
|
|
|
|
Note 9.8. Segment Information
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures“Disclosures About Segments of An Enterprise And Related Information"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 Company for making operational decisions and assessments of financial performance.
The Company'sCompany’s chief operating decision maker is considered to be the Company'sCompany’s Chief Executive Officer ("CEO"(“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region and by product lines for purposes of making operating decisions and assessing financial performance.
The Company operates in two principal business segments globally:
.
§ EA Core business segment: creation, marketing and distribution of entertainment software.
.
§ EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising.
Please see the discussion regarding segment reporting in the
MD&A.
9
Management’s Discussion and Analysis of Financial Condition and Results of Operations.ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Information about the
Company'sCompany’s business segments is presented below for the three
and nine months ended
December 31,June 30, 2002 and 2001
and 2000 (in thousands):
- ---------------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $ 810,930 $ 21,948 $ - $ 832,878
Group sales 1,877 - (1,877) (a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total net revenues 812,807 21,948 (1,877) 832,878
- ---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 397,138 3,715 - 400,853
Group cost of goods sold - 1,877 (1,877) (a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 397,138 5,592 (1,877) 400,853
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 415,669 16,356 - 432,025
Operating expenses:
Marketing and sales 84,192 5,217 4,466 (c) 93,875
General and administrative 29,116 2,717 - 31,833
Research and development 66,030 13,935 17,441 (b) 97,406
Network development and support - 14,858 (14,858)(b) -
Customer relationship management - 2,583 (2,583)(b) -
Carriage fee - 4,466 (4,466)(c) -
Amortization of intangibles 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
10
|
|
|
|
|
|
|
|
|
| | | Three Months Ended June 30, 2002 |
|
| | | EA Core (excl. EA.com) | | EA.com | | | Adjustments and Eliminations | | | Electronic Arts |
|
|
|
|
|
|
|
|
|
| Net revenues from unaffiliated customers | | $ | 312,119 | | $ | 19,779 | | | $ | — | | | $ | 331,898 |
| Group sales | | | 324 | | | — | | | | (324 | )(a) | | | — |
|
|
|
|
|
|
|
|
|
| Total net revenues | | | 312,443 | | | 19,779 | | | | (324 | ) | | | 331,898 |
|
|
|
|
|
|
|
|
|
| Cost of goods sold from unaffiliated customers | | | 138,819 | | | 2,546 | | | | — | | | | 141,365 |
| Group cost of goods sold | | | — | | | 324 | | | | (324 | )(a) | | | — |
|
|
|
|
|
|
|
|
|
| Total cost of goods sold | | | 138,819 | | | 2,870 | | | | (324 | ) | | | 141,365 |
|
|
|
|
|
|
|
|
|
| Gross profit | | | 173,624 | | | 16,909 | | | | — | | | | 190,533 |
| Operating expenses: | | | | | | | | | | | | | | |
| Marketing and sales | | | 57,442 | | | 3,466 | | | | 4,466 | (c) | | | 65,374 |
| General and administrative | | | 23,515 | | | 2,148 | | | | — | | | | 25,663 |
| Research and development | | | 65,601 | | | 11,048 | | | | 14,320 | (b) | | | 90,969 |
| Network development and support | | | — | | | 12,113 | | | | (12,113 | )(b) | | | — |
| Customer relationship management | | | — | | | 2,207 | | | | (2,207 | )(b) | | | — |
| Carriage fee | | | — | | | 4,466 | | | | (4,466 | )(c) | | | — |
| Amortization of intangibles | | | 926 | | | 1,319 | | | | — | | | | 2,245 |
|
|
|
|
|
|
|
|
|
| Total operating expenses | | | 147,484 | | | 36,767 | | | | — | | | | 184,251 |
|
|
|
|
|
|
|
|
|
| Operating income (loss) | | | 26,140 | | | (19,858 | ) | | | — | | | | 6,282 |
| Interest and other income (expense), net | | | 3,221 | | | (74 | ) | | | — | | | | 3,147 |
|
|
|
|
|
|
|
|
|
| Income (loss) before provision for income taxes and minority interest | | | 29,361 | | | (19,932 | ) | | | — | | | | 9,429 |
| Provision for income taxes | | | 2,923 | | | — | | | | — | | | | 2,923 |
|
|
|
|
|
|
|
|
|
| Income (loss) before minority interest | | | 26,438 | | | (19,932 | ) | | | — | | | | 6,506 |
| Minority interest in consolidated joint venture | | | 898 | | | — | | | | — | | | | 898 |
|
|
|
|
|
|
|
|
|
| Net income (loss) before retained interest in EA.com | | $ | 27,336 | | $ | (19,932 | ) | | $ | — | | | $ | 7,404 |
|
|
|
|
|
|
|
|
|
| Interest income | | $ | 4,631 | | $ | 66 | | | $ | — | | | $ | 4,697 |
| Depreciation and amortization | | | 11,908 | | | 12,398 | | | | — | | | | 24,306 |
| Identifiable assets | | | 1,518,659 | | | 155,206 | | | | — | | | | 1,673,865 |
| Capital expenditures | | | 8,107 | | | 302 | | | | — | | | | 8,409 |
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
|
|
|
|
|
|
|
|
|
| | | Three Months Ended June 30, 2001 | |
|
| | | EA Core (excl. EA.com) | | | EA.com | | | Adjustments and Eliminations | | | Electronic Arts | |
|
|
|
|
|
|
|
|
|
| Net revenues from unaffiliated customers | | $ | 165,551 | | | $ | 16,399 | | | $ | — | | | $ | 181,950 | |
| Group sales | | | 518 | | | | — | | | | (518 | )(a) | | | — | |
|
|
|
|
|
|
|
|
|
| Total net revenues | | | 166,069 | | | | 16,399 | | | | (518 | ) | | | 181,950 | |
|
|
|
|
|
|
|
|
|
| Cost of goods sold from unaffiliated customers | | | 85,937 | | | | 3,092 | | | | — | | | | 89,029 | |
| Group cost of goods sold | | | — | | | | 518 | | | | (518 | )(a) | | | — | |
|
|
|
|
|
|
|
|
|
| Total cost of goods sold | | | 85,937 | | | | 3,610 | | | | (518 | ) | | | 89,029 | |
|
|
|
|
|
|
|
|
|
| Gross profit | | | 80,132 | | | | 12,789 | | | | — | | | | 92,921 | |
| Operating expenses: | | | | | | | | | | | | | | | | |
| Marketing and sales | | | 30,831 | | | | 5,507 | | | | 4,466 | (c) | | | 40,804 | |
| General and administrative | | | 20,267 | | | | 2,948 | | | | — | | | | 23,215 | |
| Research and development | | | 55,383 | | | | 15,633 | | | | 19,789 | (b) | | | 90,805 | |
| Network development and support | | | — | | | | 16,875 | | | | (16,875 | )(b) | | | — | |
| Customer relationship management | | | — | | | | 2,914 | | | | (2,914 | )(b) | | | — | |
| Carriage fee | | | — | | | | 4,466 | | | | (4,466 | )(c) | | | — | |
| Amortization of intangibles(d) | | | 3,205 | | | | 3,270 | | | | — | | | | 6,475 | |
|
|
|
|
|
|
|
|
|
| Total operating expenses | | | 109,686 | | | | 51,613 | | | | — | | | | 161,299 | |
|
|
|
|
|
|
|
|
|
| Operating loss | | | (29,554 | ) | | | (38,824 | ) | | | — | | | | (68,378 | ) |
| Interest and other income (expense), net | | | 3,089 | | | | (372 | ) | | | — | | | | 2,717 | |
|
|
|
|
|
|
|
|
|
| Loss before benefit from income taxes and minority interest | | | (26,465 | ) | | | (39,196 | ) | | | — | | | | (65,661 | ) |
| Benefit from income taxes | | | (20,355 | ) | | | — | | | | — | | | | (20,355 | ) |
|
|
|
|
|
|
|
|
|
| Loss before minority interest | | | (6,110 | ) | | | (39,196 | ) | | | — | | | | (45,306 | ) |
| Minority interest in consolidated joint venture | | | 52 | | | | — | | | | — | | | | 52 | |
|
|
|
|
|
|
|
|
|
| Net loss before retained interest in EA.com | | $ | (6,058 | ) | | $ | (39,196 | ) | | $ | — | | | $ | (45,254 | ) |
|
|
|
|
|
|
|
|
|
| Interest income | | $ | 5,168 | | | $ | 19 | | | $ | — | | | $ | 5,187 | |
| Depreciation and amortization | | | 11,463 | | | | 15,892 | | | | — | | | | 27,355 | |
| Identifiable assets | | | 1,083,923 | | | | 205,055 | | | | — | | | | 1,288,978 | |
| Capital expenditures | | | 7,833 | | | | 7,197 | | | | — | | | | 15,030 | |
===========================================================================================================================
Three Months Ended December 31, 2000 | (a) | | Represents elimination of intercompany sales of Electronic Arts packaged goods products to EA.com, and represents elimination of royalties paid to Electronic Arts by EA.com for intellectual property rights. |
| (b) | | Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. |
| (c) | | Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. |
| (d) | | Includes goodwill amortization of $1,486,000 for EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $ 629,145 $ 11,174 $ - $ 640,319
Group sales 752 - (752)(a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total net revenues 629,897 11,174 (752) 640,319
- ---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 304,036 2,761 - 306,797
Group cost of goods sold - 752 (752)(a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 304,036 3,513 (752) 306,797
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 325,861 7,661 - 333,522
Operating expenses:
Marketing and sales 56,690 4,233 4,466 (c) 65,389
General and administrative 25,722 2,758 - 28,480
Research and development 65,081 23,223 21,300 (b) 109,604
Network development and support - 18,640 (18,640)(b) -
Customer relationship management - 2,660 (2,660)(b) -
Carriage fee - 4,466 (4,466)(c) -
Amortization of intangibles 3,184 1,497 - 4,681
- ---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 150,677 57,477 - 208,154
- ---------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 175,184 (49,816) - 125,368
Interest and other income, net 2,456 234 - 2,690
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision$1,445,000 for income
taxes and minority interest 177,640 (49,582) - 128,058
Provision for income taxes 39,698 - - 39,698
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 137,942 (49,582) - 88,360
Minority interest in consolidated joint venture (382) - - (382)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) before retained interest in
EA.com $ 137,560 $ (49,582) $ - $ 87,978
===========================================================================================================================
Interest income $ 3,147 $ 22 $ - $ 3,169
Depreciation and amortization 7,539 11,150 - 18,689
Identifiable assets 1,172,112 165,164 - 1,337,276
Capital expenditures 10,192 7,807 - 17,999
EA.com. |
11
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
===========================================================================================================================
Nine Months Ended December 31, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $1,201,407 $ 53,577 $ - $1,254,984
Group sales 2,927 - (2,927)(a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total net revenues 1,204,334 53,577 (2,927) 1,254,984
- ---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 598,395 9,247 - 607,642
Group cost of goods sold - 2,927 (2,927)(a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 598,395 12,174 (2,927) 607,642
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 605,939 41,403 - 647,342
Operating expenses:
Marketing and sales 150,002 16,299 13,398 (c) 179,699
General and administrative 72,535 7,916 - 80,451
Research and development 185,138 45,232 55,396 (b) 285,766
Network development and support - 46,903 (46,903)(b) -
Customer relationship management - 8,493 (8,493)(b) -
Carriage fee - 13,398 (13,398)(c) -
Amortization of intangibles 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
12
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
===========================================================================================================================
Nine Months Ended December 31, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $985,754 $ 29,264 $ - $1,015,018
Group sales 1,795 - (1,795)(a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total net revenues 987,549 29,264 (1,795) 1,015,018
- ---------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 496,620 8,744 - 505,364
Group cost of goods sold - 1,795 (1,795)(a) -
- ---------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 496,620 10,539 (1,795) 505,364
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 490,929 18,725 - 509,654
Operating expenses:
Marketing and sales 126,702 7,677 4,466 (c) 138,845
General and administrative 69,611 7,370 - 76,981
Research and development 182,935 55,562 40,443 (b) 278,940
Network development and support - 34,096 (34,096)(b) -
Customer relationship management - 6,347 (6,347)(b) -
Carriage fee - 4,466 (4,466)(c) -
Amortization of intangibles 9,645 4,406 - 14,051
- ---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 388,893 119,924 - 508,817
- ---------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 102,036 (101,199) - 837
Interest and other income, net 10,387 241 - 10,628
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 112,423 (100,958) - 11,465
Provision for income taxes 3,554 - - 3,554
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 108,869 (100,958) - 7,911
Minority interest in consolidated joint venture (1,113) - - (1,113)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) before retained interest in
EA.com $107,756 $ (100,958) $ - $ 6,798
===========================================================================================================================
Interest income $ 11,546 $ 71 $ - $ 11,617
Depreciation and amortization 29,449 20,823 - 50,272
Capital expenditures 39,442 65,418 - 104,860
(a) Represents elimination of intercompany sales of EA Core packaged goods
products to EA.com, and represents elimination of royalties paid to EA Core
by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support and Customer
Relationship Management to Research and Development.
(c) Represents reclassification of amortization of the Carriage Fee to
Marketing and Sales.
13
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Information about the
Company'sCompany’s operations in the North America and foreign areas for the three
and nine months ended
December 31,June 30, 2002 and 2001
and 2000 is presented
below:
===================================================================================================================================
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
--------------------------------------------------------------------------------
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, 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
Three months ended December 31, 2000
- ------------------------------------
Net revenues from unaffiliated customers $ 416,904 $189,943 $19,887 $13,585 $ - $ 640,319
Intercompany revenues 3,692 11,161 3,569 2,071 (20,493) -
--------------------------------------------------------------------------------
Total net revenues 420,596 201,104 23,456 15,656 (20,493) 640,319
================================================================================
Operating income 82,257 39,588 2,941 1,411 (829) 125,368
Interest income 2,598 494 77 - - 3,169
Depreciation and amortization 15,393 2,932 218 146 - 18,689
Identifiable assets 876,560 406,952 29,083 24,681 - 1,337,276
Capital expenditures 15,361 2,202 328 108 - 17,999
Long-lived assets 323,825 160,420 4,146 3,967 - 492,358
Nine months ended December 31, 2000
- -----------------------------------
Net revenues from unaffiliated customers $ 641,502 $291,786 $41,526 $40,204 $ - $1,015,018
Intercompany revenues 8,971 19,979 10,126 2,071 (41,147) -
--------------------------------------------------------------------------------
Total net revenues 650,473 311,765 51,652 42,275 (41,147) 1,015,018
================================================================================
Operating income (loss) 2,547 (11,624) 4,812 4,800 302 837
Interest income 8,847 2,430 340 - - 11,617
Depreciation and amortization 41,053 8,202 591 426 - 50,272
Capital expenditures 88,796 14,683 999 382 - 104,860
14
below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
| | | North America | | | Europe | | | Asia Pacific (excluding Japan) | | Japan | | | Eliminations | | | Total | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended June 30, 2002
| | | | | | | | | | | | | | | | | | | | | | | |
| Net revenues from unaffiliated customers | | $ | 173,579 | | | $ | 126,530 | | | $ | 15,189 | | $ | 16,600 | | | $ | — | | | $ | 331,898 | |
| Intercompany revenues | | | 181 | | | | 9,950 | | | | 943 | | | — | | | | (11,074 | ) | | | — | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Total net revenues | | | 173,760 | | | | 136,480 | | | | 16,132 | | | 16,600 | | | | (11,074 | ) | | | 331,898 | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Operating income (loss) | | | (10,543 | ) | | | 19,152 | | | | 363 | | | (3,168 | ) | | | 478 | | | | 6,282 | |
| Interest income | | | 4,272 | | | | 372 | | | | 53 | | | — | | | | — | | | | 4,697 | |
| Depreciation and amortization | | | 20,506 | | | | 3,425 | | | | 233 | | | 142 | | | | — | | | | 24,306 | |
| Identifiable assets | | | 1,252,382 | | | | 378,248 | | | | 24,416 | | | 18,819 | | | | — | | | | 1,673,865 | |
| Capital expenditures | | | 6,326 | | | | 1,846 | | | | 160 | | | 77 | | | | — | | | | 8,409 | |
| Long-lived assets | | | 350,263 | | | | 174,169 | | | | 4,903 | | | 4,920 | | | | — | | | | 534,255 | |
|
Three months ended June 30, 2001
| | | | | | | | | | | | | | | | | | | | | | | |
| Net revenues from unaffiliated customers | | $ | 103,062 | | | $ | 59,812 | | | $ | 10,051 | | $ | 9,025 | | | $ | — | | | $ | 181,950 | |
| Intercompany revenues | | | 1,515 | | | | 4,552 | | | | 1,373 | | | (176 | ) | | | (7,264 | ) | | | — | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Total net revenues | | | 104,577 | | | | 64,364 | | | | 11,424 | | | 8,849 | | | | (7,264 | ) | | | 181,950 | |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Operating income (loss) | | | (65,718 | ) | | | (3,640 | ) | | | 4 | | | 160 | | | | 816 | | | | (68,378 | ) |
| Interest income | | | 4,583 | | | | 536 | | | | 68 | | | — | | | | — | | | | 5,187 | |
| Depreciation and amortization | | | 24,281 | | | | 2,760 | | | | 166 | | | 148 | | | | — | | | | 27,355 | |
| Identifiable assets | | | 971,686 | | | | 277,142 | | | | 20,883 | | | 19,267 | | | | — | | | | 1,288,978 | |
| Capital expenditures | | | 13,523 | | | | 1,053 | | | | 152 | | | 302 | | | | — | | | | 15,030 | |
| Long-lived assets | | | 351,942 | | | | 155,718 | | | | 4,094 | | | 4,154 | | | | — | | | | 515,908 | |
|
|
|
|
|
|
|
|
|
|
|
|
|
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Information about the
Company'sCompany’s net revenues by product line for the three
and
nine months ended
December 31,June 30, 2002 and 2001
and 2000 is presented
below:
======================================================================================
(In thousands) Three Months Ended Nine Months Ended
December 31, December 31,
2001 2000 2001 2000
- --------------------------------------------------------------------------------------
PlayStation 2 $227,554 $144,611 $ 369,836 $ 157,629
PC 194,856 152,689 318,818 303,445
PlayStation 122,940 183,309 162,129 277,967
Xbox 44,629 - 44,629 -
Game Boy Advance 30,543 - 30,543 -
Nintendo GameCube 30,026 - 30,026 -
Game Boy Color 24,176 - 28,455 -
Advertising 10,556 2,591 25,317 2,591
License, OEM and Other 9,384 5,218 17,868 14,953
N64 8,437 49,241 17,064 60,008
Online Subscriptions 7,002 6,753 22,146 22,209
Online Packaged Goods 1,992 557 2,532 1,951
Affiliated Label 120,783 95,350 185,621 174,265
- --------------------------------------------------------------------------------------
$832,878 $640,319 $1,254,984 $1,015,018
======================================================================================
below (in thousands):
|
|
|
|
|
| | | Three Months Ended June 30, |
|
| | | 2002 | | 2001 |
|
|
|
|
|
| PlayStation 2 | | $ | 134,598 | | $ | 50,519 |
| PC | | | 76,066 | | | 70,074 |
| Xbox | | | 20,103 | | | — |
| Nintendo Gamecube | | | 14,956 | | | — |
| PlayStation | | | 13,223 | | | 14,042 |
| Advertising | | | 10,473 | | | 7,661 |
| Online Subscriptions | | | 8,141 | | | 7,956 |
| License, OEM and Other | | | 3,363 | | | 4,290 |
| Game Boy Advance | | | 2,138 | | | — |
| Game Boy Color | | | 1,392 | | | — |
| N64 | | | 517 | | | 2,402 |
| Affiliated label | | | 46,928 | | | 25,006 |
|
|
|
|
|
| | | $ | 331,898 | | $ | 181,950 |
|
|
|
|
|
Note 10.9. Comprehensive Income (Loss)
The components of comprehensive income
(loss), net of tax, for the three
and nine
months ended
December 31,June 30, 2002 and 2001
and 2000 were as follows (in thousands):
======================================================================================================
Three Months Ended Nine Months Ended
December 31, December 31,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------
Net income $132,292 $87,978 $54,214 $ 6,798
- ------------------------------------------------------------------------------------------------------
Other comprehensive income:
Change in unrealized appreciation
(depreciation) of investments, net of tax
expense (benefit) of $356, $(112), $434 and
$(536) 1,982 (100) (1,877) 9,994
Foreign currency translation adjustments (839) 2,280 3,175 (3,463)
- ------------------------------------------------------------------------------------------------------
Total other comprehensive income 1,143 2,180 1,298 6,531
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
Total comprehensive income $133,435 $90,158 $55,512 $13,329
======================================================================================================
|
|
|
|
|
| | | Three Months Ended June 30, | |
|
| | | 2002 | | | 2001 | |
|
|
|
|
|
| Net income (loss) | | $ | 7,404 | | | $ | (45,254 | ) |
|
|
|
|
|
| Other comprehensive income: | | | | | | | | |
| Change in unrealized loss on investments, net of tax expense (benefit) of $628 and $(584) | | | (85 | ) | | | (1,299 | ) |
| Foreign currency translation adjustments | | | 9,310 | | | | 1,468 | |
|
|
|
|
|
| Total other comprehensive income | | | 9,225 | | | | 169 | |
|
|
|
|
|
| | | | | | | | | |
|
|
|
|
|
| Total comprehensive income (loss) | | $ | 16,629 | | | $ | (45,085 | ) |
|
|
|
|
|
The currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries.
15
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Note 11.10. Net Earnings (Loss) Per Share
The following summarizes the computations of Basic Earnings Per Share ("EPS"(“EPS”) and Diluted EPS. Basic EPS is computed as net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock-based compensation plans including stock options, restricted stock awards, warrants and other convertible securities using the treasury stock method.
Net income (loss) per share is computed individually for Class A common stock and Class B common stock. Please see the discussion regarding segment reporting in the MD&A.
(in thousands, except per share amounts):
- ---------------------------------------------------------------------------------------------------------
Three months ended December 31, 2001
Class A common Class A common Class B common
stock-Basic stock-Diluted 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)
- ---------------------------------------------------------------------------------------------------------
16
(in thousands, except per share amounts):
|
|
|
|
|
|
|
| | | Three months ended June 30, 2002 | |
| |
|
|
| | | Class A common stock-Basic | | | Class A common stock-Diluted | | Class B common stock | |
|
|
|
|
|
|
|
| Net income (loss) before retained interest in EA.com | | $ | 27,336 | | | $ | 7,404 | | $ | (19,932 | ) |
| Net loss related to retained interest in EA.com | | | (16,942 | ) | | | — | | | 16,942 | |
|
|
|
|
|
|
|
| Net income (loss) | | $ | 10,394 | | | $ | 7,404 | | $ | (2,990 | ) |
|
|
|
|
|
|
|
|
| Shares used to compute net income (loss) per share: | | | | | | | | | | | |
| Weighted-average common shares | | | 138,748 | | | | 138,748 | | | 6,043 | |
| Dilutive stock equivalents | | | — | | | | 6,474 | | | — | |
|
|
|
|
|
|
|
| Dilutive potential common shares | | | 138,748 | | | | 145,222 | | | 6,043 | |
|
|
|
|
|
|
|
| | | | | | | | | | | | |
|
|
|
|
|
|
|
| Net income (loss) per share: | | | | | | | | | | | |
| Basic | | $ | 0.07 | | | | N/A | | $ | (0.49 | ) |
| Diluted | | | N/A | | | $ | 0.05 | | $ | (0.49 | ) |
|
|
|
|
|
|
|
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES 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 common
stock-Basic stock-Diluted 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)
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
Three months ended December 31, 2000
Class A common Class A common Class B common
stock-Basic stock-Diluted stock
- ------------------------------------------------------------------------------------------------------
Net income (loss) before retained
interest in EA.com $137,560 $ 87,978 $ (49,582)
Net loss related to retained interest
in EA.com (42,144) - 42,144
- ------------------------------------------------------------------------------------------------------
Net income (loss) $ 95,416 $ 87,978 $ (7,438)
- ------------------------------------------------------------------------------------------------------
Shares used to compute net
income (loss) per share:
Weighted-average common shares 132,339 132,339 6,000
Dilutive stock equivalents - 6,565 -
- ------------------------------------------------------------------------------------------------------
Dilutive potential common shares 132,339 138,904 6,000
======================================================================================================
- ------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $ 0.72 N/A $ (1.24)
Diluted N/A $ 0.63 $ (1.24)
- ------------------------------------------------------------------------------------------------------
17
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
- ------------------------------------------------------------------------------------------------------
Nine months ended December 31, 2000
Class A common Class A common Class B common
stock-Basic stock-Diluted stock
- ------------------------------------------------------------------------------------------------------
Net income (loss) before retained
interest in EA.com $107,756 $ 6,798 $ (100,958)
Net loss related to retained interest
in EA.com (85,814) - 85,814
- ------------------------------------------------------------------------------------------------------
Net income (loss) $ 21,942 $ 6,798 $ (15,144)
- ------------------------------------------------------------------------------------------------------
Shares used to compute net
income (loss) per share:
Weighted-average common shares 130,716 130,716 6,000
Dilutive stock equivalents - 6,656 -
- ------------------------------------------------------------------------------------------------------
Dilutive potential common shares 130,716 137,372 6,000
======================================================================================================
- ------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Basic $ 0.17 N/A $ (2.52)
Diluted N/A $ 0.05 $ (2.52)
- ------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts):
|
|
|
|
|
|
|
| | | Three months ended June 30, 2001 | |
| |
|
|
| | | Class A common stock-Basic | | | Class A common stock-Diluted | | | Class B common stock | |
|
|
|
|
|
|
|
| Net loss before retained interest in EA.com | | $ | (6,058 | ) | | $ | (45,254 | ) | | $ | (39,196 | ) |
| Net loss related to retained interest in EA.com | | | (33,317 | ) | | | — | | | | 33,317 | |
|
|
|
|
|
|
|
| Net loss | | $ | (39,375 | ) | | $ | (45,254 | ) | | $ | (5,879 | ) |
|
|
|
|
|
|
|
| Shares used to compute net loss per share: | | | | | | | | | | | | |
| Weighted-average common shares | | | 135,730 | | | | 135,730 | | | | 6,020 | |
| Dilutive stock equivalents | | | — | | | | 652 | | | | — | |
|
|
|
|
|
|
|
| Dilutive potential common shares | | | 135,730 | | | | 136,382 | | | | 6,020 | |
|
|
|
|
|
|
|
| | | | | | | | | | | | | |
|
|
|
|
|
|
|
| Net loss per share: | | | | | | | | | | | | |
| Basic | | $ | (0.29 | ) | | | N/A | | | $ | (0.98 | ) |
| Diluted | | | N/A | | | $ | (0.33 | ) | | $ | (0.98 | ) |
|
|
|
|
|
|
|
The Diluted EPS calculation for Class A common stock, presented above, includes the potential dilution from the conversion of Class B common stock to Class A common stock in the event that the initial public offering for Class B common stock does not occur. Net income used for the calculation of Diluted EPS for Class A common stock was $132,292,000 and $87,978,000$7,404,000 for the three months ended December 31, 2001 and 2000, respectively.June 30, 2002. Net incomeloss used for the calculation of Diluted EPS for Class A common stock was $54,214,000 and $6,798,000$45,254,000 for the ninethree months ended December 31, 2001 and 2000, respectively.June 30, 2001. This net income (loss) includes the remaining 15% interest in EA.com, which is directly attributable to outstanding Class B shares owned by third parties, which would be included in the Class A common stock EPS calculation in the event that the initial public offering for Class B common stock does not occur.
Excluded from the above computation of weighted-average shares for Diluted EPS for Class A common stock were options to purchase
1,729,312 and 1,425,157217,000 shares of common stock for the three
and nine months ended
December 31, 2001,
respectively,June 30, 2002, as the
options'options’ exercise price was greater than the average market price of the common shares.
Excluded from the above computation ofThe weighted-average
shares for Diluted EPS
for Class A common stock were options to purchase 4,142,646 and 2,617,667 shares
of common stock for the three and nine months ended December 31, 2000,
respectively, as the options' exercise price
of these respective options was
greater than the average market
price of the common shares.$62.01 per share. Due to the net loss attributable for the three
and nine months ended
December
31,June 30, 2001
and 2000 on a diluted basis to Class
BA Stockholders, stock options have been excluded from the
18
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued) Diluted EPS calculation as their inclusion would have been antidilutive. Had net income been reported for the three and nine months ended December 31,June 30, 2001, an additional 828,000 and 884,0006,115,000 shares would have been added to diluted potential common shares for Class BA common stock, respectively. Forstock.ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Due to the net loss attributable for the three and nine
months ended December 31, 2000,June 30, 2002 and 2001 on a diluted basis to Class B Stockholders, stock options have been excluded from the Diluted EPS calculation as their inclusion would have been antidilutive. Had net income been reported for the three months ended June 30, 2002, an additional 1,016,000 and 287,000610,000 shares would have been added to diluted potential common shares for Class B common stock. For the three months ended June 30, 2001, an additional 932,000 shares would have been added to diluted potential common shares for Class B common stock.
Note 12.11. Restructuring and Asset Impairment Charges
During the quarter ended December 31,
In October 2001, the Company announced a restructuring plan for EA.comEA.com. The restructuring initiatives involved strategic decisions to reduce its workforcediscontinue certain product offerings and consolidate
facilities. These restructuring and resulting asset impairment charges were
necessary in order to focus only on key online priorities and reduce EA.com's
operating cost structure.that align with its fiscal 2003 operational objectives. The Company recorded total charges of $14,051,000,
consisting of $3,763,000 for workforce reductions, $3,785,000 for consolidation
of facilities and other administrative charges and $6,503,000 for the write-off
of non-current assets.
The restructuring planreduction resulted in the termination of approximately 240
personnel, or one-third of EA.com's workforce, which affected all departments
across270 positions.
The following table summarizes the
organization. The estimated costs for consolidation of facilities is
comprised of contractual rental commitments under real estate leases for
unutilized office space offset by estimated future sub-lease income. Includedactivity in
these costs are estimated costs to close offices or consolidate facilities in
various locations and costs to writeoff a portion of the
assets from these
facilities. In addition, theaccrued restructuring
efforts required an evaluation of
asset impairment in accordance with SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", to write
these depreciable assets and certain intangibles to their fair value.
Restructuring and asset impairment chargesaccount for the three months ended
December
31, 2001 were as followsJune 30, 2002 (in thousands):
- ----------------------------------------------------------------------------------------------------
Expense Recorded Unutilized
in the Quarter balance as of
Ended Cash Non-cash December 31,
December 31, 2001 Utilization Utilization 2001
- ----------------------------------------------------------------------------------------------------
Workforce $ 3,763 $2,871 $ - $ 892
Facilities 3,785 132 - 3,653
Non-current assets 6,503 - 6,503 -
- ----------------------------------------------------------------------------------------------------
Total $14,051 $3,003 $6,503 $4,545
====================================================================================================
| | | Workforce | | | Facilities | | | Non-Current Assets | | Total | |
|
|
|
|
|
|
|
|
|
| Accrual 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 | ) |
|
|
|
|
|
|
|
|
|
| Accrual balance as of June 30, 2002 | | $ | 180 | | | $ | 1,935 | | | $ | — | | $ | 2,115 | |
|
|
|
|
|
|
|
|
|
The restructuring accrual is included in accrued expenses in Note
87 of the Notes to Condensed Consolidated Financial Statements.
19
ITEM 2: Management'sItem 2. Management’s Discussion and Analysis Of Financial Condition and Results Of Operations This Quarterly Report, on Form 10-Q and, in particular, the following "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” contains forward-looking statements about circumstances that have not yet occurred. All statements, trend analysis and other information contained below relating to markets, our products and trends in revenue, as well as other statements including words such as "anticipate"“anticipate”, "believe"“believe” or "expect"“expect” and statements in the future tense are forward-looking statements. These forward-looking statements are subject to business and economic risks and actual events or our actual future results could differ materially from those set forth in the forward-looking statements due to such risks and uncertainties. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results and performance include, but are not limited to, those discussed under the heading "Risk Factors"“Risk Factors” at pages 4538 to 52,46 as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 20012002 as filed with the Securities and Exchange Commission on June 29, 200128, 2002 and other documents filed with the Commission.
SEC.
CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The policies discussed below are considered by management to be critical because they are both important to the portrayal of our financial condition and results of operations and their application places the most significant demands on management’s judgment, with financial reporting results relying on estimates about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions.
Sales allowances and bad debt reserves
We derive revenues from sales of our packaged goods product, subscriptions of online service, sales of packaged goods through our online store and website advertising. Product revenue is recognized net of an allowance for returns. We also have stock-balancing programs for our personal computer products that, under certain circumstances and up to a specified amount, allow for the exchange of personal computer products by resellers. We may decide to provide price protection under certain circumstances for our personal computer and video game system products after we analyze: inventory remaining in the channel, the rate of inventory sell through in the channel, and our remaining inventory on hand. We maintain a policy of exchanging products or giving credits, but do not 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 game 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 and their inventories as substantial overstocking in the distribution channel can result in high returns or the requirement for substantial price protection in subsequent periods. In the past, actual returns have not generally exceeded our reserves. However, actual returns in any future period are inherently uncertain 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 as Xbox, Nintendo GameCube and PlayStation 2, become more popular. While management believes it can make reliable estimates for these matters, if we changed our assumptions and estimates, our returns reserves would change, which would impact the net revenue we report. In addition, if actual returns were significantly greater than the reserves we have established, the actual results would decrease our reported revenue. Conversely, if actual returns were significantly less than our reserves, this would increase our reported revenue.
Similarly, management must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts in any accounting period. Management analyzes customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Material differences may result in the amount and timing of our bad debt expense for any period if management made different judgments or utilized different estimates. If our customers experience financial difficulties and are not able to meet their ongoing financial obligations to us, our results of operations may be adversely impacted. For example, in January 2002, one of our retail customers, Kmart, declared bankruptcy. We believe we have adequately reserved for our exposure to Kmart.
Our gross accounts receivable balance was $246,865,000 and our allowance for product returns, pricing allowances and doubtful accounts was $128,518,000 as of June 30, 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, 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. We evaluate the future realization of prepaid royalties quarterly and charge to research and development expense any amounts that we deem unlikely to be realized through product sales. We rely on forecasted revenue to evaluate the future realization of prepaid royalties. If actual revenues, or revised forecasted sales, fall below the initial forecasted sales, the charge to research and development expense may be larger than anticipated in any given quarter. Once the charge has been taken to research and development expense, 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 $69,020,000 at June 30, 2002 and $65,484,000 at March 31, 2002. The long-term portion of prepaid royalties, included in other assets, was $1,715,000 at June 30, 2002 and $1,164,000 at March 31, 2002.
Valuation of long-lived assets, including goodwill and other intangible assets
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 temporary impairment in the remaining value of the assets recorded on our balance sheet. In order to judge the remaining useful life of an asset, management makes various assumptions about the value of the asset in the future. This may include assumptions about future prospects for the business that the asset relates to and typically involves computations of the estimated future cash flows to be generated by these businesses. 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, our future net cash flows are primarily dependent on the sale of products for play on proprietary video game platforms. The success of our products is affected by the ability to accurately predict which platforms and which products we develop will be successful. Also, our revenues 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. Because of our inexperience in predicting usage patterns for our games, we may not be effective in achieving success that may otherwise be attainable from offering our games online. Due to these and other factors described in our Risk Factors, we may not realize the future net cash flows necessary to recover our long-lived assets. For example, our productMajestic™and 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 as part of EA.com’s restructuring plan in fiscal 2002.
Based on these judgments and assumptions, management determines whether we need to take an impairment charge to reduce the value of the asset stated on our balance sheet to reflect its estimated fair value. Judgments and assumptions about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including but not limited to, significant negative industry or economic trends, significant changes in the manner or use of the acquired assets or the strategy of our overall business and significant underperformance relative to expected historical or projected future operating results. Although we believe the judgments and assumptions management has made in the past have been reasonable and appropriate, there is nonetheless a high degree of uncertainty and judgment involved. For example, as part of a restructuring plan to reduce EA.com’s workforce and consolidate facilities in the fiscal year ended March 31, 2002, we recorded impairment charges to write down certain of EA.com’s depreciable assets and certain intangibles to their estimated fair value and to write off certain assets which were abandoned. The impairment charges were based on management’s projections regarding the assets’ remaining useful lives and future values. The EA.com business is still in the growing stages, therefore evaluating its business and prospects is more difficult than would be the case for a more mature business. We continue to encounter the risks and difficulties faced with launching a new business. We continue to look for ways to streamline the business by consolidating systems and reducing infrastructure costs. Different judgments and assumptions could materially impact our reported financial
results. More conservative assumptions of the anticipated future benefits from these businesses would result in greater impairment charges, which would decrease net income and result in lower asset values on our balance sheet. Conversely, less conservative assumptions would result in smaller impairment charges, higher net income and higher asset values. There were no impairment charges on long-lived assets for the three months ended June 30, 2002 and 2001.
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, which had a net book value at March 31, 2002 of $69,050,000. 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. We completed the first step of impairment testing during the current quarter and found no instances of impairment of its recorded goodwill. Accordingly, provided there are no future indicators of impairment, the second testing step is not necessary during fiscal 2003. 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.
Income taxes
As part of the process of preparing our 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 as making judgments regarding the recoverability of deferred tax assets. 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. 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 effect the overall effective tax rate.
RESULTS OF OPERATIONS
Revenues
We derive revenues primarily from shipments of entertainment software, which includes EA Studio products for dedicated entertainment systems (that we call video game systems or consoles such as PlayStation®, PlayStation® 2, Xbox™ and Nintendo GameCube™, and handheld systems such as Game Boy® Advance), EA Studio personal computer products (or PC), Co-Publishing products that are co-published and distributed by us, and Affiliated Label (or AL) products that are published by third parties and distributed by us. We also derive revenues from licensing of EA Studio products and AL products through hardware companies (or OEM), selling subscriptions on our online gaming service, selling advertisements on our online web pages and selling our packaged goods through our online store.
Information about our net revenues for North America and foreign areas for the three
and nine months ended
December 31,June 30, 2002 and 2001
and 2000 is summarized below (in thousands):
December 31, December 31,
2001 2000 Increase % change
------------------------------------------------------------------------
Net Revenues for the Three Months Ended:
North America $510,752 $416,904 $ 93,848 22.5%
-------------------------------------------------------------------------
Europe 279,601 189,943 89,658 47.2%
Asia Pacific 21,801 19,887 1,914 9.6%
Japan 20,724 13,585 7,139 52.6%
-------------------------------------------------------------------------
International 322,126 223,415 98,711 44.2%
-------------------------------------------------------------------------
Consolidated Net Revenues $832,878 $640,319 $192,559 30.1%
=========================================================================
20
December 31, December 31, Increase/
2001 2000 (Decrease) % change
--------------------------------------------------------------------------
Net Revenues for the Nine Months Ended:
North America $ 783,369 $ 641,502 $141,867 22.1%
--------------------------------------------------------------------------
Europe 392,615 291,786 100,829 34.6%
Asia Pacific 39,859 41,526 (1,667) (4.0)%
Japan 39,141 40,204 (1,063) (2.6)%
--------------------------------------------------------------------------
International 471,615 373,516 98,099 26.3%
--------------------------------------------------------------------------
Consolidated Net Revenues $1,254,984 $1,015,018 $239,966 23.6%
==========================================================================
| | | June 30, 2002 | | June 30, 2001 | | Increase | | % change | |
| |
|
|
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|
|
|
|
|
| North America | | $ | 173,579 | | $ | 103,062 | | $ | 70,517 | | 68.4 | % |
| |
|
|
|
|
|
|
|
|
| Europe | | | 126,530 | | | 59,812 | | | 66,718 | | 111.5 | % |
| Asia Pacific | | | 15,189 | | | 10,051 | | | 5,138 | | 51.1 | % |
| Japan | | | 16,600 | | | 9,025 | | | 7,575 | | 83.9 | % |
| |
|
|
|
|
|
|
|
|
| International | | | 158,319 | | | 78,888 | | | 79,431 | | 100.7 | % |
| |
|
|
|
|
|
|
|
|
| Consolidated Net Revenues | | $ | 331,898 | | $ | 181,950 | | $ | 149,948 | | 82.4 | % |
| |
|
|
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|
North America Net Revenues
The increase in North America net revenues for the three and nine months ended December 31, 2001June 30, 2002 compared to the same periods last yearthree months ended June 30, 2001 was primarily attributable to:
. A 57% increase in PlayStation 2 revenues for the quarter and 179% for the
nine months ended December 31, 2001 due to the shipment of key titles such as
Madden NFL 2002, James Bond 007...Agent Under Fire, NBA Live 2002, SSX Tricky
and NASCAR Thunder 2002, a higher installed base of hardware and a strong
catalogue business. PlayStation 2 launched in October of fiscal 2001.
Consequently, fiscal 2001 includes three months of revenues as compared to
nine months of revenues from the PlayStation 2 in fiscal 2002.
. The launch of the Xbox platform in North America in November 2001 generated
$44,629,000 in revenue from titles such as Madden NFL 2002, NBA Live 2002,
NASCAR Thunder 2002, NHL 2002 and SSX Tricky. We commenced generating
revenues for this platform following its North American launch in November
2001.
. The launch of Nintendo GameCube in North America in November 2001 generated
$27,511,000 for the quarter from key titles such as Madden NFL 2002, SSX
Tricky and FIFA Soccer 2002.
. New revenues were generated by Game Boy Advance of $18,690,000 for the
quarter from key titles including Harry Potter and the Sorcerer's Stone and
Madden NFL. Also, Game Boy Color generated new revenues of $10,345,000 for
the quarter and $13,652,000 for the nine months ended December 31, 2001 for
titles such as Harry Potter and the Sorcerer's Stone, Madden NFL 2002 and The
World Is Not Enough.
. Advertising revenues increased by 307% for the quarter and 877% for the nine
months ended December 31, 2001 as we commenced generating advertising
revenues immediately following the launch of our gamesite on the world wide
web in October 2000. In addition, advertising revenues were generated from
Pogo Corporation's ("Pogo") websites subsequent to the February 2001
acquisition.
. These increases were partially offset by the continued expected decrease in
Sony PlayStation, which had fewer titles shipping compared to the same
periods in the prior year, and Nintendo 64 revenues due to a declining
market.
| § | | PlayStation 2 revenues increased by 124% for the quarter primarily due to the shipment of key titlesMedal of Honor Frontline™and2002 FIFA World Cup, as well as a higher installed base of the PlayStation 2 hardware. |
| § | | AL product sales increased for the current quarter primarily due to new AL distribution deals with LEGO Interactive, Crave Entertainment, Inc. and Fox Interactive, which included titles such asFootball Mania,Freedom ForceandThe Simpsons™ Road Rage. |
| § | | We generated $10,207,000 in Xbox revenues with 11 skus including titles such asJames Bond 007 in...Agent Under Fire™and2002 FIFA World Cup. The Xbox platform was launched in North America in November 2001. |
| § | | We generated $6,731,000 in Nintendo GameCube revenues with 7 skus including titles such asJames Bond 007 in...Agent Under Fireand2002 FIFA World Cup. The Nintendo GameCube platform was launched in North America in November 2001. |
| § | | These increases were partially offset by a slight decrease in PC revenues primarily due to the strong shipment of hit titles includingBlack & Whitein the prior year, as well as the continued expected decreases in Sony PlayStation and Nintendo 64® (“N64”) revenues due to those declining markets. |
International Net Revenues
The increase in international net revenues for the three months ended
December
31, 2001June 30, 2002 compared to the three months ended
December 31, 2000June 30, 2001 was attributable to the following:
. Europe's net revenues increased 47% compared to the prior year primarily due
to the shipment of Harry Potter and the Sorcerer's Stone on four platforms,
higher PlayStation 2
21
revenues driven by key titles such as James Bond 007...Agent Under Fire and
FIFA Soccer 2002, and higher AL revenue resulting primarily from the
addition of Capcom as an AL in Europe. These increases were partially
offset by the expected decrease of revenues from Sony PlayStation.
. Japan's net revenues increased 53% compared to the prior year, in spite of an
unfavorable exchange rate comparison of about 13%, primarily due to higher
PlayStation sales for key title Harry Potter and the Sorcerer's Stone in the
current fiscal year.
. Asia Pacific net revenues increased 10% compared to the prior year primarily
due to sales of key title Harry Potter and the Sorcerer's Stone on the PC,
Game Boy Color and Game Boy Advance platforms, partially offset by decreases
in PlayStation 2 sales, Nintendo 64 sales and an unfavorable exchange rate
comparison.
The increase in international net revenues for the nine months ended December
31, 2001 compared to the nine months ended December 31, 2000 was attributable to
the following:
. Europe net revenues increased by 35% compared to the prior year primarily due
to higher PlayStation 2, AL and PC sales, partially offset by the expected
decrease of revenues from Sony PlayStation. PlayStation 2 launched in
November of fiscal 2001. Consequently, fiscal 2001 includes two months of
revenues as compared to nine months of revenues from the PlayStation 2 in
fiscal 2002.
. The increase was partially offset by a decrease in Asia Pacific's net
revenues of 4% compared to the prior year primarily due to the expected
decrease in PlayStation and Nintendo 64 sales, an unfavorable exchange rate
comparison and the later emergence of the PlayStation 2 in this market
resulting in fewer hardware units in the area. Additionally, Asia Pacific did
not benefit from our primary PlayStation 2 releases during the nine months
ended December 31, 2001 which have more appeal to the North American market.
. The increase was partially offset by Japan's net revenues, which decreased 3%
compared to the prior year primarily due to the strong sales of our first
PlayStation 2 title, FIFA Soccer World Championship, in the prior year and
weakness in the Yen currency. Also, Japan did not benefit from our primary
PlayStation 2 releases during the nine months ended December 31, 2001, which
have more appeal to the North American market.
22
| § | | Europe’s increase in net revenue by 112% compared to the same period in the prior year is primarily due to higher PlayStation 2 sales from hit titlesMedal of Honor Frontlineand2002 FIFA World Cup. The increase was also due to a higher installed base of the PlayStation 2 hardware, higher PC sales from key title2002 FIFA World Cup, new revenues in the current year for the Xbox and Nintendo Gamecube platforms and higher AL sales. |
| § | | Japan’s net revenues increased 84% compared to the same period in the prior year primarily due to higher revenues on the PlayStation 2 from titles such as2002 FIFA World CupandProject FIFA World Cup. |
| § | | Asia Pacific’s net revenues increased by 51% compared to the same period in the prior year primarily due to higher AL revenues from sales of titles such asFinal Fantasy XandRogue Leaderfrom new AL distribution deals with SquareSoft and LucasArts; as well as higher PlayStation 2 sales from hit titlesMedal of Honor Frontlineand2002 FIFA World Cup. |
Information about our worldwide net revenues by product line for the three
and
nine months ended
December 31,June 30, 2002 and 2001
and 2000 is presented below (in thousands):
December 31, December 31, Increase/
2001 2000 (Decrease) % change
-----------------------------------------------------
Net Revenues for the Three Months Ended:
EA Studio:
- ---------
PlayStation 2 $227,554 $144,611 $ 82,943 57.4%
PC 194,856 152,689 42,167 27.6%
PlayStation 122,940 183,309 (60,369) (32.9)%
Xbox 44,629 - 44,629 N/A
Game Boy Advance 30,543 - 30,543 N/A
Nintendo GameCube 30,026 - 30,026 N/A
Game Boy Color 24,176 - 24,176 N/A
Advertising 10,556 2,591 7,965 307.4%
Online Subscriptions 7,002 6,753 249 3.7%
License, OEM and Other 9,384 5,218 4,166 79.8%
N64 8,437 49,241 (40,804) (82.9)%
Online Packaged Goods 1,992 557 1,435 257.6%
-----------------------------------------------------
712,095 544,969 167,126 30.7%
Affiliated Label: 120,783 95,350 25,433 26.7%
- ----------------- -----------------------------------------------------
Consolidated Net Revenues $832,878 $640,319 $ 192,559 30.1%
=====================================================
December 31, December 31, Increase/
2001 2000 (Decrease) % change
----------------------------------------------------------
Net Revenues for the Nine Months Ended:
EA Studio:
- ---------
PlayStation 2 $ 369,836 $157,629 $ 212,207 134.6%
PC 318,818 303,445 15,373 5.1%
PlayStation 162,129 277,967 (115,838) (41.7)%
Xbox 44,629 - 44,629 N/A
Game Boy Advance 30,543 - 30,543 N/A
Nintendo GameCube 30,026 - 30,026 N/A
Game Boy Color 28,455 - 28,455 N/A
Advertising 25,317 2,591 22,726 877.1%
Online Subscriptions 22,146 22,209 (63) (0.3)%
License, OEM and Other 17,868 14,953 2,915 19.5%
N64 17,064 60,008 (42,944) (71.6)%
Online Packaged Goods 2,532 1,951 581 29.8%
----------------------------------------------------------
1,069,363 840,753 228,610 27.2%
Affiliated Label: 185,621 174,265 11,356 6.5%
- ----------------- ----------------------------------------------------------
Consolidated Net Revenues $1,254,984 $1,015,018 $ 239,966 23.6%
==========================================================
| | | June 30, 2002 | | June 30, 2001 | | Increase/ (Decrease) | | | % change | |
| |
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EA Studio: | | | | | | | | | | | | | |
| PlayStation 2 | | $ | 134,598 | | $ | 50,519 | | $ | 84,079 | | | 166.4 | % |
| PC | | | 76,066 | | | 70,074 | | | 5,992 | | | 8.6 | % |
| Xbox | | | 20,103 | | | — | | | 20,103 | | | N/A | |
| Nintendo Gamecube | | | 14,956 | | | — | | | 14,956 | | | N/A | |
| PlayStation | | | 13,223 | | | 14,042 | | | (819 | ) | | (5.8 | %) |
| Advertising | | | 10,473 | | | 7,661 | | | 2,812 | | | 36.7 | % |
| Online Subscriptions | | | 8,141 | | | 7,956 | | | 185 | | | 2.3 | % |
| License, OEM and Other | | | 3,363 | | | 4,290 | | | (927 | ) | | (21.6 | %) |
| Game Boy Advance | | | 2,138 | | | — | | | 2,138 | | | N/A | |
| Game Boy Color | | | 1,392 | | | — | | | 1,392 | | | N/A | |
| N64 | | | 517 | | | 2,402 | | | (1,885 | ) | | (78.5 | %) |
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| | | | 284,970 | | | 156,944 | | | 128,026 | | | 81.6 | % |
Affiliated Label: | | | 46,928 | | | 25,006 | | | 21,922 | | | 87.7 | % |
| |
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| Consolidated Net Revenues | | $ | 331,898 | | $ | 181,950 | | $ | 149,948 | | | 82.4 | % |
| |
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PlayStation 2 Product Net Revenues
Revenues increased for the three and nine months ended December 31, 2001June 30, 2002 primarily due to strong sales of hit titles released in the quarter includingMedal of Honor Frontlineand2002 FIFA World Cup. These two titles accounted for approximately 67% of total PlayStation 2 revenues for the current quarter. The increase was also due to the higher installed base of PlayStation 2 hardware and higher numberdue in part to Sony’s price cut of titles,
including catalogue, available on the platform compared to the same periods last
year. Major releases for the quarter include titles such as James Bond
007...Agent Under Fire, FIFA Soccer 2002, NBA Livehardware in North America in May 2002 and SSX Tricky.in Europe in September 2001. We 23
released sixfour PlayStation 2 titles in the current quarter compared to tentwo in the same period last year. We released 12 PlayStation 2 titles for both the nine
months ended December 31, 2001 and 2000. We expect revenues from PlayStation 2 products to continue to grow in fiscal 2002,2003, but as revenues for these products increase, we do not expect to maintain these growth rates. Personal Computer Product Net Revenues
The increase in sales of PC products for the three and nine months ended December 31, 2001June 30, 2002 compared to the same periodsperiod last year was primarily due to the stronghigher current quarter sales of major hits including Harry Potter and the Sorcerer's Stone,
The Sims Hot Datefranchise titles includingThe Sims™ Vacation Expansion Pack. The Sims House Party and Black and Whiteincrease was also due to sales in the current year.quarter of key release titles2002 FIFA World Cupand catalogue sales ofMedal of Honor Allied Assault. These increases were partially offset by strong sales in the prior year for hit titlesBlack and WhiteandEmperor: Battle for Dune. We released fivetwo PC titles in the third quarter of the current
fiscal year and the same period last year. We released ten PC titles in the ninethree months ended December 31, 2001June 30, 2002 compared to 13one in the same period last year.The Simsand its expansion packs have now sold over 16 million units.
Xbox Net Revenues
During the three months ended June 30, 2002, we released two Xbox titles,2002 FIFA World CupandF1 2002. Other significant titles on the platform includeJames Bond 007 in...Agent Under Fire,Knockout Kings 2002andSSX Tricky.
Nintendo GameCube Net Revenues
During the three months ended June 30, 2002, we released two Nintendo GameCube titles,2002 FIFA World Cup andF1 2002. Other significant titles on the platform includeJames Bond 007 in...Agent Under Fire andSSX Tricky.
PlayStation Product Net Revenues
We released four titles
The expected decrease in PlayStation product sales for the PlayStation console during the third quarter of
fiscalthree months ended June 30, 2002 compared to ten titles released in the third quarter of fiscal 2001.
We released five PlayStation titles in the nine months ended December 31, 2001
compared to 16 titles in the same period last year. As expected, PlayStation
sales decreased for the three and nine months ended December 31, 2001 compared
to the prior year primarilywas attributable to the completed transition to next generation console systems and fewer titles released for the product during the
current year.
Sony released the PlayStation 2 worldwide in the prior year.systems. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline significantly in fiscal 2002.
2003.
Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994 (the
"Sony Agreement"“Sony Agreement”), as amended, we are authorized to develop and distribute CD-based software products compatible with the PlayStation. Furthermore, under the terms of an additional licensing agreement entered into with Sony Computer Entertainment of America as of April 2000 (the
"PlayStation“PlayStation 2
Agreement"Agreement”), as amended, we are authorized to develop and distribute DVD-based software products compatible with the PlayStation 2. Pursuant to these agreements, we engage Sony to supply its PlayStation and PlayStation 2 CDs and DVDs for distribution by us. Accordingly, we have limited ability to control our supply of PlayStation and PlayStation 2 CD and DVD products or the timing of their delivery.
Xbox Net Revenues
Following the launch of the Xbox platform in North America in November 2001, we
released our first six Xbox titles during the third quarter of fiscal 2002.
Titles released included Madden NFL 2002, NBA Live 2002, NASCAR Thunder 2002,
NHL 2002, SSX Tricky and F1 2001.
Game Boy Advance Net Revenues
We released our first two Game Boy Advance titles, Harry Potter and the
Sorcerer's Stone and Madden NFL 2002, during the third quarter of fiscal 2002.
Nintendo GameCube Net Revenues
We released our first three Nintendo GameCube titles, Madden NFL 2002, SSX
Tricky and FIFA Soccer 2002, during the third quarter of fiscal 2002 following
the platform's launch in Japan in September 2001 and North America in November
2001.
24
Game Boy Color Net Revenues
We released one Game Boy Color title, Harry Potter and the Sorcerer's Stone, in
the third quarter of fiscal 2002.
Advertising Revenues
We commenced generating
The increase in advertising revenues infor the third quarter of fiscalthree months ended June 30, 2002 compared to the same period last year 2001 following the launch ofwas primarily due to higher advertising revenues generated on our gamesite on the world wide web and the AOL Games Channel in October 2000. In addition, we also generated advertising
revenuesChannel. Due to continuing uncertainties in the three and nine months ended December 31, 2001 relatedadvertising market, we may not be able to Pogo's
websites subsequent tosustain the February 2001 acquisition.
same growth rate for the remainder of fiscal 2003.
Online Subscription Net Revenues
The slight increase in online revenues for the three months ended December 31, 2001 and
slight decrease in online revenues for the nine months ended December 31, 2001June 30, 2002 as compared to the same periods in the prior year werethree months ended June 30, 2001 was primarily attributable to revenues from the following:
. An increase in the number of paying customers for Ultima Online to
208,000 as of December 31, 2001 as compared to 185,000 as of December
31, 2000.
. The launch ofMotor City Onlinein late October 2001. The number of
subscribers to Motor City OnlineThis increase was 26,000 as of December 31, 2001. Of
these, 12,000 had reached the end of their free period and were paying
monthly subscription fees.
. These increases werepartially offset by a slight decrease in subscription revenues for
Kesmai and Worldplay online games (mostfromUltima Onlinedue to the release of which were transferred to
our free service when the EA/AOL site went live Ultima Online Third Dawnin October 2000) for
the three and nine months ended December 31,March 2001.
License, OEM and Other Revenues
The increasedecrease in license, OEM and other revenues forwas due to higher licensing and OEM deal activity in Europe in the three and nine months
ended December 31, 2001 wassame quarter last year primarily due to a new OEM agreement with a customermulti-territory license deal in Europe.
Nintendo 64 Productthe United Kingdom.
Game Boy Color Net Revenues
Game Boy Color net revenues during the three months ended June 30, 2002 were generated primarily from hit titleHarry Potter and the Sorcerer’s Stone™in North America and Europe.
Game Boy Advance Net Revenues
We released no N64 titlesone Game Boy Advance title in the three months ended December 31, 2001 compared
to twoJune 30, 2002,Desert Strike Advance. Revenues were generated primarily in North America and Europe from titles insuch asHarry Potter and the same period of the prior year. We released one N64 title in
the nine months ended December 31, 2001 compared to three titles in the nine
months ended December 31, 2000. Sorcerer’s StoneandDesert Strike Advance.
Nintendo 64 Product Net Revenues
The expected decrease in N64 revenues for the three
and nine months ended
December 31, 2001June 30, 2002, compared to the
same periods lastprior fiscal year, was primarily due to the declining market for N64
products and fewer titles
released on this platform in the current fiscal year.products. We
expect revenues fromdo not intend to release any new N64 products
to decline significantly in fiscal
2002.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64
cartridges for distribution by us. Accordingly, we have little ability to
control our supply of N64 cartridges or the timing of their delivery. A shortage
of microchips or other factors outside our control could impair our ability to
obtain an adequate supply of cartridges.
25
2003.Affiliated Label Product Net Revenues
AL product sales increased forduring the three and nine months ended December 31, 2001current quarter compared to the same periodsperiod last year primarily due to strong sales of hitnew AL distribution deals with LEGO Interactive, Crave Entertainment, Inc. and LucasArts which included titles includingsuch asFootball Mania,Global OpsandThe Simpsons Road Rage as well as Devil May Cry and Resident Evil:
Code Veronica resulting. The increase was also due to the expansion of AL’s in other territories. These increases were partially offset by lower revenues from new distribution deals with Capcom in the current
year.
shipment of Square EA products due to stronger prior year sales.
Operations by Segment
Management considers EA.com to be separate reportable segment.
We operate in two principal business segments globally (see Note 3 of the Notes to Condensed
Consolidated Financial Statements):
. EA Core business segment: creation, marketing and distribution of
entertainment software.
. EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online, ongoing
management of subscriptions of online games and website advertising.
globally:
| § | | Electronic Arts Core business segment: creation, marketing and distribution of entertainment software. |
| § | | EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online,ongoing management of subscriptions of online games and website advertising. |
EA.com represents Electronic
Arts'Arts’ online and e-Commerce businesses.
EA.com'sEA.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 Consolidated Statements of Operations includes all revenues and costs directly attributable to EA.com, including charges for shared facilities, functions and services used by EA.com and provided by EA Core. Certain costs and expenses have been allocated based on
management'smanagement’s estimates of the cost of services provided to EA.com by EA Core.
26
Information about our operations by segment for the three
and nine months ended
December 31,June 30, 2002 and 2001
and 2000 is presented below (in thousands):
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $810,930 $ 21,948 $ - $832,878
Group sales 1,877 - (1,877) (a) -
- ---------------------------------------------------------------------------------------------------------------------
Total net revenues 812,807 21,948 (1,877) 832,878
- ---------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 397,138 3,715 - 400,853
Group cost of goods sold - 1,877 (1,877) (a) -
- ---------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 397,138 5,592 (1,877) 400,853
- ---------------------------------------------------------------------------------------------------------------------
Gross profit 415,669 16,356 - 432,025
Operating expenses:
Marketing and sales 84,192 5,217 4,466 (c) 93,875
General and administrative 29,116 2,717 - 31,833
Research and development 66,030 13,935 17,441 (b) 97,406
Network development and support - 14,858 (14,858) (b) -
Customer relationship management - 2,583 (2,583) (b) -
Carriage fee - 4,466 (4,466) (c) -
Amortization of intangibles 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
=====================================================================================================================
|
|
| | | | | | |
|
| | | Three Months Ended June 30, 2002 |
|
| | | EA Core (excl. EA.com) | | EA.com | | | Adjustments and Eliminations | | | Electronic Arts |
|
|
|
|
|
|
|
|
|
| Net revenues from unaffiliated customers | | $ | 312,119 | | $ | 19,779 | | | $ | — | | | $ | 331,898 |
| Group sales | | | 324 | | | — | | | | (324 | )(a) | | | — |
|
|
|
|
|
|
|
|
|
| Total net revenues | | | 312,443 | | | 19,779 | | | | (324 | ) | | | 331,898 |
|
|
|
|
|
|
|
|
|
| Cost of goods sold from unaffiliated customers | | | 138,819 | | | 2,546 | | | | — | | | | 141,365 |
| Group cost of goods sold | | | — | | | 324 | | | | (324 | )(a) | | | — |
|
|
|
|
|
|
|
|
|
| Total cost of goods sold | | | 138,819 | | | 2,870 | | | | (324 | ) | | | 141,365 |
|
|
|
|
|
|
|
|
|
| Gross profit | | | 173,624 | | | 16,909 | | | | — | | | | 190,533 |
| Operating expenses: | | | | | | | | | | | | | | |
| Marketing and sales | | | 57,442 | | | 3,466 | | | | 4,466 | (c) | | | 65,374 |
| General and administrative | | | 23,515 | | | 2,148 | | | | — | | | | 25,663 |
| Research and development | | | 65,601 | | | 11,048 | | | | 14,320 | (b) | | | 90,969 |
| Network development and support | | | — | | | 12,113 | | | | (12,113 | )(b) | | | — |
| Customer relationship management | | | — | | | 2,207 | | | | (2,207 | )(b) | | | — |
| Carriage fee | | | — | | | 4,466 | | | | (4,466 | )(c) | | | — |
| Amortization of intangibles | | | 926 | | | 1,319 | | | | — | | | | 2,245 |
|
|
|
|
|
|
|
|
|
| Total operating expenses | | | 147,484 | | | 36,767 | | | | — | | | | 184,251 |
|
|
|
|
|
|
|
|
|
| Operating income (loss) | | | 26,140 | | | (19,858 | ) | | | — | | | | 6,282 |
| Interest and other income (expense), net | | | 3,221 | | | (74 | ) | | | — | | | | 3,147 |
|
|
|
|
|
|
|
|
|
| Income (loss) before provision for income taxes and minority interest | | | 29,361 | | | (19,932 | ) | | | — | | | | 9,429 |
| Provision for income taxes | | | 2,923 | | | — | | | | — | | | | 2,923 |
|
|
|
|
|
|
|
|
|
| Income (loss) before minority interest | | | 26,438 | | | (19,932 | ) | | | — | | | | 6,506 |
| Minority interest in consolidated joint venture | | | 898 | | | — | | | | — | | | | 898 |
|
|
|
|
|
|
|
|
|
| Net income (loss) before retained interest in EA.com | | $ | 27,336 | | $ | (19,932 | ) | | $ | — | | | $ | 7,404 |
|
|
|
|
|
|
|
|
|
Allocation of retained interest (in thousands):
- ---------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------
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
=====================================================================================================================
27
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- --------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $ 629,145 $ 11,174 $ - $ 640,319
Group sales 752 - (752) (a) -
- --------------------------------------------------------------------------------------------------------------------
Total net revenues 629,897 11,174 (752) 640,319
- --------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 304,036 2,761 - 306,797
Group cost of goods sold - 752 (752) (a) -
- --------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 304,036 3,513 (752) 306,797
- --------------------------------------------------------------------------------------------------------------------
Gross profit 325,861 7,661 - 333,522
Operating expenses:
Marketing and sales 56,690 4,233 4,466 (c) 65,389
General and administrative 25,722 2,758 - 28,480
Research and development 65,081 23,223 21,300 (b) 109,604
Network development and support - 18,640 (18,640) (b) -
Customer relationship management - 2,660 (2,660) (b) -
Carriage fee - 4,466 (4,466) (c) -
Amortization of intangibles 3,184 1,497 - 4,681
- --------------------------------------------------------------------------------------------------------------------
Total operating expenses 150,677 57,477 - 208,154
- --------------------------------------------------------------------------------------------------------------------
Operating income (loss) 175,184 (49,816) - 125,368
Interest and other income, net 2,456 234 - 2,690
- --------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 177,640 (49,582) - 128,058
Provision for income taxes 39,698 - - 39,698
- --------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 137,942 (49,582) - 88,360
Minority interest in consolidated joint venture (382) - - (382)
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) before retained interest in
EA.com $ 137,560 $(49,582) $ - $ 87,978
====================================================================================================================
|
|
| | | | | | |
|
| | | Three Months Ended June 30, 2002 |
|
| | | EA Core (excl. EA.com) | | | EA.com | | | Adjustments and Eliminations | | Electronic Arts |
|
|
|
|
|
|
|
|
|
| Net income (loss) before retained interest in EA.com | | $ | 27,336 | | | $ | (19,932 | ) | | $ | — | | $ | 7,404 |
| Net income (loss) related to retained interest in EA.com | | | (16,942 | ) | | | 16,942 | | | | — | | | — |
|
|
|
|
|
|
|
|
|
| Net income (loss) | | $ | 10,394 | | | $ | (2,990 | ) | | $ | — | | $ | 7,404 |
|
|
|
|
|
|
|
|
|
|
|
| | | | | | |
|
| | | Three Months Ended June 30, 2001 | |
|
| | | EA Core (excl. EA.com) | | | EA.com | | | Adjustments and Eliminations | | | Electronic Arts | |
|
|
|
|
|
|
|
|
|
| Net revenues from unaffiliated customers | | $ | 165,551 | | | $ | 16,399 | | | $ | — | | | $ | 181,950 | |
| Group sales | | | 518 | | | | — | | | | (518 | )(a) | | | — | |
|
|
|
|
|
|
|
|
|
| Total net revenues | | | 166,069 | | | | 16,399 | | | | (518 | ) | | | 181,950 | |
|
|
|
|
|
|
|
|
|
| Cost of goods sold from unaffiliated customers | | | 85,937 | | | | 3,092 | | | | — | | | | 89,029 | |
| Group cost of goods sold | | | — | | | | 518 | | | | (518 | )(a) | | | — | |
|
|
|
|
|
|
|
|
|
| Total cost of goods sold | | | 85,937 | | | | 3,610 | | | | (518 | ) | | | 89,029 | |
|
|
|
|
|
|
|
|
|
| Gross profit | | | 80,132 | | | | 12,789 | | | | — | | | | 92,921 | |
| Operating expenses: | | | | | | | | | | | | | | | | |
| Marketing and sales | | | 30,831 | | | | 5,507 | | | | 4,466 | (c) | | | 40,804 | |
| General and administrative | | | 20,267 | | | | 2,948 | | | | — | | | | 23,215 | |
| Research and development | | | 55,383 | | | | 15,633 | | | | 19,789 | (b) | | | 90,805 | |
| Network development and support | | | — | | | | 16,875 | | | | (16,875 | )(b) | | | — | |
| Customer relationship management | | | — | | | | 2,914 | | | | (2,914 | )(b) | | | — | |
| Carriage fee | | | — | | | | 4,466 | | | | (4,466 | )(c) | | | — | |
| Amortization of intangibles(d) | | | 3,205 | | | | 3,270 | | | | — | | | | 6,475 | |
|
|
|
|
|
|
|
|
|
| Total operating expenses | | | 109,686 | | | | 51,613 | | | | — | | | | 161,299 | |
|
|
|
|
|
|
|
|
|
| Operating loss | | | (29,554 | ) | | | (38,824 | ) | | | — | | | | (68,378 | ) |
| Interest and other income (expense), net | | | 3,089 | | | | (372 | ) | | | — | | | | 2,717 | |
|
|
|
|
|
|
|
|
|
| Loss before benefit from income taxes and minority interest | | | (26,465 | ) | | | (39,196 | ) | | | — | | | | (65,661 | ) |
| Benefit from income taxes | | | (20,355 | ) | | | — | | | | — | | | | (20,355 | ) |
|
|
|
|
|
|
|
|
|
| Loss before minority interest | | | (6,110 | ) | | | (39,196 | ) | | | — | | | | (45,306 | ) |
| Minority interest in consolidated joint venture | | | 52 | | | | — | | | | — | | | | 52 | |
|
|
|
|
|
|
|
|
|
| Net loss before retained interest in EA.com | | $ | (6,058 | ) | | $ | (39,196 | ) | | $ | — | | | $ | (45,254 | ) |
|
|
|
|
|
|
|
|
|
Allocation of retained interest (in thousands):
|
|
| | | | | | |
|
| | | Three Months Ended June 30, 2001 | |
|
| | | EA Core (excl. EA.com) | | | EA.com | | | Adjustments and Eliminations | | Electronic Arts | |
|
|
|
|
|
|
|
|
|
| Net loss before retained interest in EA.com | | $ | (6,058 | ) | | $ | (39,196 | ) | | $ | — | | $ | (45,254 | ) |
| Net loss related to retained interest in EA.com | | | (33,317 | ) | | | 33,317 | | | | — | | | — | |
|
|
|
|
|
|
|
|
|
| Net loss | | $ | (39,375 | ) | | $ | (5,879 | ) | | $ | — | | $ | (45,254 | ) |
|
|
|
|
|
|
|
|
|
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2000| (a) | | Represents elimination of intercompany sales of Electronic Arts packaged goods products to EA.com, and represents elimination of royalties paid to Electronic Arts by EA.com for intellectual property rights. |
| (b) | | Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. |
| (c) | | Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. |
| (d) | | Includes goodwill amortization of $1,486,000 for EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) before retained interest in
EA.com $ 137,560 $(49,582) $ - $ 87,978
Net loss related to retained interest in EA.com (42,144) 42,144 - -
- --------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 95,416 $ (7,438) $ - $ 87,978
====================================================================================================================
|
28
- ----------------------------------------------------------------------------------------------------------------------
Nine Months Ended December 31, 2001
EA Core Adjustments and
excl. EA.com) EA.com Eliminations Electronic Arts
- ----------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $1,201,407 $ 53,577 $ - $1,254,984
Group sales 2,927 - (2,927) (a) -
- ----------------------------------------------------------------------------------------------------------------------
Total net revenues 1,204,334 53,577 (2,927) 1,254,984
- ----------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 598,395 9,247 - 607,642
Group cost of goods sold - 2,927 (2,927) (a) -
- ----------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 598,395 12,174 (2,927) 607,642
- ----------------------------------------------------------------------------------------------------------------------
Gross profit 605,939 41,403 - 647,342
Operating expenses:
Marketing and sales 150,002 16,299 13,398 (c) 179,699
General and administrative 72,535 7,916 - 80,451
Research and development 185,138 45,232 55,396 (b) 285,766
Network development and support - 46,903 (46,903) (b) -
Customer relationship management - 8,493 (8,493) (b) -
Carriage fee - 13,398 (13,398) (c) -
Amortization of intangibles 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$1,445,000 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
======================================================================================================================
EA.com.
Allocation of retained interest (in thousands):
- ----------------------------------------------------------------------------------------------------------------------
Nine Months Ended December 31, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ----------------------------------------------------------------------------------------------------------------------
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
======================================================================================================================
29
- ----------------------------------------------------------------------------------------------------------------------
Nine Months Ended December 31, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ----------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $985,754 $ 29,264 $ - $1,015,018
Group sales 1,795 - (1,795) (a) -
- ----------------------------------------------------------------------------------------------------------------------
Total net revenues 987,549 29,264 (1,795) 1,015,018
- ----------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 496,620 8,744 - 505,364
Group cost of goods sold - 1,795 (1,795) (a) -
- ----------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 496,620 10,539 (1,795) 505,364
- ----------------------------------------------------------------------------------------------------------------------
Gross profit 490,929 18,725 - 509,654
Operating expenses:
Marketing and sales 126,702 7,677 4,466 (c) 138,845
General and administrative 69,611 7,370 - 76,981
Research and development 182,935 55,562 40,443 (b) 278,940
Network development and support - 34,096 (34,096) (b) -
Customer relationship management - 6,347 (6,347) (b) -
Carriage fee - 4,466 (4,466) (c) -
Amortization of intangibles 9,645 4,406 - 14,051
- ----------------------------------------------------------------------------------------------------------------------
Total operating expenses 388,893 119,924 - 508,817
- ----------------------------------------------------------------------------------------------------------------------
Operating income (loss) 102,036 (101,199) - 837
Interest and other income, net 10,387 241 - 10,628
- ----------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 112,423 (100,958) - 11,465
Provision for income taxes 3,554 - - 3,554
- ----------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 108,869 (100,958) - 7,911
Minority interest in consolidated joint venture (1,113) - - (1,113)
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) before retained interest in
EA.com $107,756 $(100,958) $ - $ 6,798
======================================================================================================================
Allocation of retained interest (in thousands):
- ----------------------------------------------------------------------------------------------------------------------
Nine Months Ended December 31, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) before retained interest in
EA.com $107,756 $(100,958) $ - $ 6,798
Net loss related to retained interest in EA.com (85,814) 85,814 - -
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 21,942 $ (15,144) $ - $ 6,798
======================================================================================================================
(a) Represents elimination of intercompany sales of EA Core packaged goods
products to EA.com, and represents elimination of royalties paid to EA Core
by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support and Customer
Relationship Management to Research and Development.
(c) Represents reclassification of amortization of the Carriage Fee to
Marketing and Sales.
30
The following table presents pro-formashows our pro forma results of operations allocating taxes
between EA Core and EA.com. This presentation is not consistent withreconciled to the Generally Accepted Accounting Principles ("GAAP"(“GAAP”) reporting. Consolidated Statements of Operations. Our pro forma results do not include unusual events or transactions, such as restructuring and asset impairment costs and charges for acquired in-process technology, and also excludes amortization of intangibles. In addition, income taxes have beenare allocated to EA Core and EA.com at the consolidated effective tax rate (31%) on a pro rata basis based onbasis. We believe the consolidated
effective tax rates, thereby giving EA.com the tax benefit of its losses which
is utilized by the consolidated group. Such tax benefit could not be recognized
by EA.com on a stand-alone basis. The sum of tax expense and tax benefit for EA
Core and EA.com is the same as consolidated tax expense and tax benefit. This
presentation represents how management analyzes each segmentdisclosure of the businesspro forma net income (loss) and operating profit (loss), which excludes the items noted in the table below, helps investors more meaningfully evaluate the results of our ongoing operations. However, we urge investors to carefully review the GAAP financial information included as part of this Form 10-Q and compare GAAP financial information with the pro forma financial results disclosed in this Form 10-Q.
Reconciliation of GAAP to Pro Forma net income (loss) (in thousands):
|
|
| | | | | | | | | | | | |
|
| | | Three Months Ended | |
| |
|
|
|
| | | June 30, 2002 | | | | | June 30, 2001 | |
| |
|
| | |
|
|
| | | EA Core (excl. EA.com) | | | EA.com | | | Electronic Arts | | | | | EA Core (excl. EA.com) | | | EA.com | | | Electronic Arts | |
| |
|
|
|
|
|
| | |
|
|
|
|
|
|
| Net income (loss)—GAAP | | $ | 10,394 | | | $ | (2,990 | ) | | $ | 7,404 | | | | | $ | (39,375 | ) | | $ | (5,879 | ) | | $ | (45,254 | ) |
|
| Net loss related to retained interest in EA.com (note 1) | | | 16,942 | | | | (16,942 | ) | | | — | | | | | | 33,317 | | | | (33,317 | ) | | | — | |
| Pro forma allocation of income taxes (note 2) | | | (6,179 | ) | | | 6,179 | | | | — | | | | | | (12,151 | ) | | | 12,151 | | | | — | |
| |
|
|
|
|
|
| | |
|
|
|
|
|
|
| Pro forma net income (loss) | | | 21,157 | | | | (13,753 | ) | | | 7,404 | | | | | | (18,209 | ) | | | (27,045 | ) | | | (45,254 | ) |
|
| Amortization of intangibles | | | 926 | | | | 1,319 | | | | 2,245 | | | | | | 3,205 | | | | 3,270 | | | | 6,475 | |
| Income tax effect on the above item | | | (287 | ) | | | (409 | ) | | | (696 | ) | | | | | (993 | ) | | | (1,014 | ) | | | (2,007 | ) |
| |
|
|
|
|
|
| | |
|
|
|
|
|
|
| Pro forma net income (loss) excluding the items above | | $ | 21,796 | | | $ | (12,843 | ) | | $ | 8,953 | | | | | $ | (15,997 | ) | | $ | (24,789 | ) | | $ | (40,786 | ) |
| |
|
|
|
|
|
| | |
|
|
|
|
|
|
- ---------------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2001
| (1) | | EA Core Adjustmentsmaintains approximately 85% retained interest in EA.com and (excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Incomeis reflected in the Net income (loss) before—GAAP for EA Core. The pro forma statements exclude the retained interest allocation. |
| (2) | | The provision for (benefit from) income taxes and minority interest $236,723 $ (44,707) $ - $192,016
Provision for (benefit from) income taxes 73,384 (13,859) - 59,525
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 163,339 (30,848) - 132,491
Minority interest in consolidated joint venture (199) - - (199)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $163,140 $ (30,848) $ - $132,292
===========================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------
Three Months Ended December 31, 2000was allocated between EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) beforeat the worldwide effective tax rate (31%) based on each segment’s pro rata share of income or loss. The sum of tax provision (benefit) for (benefit from)
income taxes and minority interest $177,640 $ (49,582) $ - $128,058
Provision for (benefit from) income taxes 55,068 (15,370) - 39,698
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 122,572 (34,212) - 88,360
Minority interest in consolidated joint venture (382) - - (382)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $122,190 $ (34,212) $ - $ 87,978
===========================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------
Nine Months Ended December 31, 2001 EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) beforeis the same as consolidated tax provision for (benefit from)
income taxes and minority interest $199,514 $(121,156) $ - $ 78,358
Provision for (benefit from) income taxes 61,849 (37,558) - 24,291
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 137,665 (83,598) - 54,067
Minority interest in consolidated joint venture 147 - - 147
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $137,812 $ (83,598) $ - $ 54,214
===========================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------
Nine Months Ended December 31, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for (benefit from)
income taxes and minority interest $112,423 $(100,958) $ - $ 11,465
Provision for (benefit from) income taxes 34,851 (31,297) - 3,554
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest 77,572 (69,661) - 7,911
Minority interest in consolidated joint venture (1,113) - - (1,113)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 76,459 $ (69,661) $ - $ 6,798
===========================================================================================================================
(benefit). |
31
Costs and Expenses, Interest and Other Income, Net, 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 business consists of actual product costs, royalties expense for celebrities, professional sports and other organizations and independent software developers, manufacturing royalties, expense for defective products and operations expense. Cost of goods sold for our 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 advertising business consists primarily of ad serving costs.
Marketing and Sales. Marketing and sales expenses consist of personnel relatedpersonnel-related costs, advertising and marketing and promotional expenses. In addition, marketing and sales includes the amortization of the AOL carriage and revenue
share fees ("fee (“Carriage Fee"Fee”), which began with the launch of EA.com in October 2000. The Carriage Fee is being amortized straight linestraight-line over the five-year term of the AOL agreement.
agreement entered into in November 1999.
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 personnel
relatedpersonnel-related costs, consulting and equipment depreciation, and customer relationship management expenses associated with Electronic Arts'Arts’ product and online games.games and write-offs of prepaid royalties. EA.com has research and development expenses incurred by Electronic Arts'Arts’ studios consisting of direct development costs and related overhead costs (facilities, network and development management and supervision) in connection with the development and production of EA.com online games. Research and development expenses also include product development expenses incurred directly by EA.com.
Network Development and Support. Network development and support costs consist of expenses associated with development of web 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. Cost of goods sold as a percentage of revenues increased
slightly for the three months ended December 31, 2001 as compared to the same
period last year primarily due to:
. Higher cost of goods sold as a percentage of revenue on PlayStation
products due to lower average sales price on the platform along with higher
royalty rates for Harry Potter and the Sorcerer's Stone.
. Higher cost of goods sold as a percentage of revenue on PlayStation 2
products as compared to the prior year due to a higher mix of catalogue
sales with lower sales prices.
. Revenues in the current year on Nintendo Game Boy Advance and Game Boy
Color with higher cost of goods sold as a percentage of revenues. There
were no revenues on these platforms last year.
These were mainly offset by:
. Higher advertising revenues with low cost of goods sold as a percentage of
revenues for the three months ended December 31, 2001.
32
. New revenues with low cost of goods sold as percentage of revenues for the
Nintendo GameCube and Xbox products.
Sold
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| 2002 | | % of net revenues | | 2001 | | % of net revenues | | % change |
|
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| $141,365,000 | | 42.6% | | $89,029,000 | | 48.9% | | 58.8% |
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Cost of goods sold as a percentage of revenues decreased for the nine months
ended December 31, 2001 as compared to the same period last year primarily due
to:
. Revenues from the Xbox and Nintendo GameCube with low cost of goods sold as
a percentage of revenue.
. Higher advertising revenues with low cost of goods sold as a percentage of
revenue for the nine months ended December 31, 2001.
. Lower revenue on Nintendo 64 products with high cost of goods sold as a
percentage of revenue.
These were partially offset by:
. Higher cost of goods sold as a percentage of revenues on the PlayStation
and PlayStation 2 products as compared to the prior year.
. Revenues from the Nintendo Game Boy Advance and Game Boy Color with high
cost of goods sold as a percentage of revenue.
Marketing and Sales. Marketing and sales expenses42.6% for the three months ended December 31,June 30, 2002 as compared to 48.9% for the three months ended June 30, 2001 due to:
| § | | An increase, as a percentage of revenues, of higher margin PlayStation 2 products as compared to the prior year. The current quarter includes sales fromMedal of Honor Frontline, a wholly owned intellectual property, developed internally, and on which we pay no royalties. |
| § | | New revenues with relatively low cost of goods sold as percentage of revenue for the Nintendo GameCube and Xbox products. |
| § | | Higher average margins on the PC due to higher sales of products that are wholly owned intellectual properties such as the Sims family of titles compared toBlack & Whitein the prior year. |
| § | | Higher average margins on AL’s due to higher sales of co-published titles. |
| § | | Offset by lower mix of high margin PC products compared to the prior year. |
Marketing and Sales
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| 2002 | | % of net revenues | | 2001 | | % of net revenues | | % change |
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| $65,374,000 | | 19.7% | | $40,804,000 | | 22.4% | | 60.2% |
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Marketing and sales expenses increased in absolute dollars by 44%, and increased 29% for
the nine months ended December 31, 200160.2% primarily attributed to:
. Higher marketing and advertising in North America and Europe for programs
to support SSX Tricky, Harry Potter and the Sorcerer's Stone, Madden NFL
2002, FIFA Soccer 2002 and James Bond 007...Agent Under Fire.
. The amortization of the AOL carriage fee for the nine months ended December
31, 2001 which began with the launch of EA.com in October 2000. The AOL
carriage fee amortization expense remained flat for the quarter as compared
to the same period last
| § | | Higher advertising and marketing due to the increase in titles released in the quarter compared to the prior year. A significant portion of our marketing and sales expenses in the current quarter related to advertising spending to support key releases in multiple territories includingMedal of Honor Frontlineand2002 FIFA World Cup. |
| § | | Partially offset by lower EA.com marketing and sales expense due to higher consumer promotions and advertising media placement costs to promote new game offerings during the three months ended June 30, 2001, particularlyUltima Online Third Dawn, and lower headcount expenses as a result of headcount reductions taken in October 2001. |
General and Administrative. Administrative
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| 2002 | | % of net revenues | | 2001 | | % of net revenues | | % change |
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| $25,663,000 | | 7.7% | | $23,215,000 | | 12.8% | | 10.5% |
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General and administrative expenses increased for
the three months ended December 31, 2001 in absolute dollars by 12%,10.5% primarily due to:
. $1,000,000 contribution to charity organizations providing support for the
September 11th tragedy.
.
| § | | Increase in payroll and occupancy costs to support the increased growth in North America and Europe. |
| § | | An increase in the bad debt provision due to higher accounts receivables in the current quarter compared to the same period last year. |
Research and occupancy costs to support the increased growth in
North America.
General and administrative expenses increased for the nine months ended December
31, 2001 in absolute dollars by 5%, primarily due to:
. $1,000,000 contribution to charity organizations providing support for the
September 11th tragedy.
. Increase in payroll and occupancy costs to support the increased growth in
North America.
. Increase in EA.com bad debt expense due to higher product sales.
Development
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| | | 2002 | | % of net revenues | | | 2001 | | % of net revenues | | | %change | |
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| Research and development | | $ | 76,649,000 | | 23.1 | % | | $ | 71,016,000 | | 39.0 | % | | 7.9 | % |
| Network development and support | | | 12,113,000 | | 3.6 | % | | | 16,875,000 | | 9.3 | % | | (28.2 | %) |
| Customer relationship management | | | 2,207,000 | | 0.7 | % | | | 2,914,000 | | 1.6 | % | | (24.3 | %) |
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| Total research and development | | $ | 90,969,000 | | 27.4 | % | | $ | 90,805,000 | | 49.9 | % | | 0.2 | % |
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Research and Development (excluding Network Development and Support and Customer Relationship Management). Research The increase in absolute dollars by 7.9% for research and development expenses (excluding network development and support and customer relationship management) was due to additional headcount-related expenses attributable to the
increased in-house development capacity, net of co-development arrangements. This was partially offset by lower EA.com spending due to the headcount reductions in October 2001.
Network Development and Support. Network development and support expenses decreased in absolute 33
dollars by 28.2% due to EA.com headcount reductions in October 2001. Customer Relationship Management. Customer relationship management expenses decreased in absolute dollars by 24.3% due to headcount reductions in October 2001.
Amortization of Intangibles
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| 2002 | | % of net revenues | | 2001 | | % of net revenues | | % change |
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| $2,245,000 | | 0.7% | | $6,475,000 | | 3.6% | | (65.3%) |
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For the three months ended June 30, 2002, amortization of intangibles relates to amortization of definite-lived identifiable intangible assets from acquisitions of Pogo, Westwood, Dreamworks and Kesmai. For the three months ended June 30, 2001, amortization of intangibles relates primarily to amortization of purchased goodwill and intangibles from acquisitions of Westwood, Pogo, Kesmai, Dreamworks, ABC Software and other acquisitions. The decrease in amortization for
the three months ended June 30, 2002 was the result of adopting SFAS No. 142. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. As of April 1, 2002, we have ceased to amortize approximately $69,050,000 of goodwill. For the three months ended June 30, 2001, amortization of goodwill totaled $2,931,000. In addition, during the three months ended December 31, 2001,
by 9% compared to the same
period in the prior year due to:
. Headcount reductions and office closures for EA.com in October 2001 as part
of restructuring of that segment (see Charge for Restructuring and
Impairment discussion below).
. Partially offset by increased spending on EA.com online projects in
development, primarily The Sims Online and Earth and Beyond.
Research and development expenses (excluding network development and support and
customer relationship management) decreased slightly in absolute dollars for the
nine months ended December 31, 2001 by 3% compared to the same period in the
prior year due to:
. Headcount reductions in EA.com in October 2001 (see Charge for
Restructuring and Impairment discussion below).
. Offset by increased payroll costs due to higher headcount in Maxis and
Westwood.
. Offset by increased spending on EA.com online projects in development,
primarily The Sims Online and Earth and Beyond.
We expect research and development spending to increase in fiscal 2003 due to an
increase in development spending for next generation console products including
the PlayStation 2, Xbox and Nintendo GameCube, as well as extending our
investment in the PC platform.
Network Development and Support. Network development and support expenses
decreased for the three months ended December 31, 2001 in absolute dollars by
20% primarily for:
. Post-launch costs associated with data migration projects upon the launch
of the EA.com gamesite in October 2000.
. Decrease in payroll costs due to a significant decrease in consultants.
Network development and support expenses increased for the nine months ended
December 31, 2001 in absolute dollars by 38% primarily due to:
. Costs associated with the launch of the EA.com gamesite.
. Depreciation related to both hardware and internally developed software
that began when the site went live in October 2000.
. Increased headcount and network-related costs associated with Pogo.
. Higher headcount and capital spending on our network infrastructure to
support the growth of our live gamesites and related depreciation during
the first six months of the year.
Customer Relationship Management. Customer relationship management expenses
decreased slightly for the three months ended December 31, 2001 by 3% primarily
due to headcount reductions in October 2001 as part of the restructuring plan
(see Charge for Restructuring and Impairment discussion below).
34
Customer relationship management expenses increased by 34% for the nine months
ended December 31, 2001 primarily due to increased headcount in the first six
months of fiscal 2002 (prior to the reduction noted above) to support the growth
in the Ultima Online subscriber base, launch of Majestic and Motor City Online,
and the increase in the number of free games and subscription offerings.
Amortization of Intangibles. The amortization of intangibles results primarily
from the acquisitions of Westwood, Pogo, Kesmai, DreamWorks Interactive, ABC
Software and other acquisitions. The increase for the three and nine months
ended December 31, 2001 for EA.com, compared to the same periods in the prior
year, was due to the acquisition of Pogo in February 2001.
With the implementation of new accounting pronouncements (see Impact of Recently
Issued Accounting Standards on page 42) as of April 2002, we will no longer
amortize goodwill. We are in the process of determining the impact on our
amortization of other intangibles.
Charge for Restructuring and Impairment. During the quarter ended December 31,
2001, we announced a restructuring plan for EA.com to reduce EA.com's workforce
and consolidate facilities. These restructuring and resulting assetrecorded intangible impairment charges were necessary in orderof $1,641,000 relating to focus on key online priorities and reduce
EA.com's operating cost structure. We recorded total charges of $14,051,000,
consisting of $3,763,000 for workforce reductions, $3,785,000 for consolidation
of facilities and other administrative charges and $6,503,000 for the write-off
of non-current assets.
The restructuring plan resulted in the termination of approximately 240
personnel, or one-third of EA.com's workforce, which affected all departments
across the organization. The estimated costs for consolidation of facilities is
comprised of contractual rental commitments under real estate leases for
unutilized office space offset by estimated future sub-lease income. Included in
these costs are estimated costs to close offices or consolidate facilities in
various locations and costs to write off a portion of the assets from these
facilities. In addition, the restructuring efforts required an evaluation of
asset impairment in accordance with SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", to write
these depreciable assets and certain intangibles to their fair value.
We will continue to evaluate the effectiveness of products, departments,
technology and processes and look for ways to consolidate and streamline EA.com
operations in an effort to further reduce operating expenses.
EA.com’s restructuring. Interest and Other Income, Net. Net
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| 2002 | | % of net revenues | | 2001 | | % of net revenues | | % change |
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| $3,147,000 | | 0.9% | | $2,717,000 | | 1.5% | | 15.8% |
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Interest and other income, net, for the three
months ended December 31, 2001 increased by 31% in absolute dollars comparedprimarily due to the same perioda write-off of an investment in an affiliate in the prior year, primarily due tooffset by an increase in our equity
share in Square EAthe cost of utilizing foreign exchange hedge contracts in the current year, partially offset by foreign currency
losses. For the nine months ended December 31, 2001, interest and other income,
net, decreased slightly by 3% compared to the same period in the prior year.
quarter.
Income Taxes. Taxes
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| 2002 | | Effective tax rate | | 2001 | | Effective tax rate | | % change |
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| $2,923,000 | | 31.0% | | $(20,355,000) | | 31.0% | | 114.4% |
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Our effective tax rate was 31% for the three
and nine months ended
December 31, 2001June 30, 2002 and
2000.
35
2001.Net Income. Income (loss)
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| 2002 | | % of net revenues | | 2001 | | % of net revenues | | % change |
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| $7,404,000 | | 2.2% | | $(45,254,000) | | (24.9%) | | 116.4% |
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In absolute dollars, reported net income for the three and nine
months ended December 31, 2001(loss) increased primarily related to higher revenues and gross profits, asoffset by the increase in expenses compared to the same periodsperiod last year. ThisThe
increase in expenses was partially
offset by an increaseprimarily due to the increases in marketing and sales expensesadvertising costs to support programs for
key titles shipping ina higher number of franchise titles.
We believe the current year and restructuring charges incurred in
the current quarterdisclosure of fiscal 2002.
We consider pro forma net income (loss) and operating profit (loss), which does not include unusual events or transactions, such as restructuring and asset impairment costs and charges for acquired in-process technology, and also excludes amortization of intangibles, helps investors more meaningfully evaluate the items
noted in the table below, to be the most relevant benchmarksresults of our operating
performance.
ongoing operations. However, we urge investors to carefully review the GAAP financial information included as part of this Form 10-Q and compare GAAP financial information with the pro forma financial results disclosed in this Form 10-Q.
Pro forma net income
(loss), excluding the items noted
in the table below,above, was
$147,140,000net income of $8,953,000 for the three months ended
December 31, 2001June 30, 2002 and
$91,457,000net loss of $40,786,000 for the three months ended
December 31, 2000. Pro forma net income, excluding the
items noted in the table below, was $78,794,000 for the nine months ended
December 31, 2001 and $17,826,000 for the nine months ended December 31, 2000.June 30, 2001. The increase in pro forma net income for the three
and nine months ended
December 31, 2001June 30, 2002 was due to higher revenues and gross profits as compared to the same periods last year. This was partially offset by an increase in marketing and sales expenses to support programs for key titles shipped in the current
year.
With the implementation of new accounting pronouncements relating to goodwill
and intangible assets (see Impact of Recently Issued Accounting Standards on
page 42) as of April 2002, we will no longer amortize goodwill. We are in the
process of determining the impact on our amortization of other intangibles.
36
(in thousands):
- --------------------------------------------------------------------------------
Reconciliation of GAAP to Pro
Forma net income (loss)
Three Months Ended
------------------------------------------------------------------------------------
December 31, 2001 December 31, 2000
----------------------------------------- ------------------------------------------
EA Core Electronic EA Core Electronic
(excl. EA.com) EA.com Arts (excl. EA.com) EA.com Arts
----------------------------------------- ------------------------------------------
Net income (loss) - GAAP $ 138,998 $ (6,706) $132,292 $ 95,416 $ (7,438) $ 87,978
Net loss related to retained
interest in EA.com (note 1) 38,001 (38,001) - 42,144 (42,144) -
Pro forma allocation of income
taxes (note 2) (13,859) 13,859 - (15,370) 15,370 -
----------------------------------------- ------------------------------------------
Pro forma net income (loss) 163,140 (30,848) 132,292 122,190 (34,212) 87,978
Amortization of intangibles 3,205 3,154 6,359 3,184 1,497 4,681
Restructuring and asset impairment
charges - 14,051 14,051 - - -
Non-cash stock compensation for
non-employees (note 3) 882 227 1,109 291 70 361
Income taxes effect on the above
items (1,267) (5,404) (6,671) (1,077) (486) (1,563)
----------------------------------------- ------------------------------------------
Pro forma net income (loss)
excluding the items above $ 165,960 $ (18,820) $147,140 $124,588 $(33,131) $ 91,457
========================================= ==========================================
1) EA Core maintains approximately 85% retained interest in EA.com and is
reflected in the Net income - GAAP for EA Core. The pro forma statements
exclude the retained interest allocation.
2) The provision for income taxes was allocated between quarter.LIQUIDITY AND CAPITAL RESOURCES
EA Core and EA.com at
the worldwide effective tax rate (31%) based on each segment's pro rata share
of income or loss. The sum of tax provision for EA Core and EA.com is the
same as consolidated tax provision.
3) Total non-cash stock compensation charges are included in Research and
Development in GAAP financials, and excluded in the pro forma.
37
(in thousands):
- --------------------------------------------------------------------------------
Reconciliation of GAAP to Pro
Forma net income (loss)
Nine Months Ended
-------------------------------------------------------------------------------------------
December 31, 2001 December 31, 2000
--------------------------------------------- ---------------------------------------------
EA Core Electronic EA Core Electronic
(excl. EA.com) EA.com Arts (excl. EA.com) EA.com Arts
-------------------------------------------------------------------------------------------
Net income (loss) - GAAP $ 72,387 $ (18,173) $ 54,214 $ 21,942 $ (15,144) $ 6,798
Net loss related to retained
interest in EA.com (note 1) 102,983 (102,983) - 85,814 (85,814) -
Pro forma allocation of income
taxes (note 2) (37,558) 37,558 - (31,297) 31,297 -
--------------------------------------------- ---------------------------------------------
Pro forma net income (loss) 137,812 (83,598) 54,214 76,459 (69,661) 6,798
Amortization of intangibles 9,615 9,694 19,309 9,645 4,406 14,051
Restructuring and asset impairment
charges - 14,051 14,051 - - -
Non-cash stock compensation for
non-employees (note 3) 1,923 340 2,263 1,804 128 1,932
Income taxes effect on the above
items (3,577) (7,466) (11,043) (3,549) (1,406) (4,955)
--------------------------------------------- ---------------------------------------------
Pro forma net income (loss)
excluding the items above $ 145,773 $ (66,979) $ 78,794 $ 84,359 $ (66,533) $ 17,826
============================================= =============================================
1) EA Core maintains approximately 85% retained interest in EA.com and is
reflected in the Net income - GAAP for EA Core. The pro forma statements
exclude the retained interest allocation.
2) The provision for income taxes was allocated between EA Core and EA.com at
the worldwide effective tax rate (31%) based on each segment's pro rata share
of income or loss. The sum of tax provision for EA Core and EA.com is the
same as consolidated tax provision.
3) Total non-cash stock compensation charges are included in Research and
Development in GAAP financials, and excluded in the pro forma.
38
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
EA Core and EA.com
As of December 31, 2001,June 30, 2002, our working capital was $647,853,000$744,982,000 compared to $478,701,000$699,561,000 at March 31, 2001.2002. Cash, cash equivalents and short-term investments increased by $20,350,000approximately $30,000,000 during the ninethree months ended December 31,
2001.June 30, 2002. We used $10,606,000generated $6,643,000 of cash from operations, $64,624,000 for short-term
investments, $40,056,000$19,894,000 of cash for capital expenditures, offset by $75,819,000
of cash generated through the sale of equity securities under our stock plans, offset by $8,409,000 of cash used in capital expenditures during the ninethree months ended December 31, 2001.
June 30, 2002.
Reserves for bad debts and sales returns increased from $89,833,000$115,870,000 at March 31, 20012002 to $139,898,000$128,518,000 at December 31, 2001.June 30, 2002. Reserves have been charged for returns of product and price protection credits issued for products sold in prior periods. Management believes these reserves are adequate based on historical experience and its current estimate of potential returns and allowances.
Our principal source of liquidity is $486,842,000$826,866,000 in cash, cash equivalents and short-term investments and $7,282,000$5,403,000 in marketable securities. We expect that for the foreseeable future, our operating expenses will constitute a significant use of our cash balances. Management believes the existing cash, cash equivalents, short-term investments, marketable securities and cash generated from operations will be sufficient to meet cash and investment requirements for at least the next 12 months. However, 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 titles on both a short-termnew platforms and long-term basis.
new title versions 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
Included in the amounts above is the following for the EA.com business:
. With the exception of the proceeds from the sale of stock and warrant
to AOL in fiscal 2000 in the amount of $20,000,000, to date, EA.com has
been funded solely by Electronic Arts. This funding has been accounted for
as capital contributions from Electronic Arts. Excess cash generated from
operations is transferred to Electronic Arts, and has been accounted for as
a return of capital. We anticipate these funding procedures will continue
in the near-term. However, Electronic Arts may, at its discretion, provide
funds to EA.com under a debt arrangement, instead of treating such funding
as a capital contribution.
. During the nine months ended December 31, 2001, EA.com used
$88,700,000 of cash in operations, $12,447,000 in capital expenditures for
computer equipment, network infrastructure, internal use software and
related third party software, offset by $107,571,000 provided through the
capital contributions from Electronic Arts. As a result of the net
operating loss generated, we realized a tax benefit of approximately
$37,558,000.
. During the nine months ended December 31, 2000, EA.com used
$93,934,000 of cash in operations, $65,418,000 in capital expenditures for
computer equipment, network infrastructure and related software (including
$41,263,000 of consulting, hardware, software and direct payroll and
payroll-related costs associated with the implementation of customized
internal-use software), offset by $159,667,000 provided through the capital
contributions from Electronic Arts. As a result of the net operating loss
generated, we realized a tax benefit of approximately $31,297,000.
39
| § | | With the exception of the proceeds from the sale of stock and warrant to AOL in fiscal 2000 in the amount of $20,000,000, to date, EA.com has been funded solely by Electronic Arts. This funding has been accounted for as capital contributions from Electronic Arts. Excess cash generated from operations is transferred to Electronic Arts, and has been accounted for as a return of capital. We anticipate these funding procedures will continue in the near-term. However, Electronic Arts may, at its discretion, provide funds to EA.com under a debt arrangement, instead of treating such funding as a capital contribution. |
| § | | During the three months ended June 30, 2002, EA.com used $10,584,000 of cash in operations, $302,000 in capital expenditures for computer equipment, network infrastructure, internal use software and related third party software, offset by $10,594,000 in capital contributions from Electronic Arts. As a result of the net operating loss generated, we realized a tax benefit of approximately $6,179,000. |
| § | | During the three months ended June 30, 2001, EA.com used $28,670,000 of cash in operations, $7,197,000 in capital expenditures for computer equipment, network infrastructure and related software, offset by $36,349,000 in capital contributions from Electronic Arts. As a result of the net operating loss generated, we realized a tax benefit of approximately $12,151,000. |
Under the AOL agreement entered into in November 1999, EA.com is required to pay $50,000,000$81,000,000 to AOL as a carriage fee and $31,000,000 as a minimum
guaranteed revenue share for revenues generated by subscriptions and other
certain commercial transactions onover the EA.com site.life of the five-year agreement. Of these amounts,
$25,000,000 in carriage fee and $11,000,000 in revenue share werethis amount, $36,000,000 was paid upon signing the agreement with the remainder of the respective items due in four equal annual installments beginning with the first anniversary of the initial payments.payment. EA.com paid AOL an annual carriage payment of $6,250,000 and an annual
revenue share payment of $5,000,000$11,250,000 in both fiscal 2001 and 2002. No payments were made to AOL in the three months ended June 30, 2002.
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, prior to March 31, 2005. As of December 31, 2001,June 30, 2002, we have spent $2,500,000approximately $3,500,000 against this commitment.
On February 7, 2000, we acquired Kesmai Corporation (now referred to as
"Kesmai") from News America Corporation ("(“News Corp"Corp”) in exchange for $22,500,000 in cash and approximately 206,000 shares of our existing common stock valued at $8,650,000. 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, if certain conditions are met, including that a qualified public offering of Class B common stock does not occur within twenty-four months of News Corp'sCorp’s purchase of such shares and all of the Class B outstanding shares have been converted to Class A common stock, then (1) News Corp has the right to (i) exchange Class B common stock for approximately 206,000 shares of Class A common stock, and (ii) receive cash from Electronic Arts in the amount of $9,650,000, and (2) we will agree to spend an additional $11,675,000 in advertising with News Corp and its affiliates.
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 of 1995, we entered into an operatinga build-to-suit lease with a financial institution on our headquarter'sheadquarter’s facility in Redwood City, California, which aswas extended in July of 2001 and runs through July of 2006. We 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. We have an option to purchase the property (land and facilities) for $145,000,000 or, at the end of the lease, to arrange for (1) an additional extension of the lease or (2) sale of the property to a third party
with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000 if the sales price is less than this amount, subject to certain provisions of the lease.
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In December 2000, we entered into a second operatingbuild-to-suit lease with a financial institution for a five year term from December 2000 to expand our headquarter'sheadquarter’s facilities and develop adjacent property adding approximately 310,000 square feet to our campus. We
expect to complete constructionConstruction was completed in June of 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 $130,000,000$127,000,000 or, at the end of the lease, to arrange for (1) an extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118,800,000 if the sales price is less than this amount, subject to certain provisions of the lease.
Lease rates are based upon the Commercial Paper Rate and the London
Interbank Offered Rate. The two lease agreements described above require us to maintain certain financial covenants, all of which we were in compliance with as of December 31, 2001.
June 30, 2002.
Letters of Credit
In connection with our purchases of N64 cartridges and Nintendo GameCube optical disks for distribution in North America, Nintendo requires us to provide irrevocable letters of credit prior to Nintendo'sNintendo’s acceptance of purchase orders from us for purchases of these cartridges and optical disks. For purchases of
N64 cartridges and Nintendo GameCube optical disks for distribution in Japan and Europe, Nintendo requires us to make cash deposits.
Development, Celebrity, League and Content Licenses: Payments and Commitments
The products published by EA Studios are designed and created by our in-house designers and artists and by independent software developers ("(“independent artists"artists”). We typically pay the independent artists royalties based on the sales of the specific products, as defined in the related independent artist agreements. Advance payments on these royalties are paid to independent artists upon meeting deliverables as detailed in the contractual agreement. In addition, certain celebrity, league and content license contracts contain minimum guarantee payments and marketing commitments that are not dependent on any deliverables. Celebrities and organizations with whom we have contracts include: FIFA, NASCAR, John Madden, the National Basketball Association, the PGA TOUR, Tiger Woods, the National Hockey League, Formula One, Warner Bros. (Harry Potter), MGM/Danjaq (James Bond), The Saul Zaentz Company d/b/a Tolkien Enterprises (The Lord of The Rings) and MGM / Danjag (James Bond).National Football League. These minimum guarantee payments and marketing commitments are included in the table below.
Summary of minimum contractual obligations and commercial commitments as of June 30, 2002 (in thousands):
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| Fiscal Year Ended March 31, | | Leases | | Advertising | | Minimum Guarantees | | AOL | | Marketing | | | | Bank and Other Guarantees | | Letters of Credit | | Total |
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| 2003 | | $ | 13,716 | | $ | 6,100 | | $ | 23,654 | | $ | 11,250 | | $ | 20,316 | | | | $ | 1,050 | | $ | 4,057 | | $ | 80,143 |
| 2004 | | | 15,011 | | | 3,500 | | | 22,062 | | | 11,250 | | | 16,554 | | | | | 171 | | | — | | | 68,548 |
| 2005 | | | 11,354 | | | 4,500 | | | 15,887 | | | — | | | 11,159 | | | | | 171 | | | — | | | 43,071 |
| 2006 | | | 10,810 | | | — | | | 16,483 | | | — | | | 4,572 | | | | | 171 | | | — | | | 32,036 |
| 2007 | | | 9,122 | | | — | | | 2,997 | | | — | | | 3,571 | | | | | 170 | | | — | | | 15,860 |
| Thereafter | | | 11,609 | | | — | | | 2,260 | | | — | | | 3,571 | | | | | 170 | | | — | | | 17,610 |
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| | | $ | 71,622 | | $ | 14,100 | | $ | 83,343 | | $ | 22,500 | | $ | 59,743 | | | | $ | 1,903 | | $ | 4,057 | | $ | 257,268 |
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Transactions with Related Parties
Square EA
In May 1998, we completed the formation of a new joint venture with Square Co., Ltd. (“Square”), a leading developer and publisher 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 have the exclusive right to distribute in North America products published by this joint venture. Either party may terminate the existence of Square EA and the distribution agreement effective March 31,
2001 (in thousands):
============================================================================================================
Fiscal Year Ended Minimum Letters of
March 31, Leases Advertising Guarantees Credit AOL Marketing
-------------------------------------------------------------------------------
2003 $16,045 $17,000 $26,572 $4,269 $11,250 $ 6,340
2004 12,699 3,500 20,642 - 11,250 6,615
2005 10,437 4,500 15,832 - - 2,010
2006 10,031 - 16,172 - - 1,000
2007 7,985 - 6,822 - - -
Thereafter 10,076 - 2,500 - - -
------------------------------------------------------------------------------------------------------------
$67,273 $25,000 $88,540 $4,269 $22,500 $15,965
------------------------------------------------------------------------------------------------------------
41
2003. We own a 30% minority interest in this joint venture while Square owns 70%. This joint venture is accounted for under the equity method. We generated $6,286,000 in net revenues from sales of Square EA products during the three months ended June 30, 2002 and $7,411,000 in net revenues from sales of Square EA products during the three months ended June 30, 2001.
Executive Officer Compensation
On June 24, 2002, the Company hired Warren Jenson, 46, as Executive Vice President of the Company. Mr. Jenson joined the Company from Amazon.com where he was the Chief Financial Officer (“CFO”). Prior to his tenure at Amazon.com, Mr Jenson has served as CFO of Delta Airlines and of General Electric’s NBC television unit. Mr. Jenson assumed the responsibilities of the office of CFO of the Company as of August 2, 2002. In order to incent Mr. Jenson to join the Company and to facilitate his relocation to the San Francisco Bay Area, the Company agreed to loan Mr. Jenson $4,000,000, to be forgiven over four years based on his continuing employment. This agreement was made and in effect prior to the introduction of and enactment of the Sarbanes-Oxley Act of 2002.
Impact of Recently Issued Accounting Standards
In June 1998,2001, the Financial Accounting Standards Board ("FASB"(“FASB”) issued SFAS 133
"Accounting for Derivative Instruments and Hedging Activities", as amended by
SFAS 137 "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of FASB
Statement No. 133" and SFAS 138 "Accounting for Certain Derivative Instruments
and Certain Hedging Activities - an Amendment of FASB Statement No. 133", which
establishes accounting and reporting standards for derivative instruments and
hedging activities. The terms of SFAS 133 and SFAS 138 are effective as of the
beginning of the first quarter of the fiscal year beginning after June 15, 2000.
SFAS 133, as amended, requires that all derivative instruments be recorded on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. We utilize fair value foreign
exchange contracts to hedge foreign currency exposures of underlying assets and
liabilities, primarily certain intercompany receivables that are denominated in
foreign currencies. We adopted SFAS 133 on April 1, 2001. The adoption of SFAS
133 did not have a material impact on our consolidated financial position or
results of operations.
In April 2001, the Emerging Issues Task Force issued No. 00-25 ("EITF 00-25"),
"Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products", which states that consideration from a vendor to a
reseller of the vendor's products is presumed to be a reduction of the selling
prices of the vendor's products and, therefore, should be characterized as a
reduction of revenue when recognized in the vendor's income statement. That
presumption is overcome and the consideration can be categorized as a cost
incurred if, and to the extent that, a benefit is or will be received from the
recipient of the consideration. That benefit must meet certain conditions
described in EITF 00-25. The consensus should be applied no later than in annual
or interim financial statements for periods beginning after December 15, 2001.
We believe the adoption of EITF 00-25 will not have a material impact on our
consolidated financial position or results of operations.
In June 2001, the FASB issued SFAS 141, "Business Combinations", which addresses
financial accounting and reporting for business combinations and supersedes
Accounting Principles Board Opinion No. 16 ("APB 16"), "Business Combinations",
and SFAS 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises". All business combinations in the scope of SFAS 141 are to be
accounted for using one method, the purchase method. This Statement requires
that intangible assets be recognized as assets apart from goodwill if they meet
one of two criteria--the contractual-legal criterion or the separability
criterion. SFAS 141 also requires disclosure of the primary reasons for a
business combination and the allocation of the purchase price paid to the assets
acquired and liabilities assumed by major balance sheet caption. This Statement
does not change many of the provisions of APB 16 and SFAS 38 related to the
application of the purchase method. Also, SFAS 141 does not change the
requirement to write off certain research and development assets acquired in a
business combination as required by FASB Interpretation No. 4, "Applicability of
FASB Statement No. 2 to Business Combinations Accounted for by the Purchase
Method". The provisions of SFAS 141 apply to all business combinations initiated
after June 30, 2001 and
42
applies to all business combinations accounted for using the purchase method for
which the date of acquisition is July 1, 2001, or later. We had no acquisitions
subsequent to June 30, 2001, therefore SFAS 141 has had no impact on our
consolidated financial position or results of operations.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets",
which supersedes APB 17, "Intangible Assets". SFAS 142 addresses the accounting
treatment for goodwill and other intangible assets acquired individually or with
a group of other assets upon their acquisition, but not acquired in a business
combination. This statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. With the adoption of SFAS 142, goodwill is no longer
subject to amortization over its estimated useful life; rather, goodwill will be
subject to at least an annual assessment for impairment by applying a
fair-value-based test. Also, if the benefit of an intangible asset is obtained
through contractual or other legal rights, or if the intangible asset can be
sold, transferred, licensed, rented or exchanged, an acquired intangible asset
should be separately recognized. The terms of SFAS 142 are effective as of the
beginning of the first quarter of the fiscal year beginning after December 15,
2001. Certain provisions of SFAS 142 shall be applied to goodwill and other
acquired intangible assets for which the acquisition date is after June 30,
2001. With the implementation of SFAS 142 as of April 2002, we will no longer
amortize goodwill. We are in the process of determining the impact on our
amortization of other intangibles.
In June 2001, the FASB issued SFAS 143, "Accounting“Accounting for Asset Retirement Obligations"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 Statementstatement 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 143No.143 to have a material impact on our consolidated financial position or results of operations.
In October 2001,April 2002, the FASB issued SFAS 144, "Accounting for the Impairment or
DisposalNo. 145, “Rescission of Long-Lived Assets", which addresses financial accountingFASB Statements No.4, 44, and reporting for the impairment or disposal64, Amendment of long-lived assets. SFAS 144
supersedes FASB Statement No. 121, "Accounting13, 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”regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of", and also supersedes the
accounting and reporting provisions of APBAccounting Principles Board Opinion No. 30, "Reporting“Reporting the Results of Operations-ReportingOperations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions"Transactions” are met. SFAS No. 145 also rescinds SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers” and amends SFAS No. 13, “Accounting for Leases”, for the disposalas well as makes various technical corrections to existing pronouncements. SFAS No. 145 provisions regarding early extinguishment of a segment of a business. SFAS 144 isdebt are generally effective for fiscal years beginning after DecemberMay 15, 20012002. We do not expect the adoption of SFAS No. 145 to 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 interim periods
within those fiscal years. We are in the process of determining the impact of
this new accounting standard.
In November 2001,reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force issued(EITF) Issue No. 01-09 ("EITF 01-09"),
"Accounting for Consideration Given by a Vendor to a Customer or a Reseller of
the Vendor's Products", which codifies and reconciles the Task Force consensuses
on all or specific aspects of EITF 00-14, "Accounting94-3, “Liability Recognition for Certain Sales
Incentives",Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)”. This statement requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred, as opposed to when the entity commits to an exit plan under EITF 00-22, "AccountingNo. 94-3. The provisions of this statement are effective for `Points' and Certain Other Time-Basedexit or Volume-Based Sales Incentives Offers, and Offers for Free Products or
Services to be Delivered in the Future" and EITF 00-25, "Vendor Income Statement
43
Characterization of Consideration Paid to a Reseller of the Vendor's Products",
and identifies other related interpretive issuesdisposal activities that haveare initiated after December 31, 2002. We do not yet been
addressed by the Task Force. The transition guidance for the codification of
EITF 00-14, 00-22 and 00-25 is governed by the original consensuses on those
Issues. For entities that have adopted EITF 00-14, 00-22 (Issue 3), and/or
00-25, the above guidance should be applied to transactions entered into after
November 15, 2001. We believeexpect the adoption of EITF 01-09 will notSFAS No. 146 to have a material impact inon our consolidated financial position or results of operations.
44
statements.
RISK Factors
================================================================================
FACTORS
Electronic Arts'Arts’ business is subject to many risks and uncertainties which may affect our future financial performance. Some of those important risks and uncertainties which may cause our operating results to vary or which may materially and adversely affect our operating results are as follows:
Risk Factors Relating to Our Core Business
Platform Transitions Such as the One Now Occurring Typically Depress the Market
for Video Game Software Until New Platforms Achieve a Wide Market Acceptance
When new video game platforms are announced or introduced into the market,
consumers typically reduce their purchases of video games for current platforms
in anticipation of new platforms being available. During that period, sales of
our video game products can be expected to slow or even decline until new
platforms have achieved a wide market and consumer acceptance. We are currently
in such a transition. Sony shipped its PlayStation 2 console in Japan, North
America and Europe in calendar year 2000. Nintendo launched its new console
system, Nintendo GameCube, in Japan in September 2001 and in North America in
November 2001, and announced its plans to launch in Europe in May 2002.
Microsoft launched its new console system, Xbox, in November 2001 in North
America, and announced its plans to launch in Japan in February 2002 and in
Europe in March 2002. Delays in the launch or shortages of these platforms could
also adversely affect our sales of products for these platforms. Current sales
of our products for the existing PlayStation and Nintendo 64 platforms have been
adversely affected (by the introduction of the PlayStation 2 and other new
platforms). We expect this trend to continue until one or more of these new
consoles achieve a wide installed base of consumers.
New Video Game Platforms Create Additional Technical and Business Model Uncertainties
Large portions of our revenues are derived from the sale of products for play on proprietary video game platforms such as the Sony PlayStation.PlayStation 2. The success of our products is significantly affected by acceptance of the new video game hardware systems and the life span of older hardware platforms and our ability to accurately predict which platforms will be most successful.
Sometimes we will spend development and marketing resources on products designed for new video game systems that have not yet achieved large installed bases or will continue product development for older hardware platforms that may have shorter life cycles than we expected. Conversely, if we do not develop for a platform that achieves significant market acceptance, or discontinue development for a platform that has a longer life cycle than expected, our revenue growth may be adversely affected.
For example, the Sega Dreamcast console launched in Japan in early 1999 and in the United States in September of 1999. We have developed no products for this platform. Had this platform achieved wide market acceptance, our revenue growth would have been adversely affected. Similarly, we are developing products for the Xbox and Nintendo GameCube. If these platforms do not achieve wide commercial acceptance, our revenue growth will be adversely impacted.
Product Development Schedules Are Frequently Unreliable and Make Predicting Quarterly Results Difficult
Product development schedules, particularly for new hardware platforms and high-end multimedia personal computers, or PCs, are difficult to predict because they involve creative processes, use of new development tools for new platforms and the learning process, research and experimentation associated 45
with development for new technologies. For example,EMPEROR: Battle for Dune for 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, JamesJames Bond 007...Agent007 in . . . Agent Under Fire for the PS2, which was expected to ship in fiscal 2001, released in October of fiscal 2002 due to development delays. Additionally, development risks for CD-ROM, DVD and DVDproprietary optical format disk products can cause particular difficulties in predicting quarterly results because brief manufacturing lead times allow finalizing products and projected release dates late in a quarter. Our revenues and earnings are dependent on our ability to meet our product release schedules, and our failure to meet those schedules could result in revenues and earnings which fall short of analysts'analysts’ expectations for any individual quarter and the fiscal year. Our Business Is Both Seasonal and Cyclical
Our business is highly seasonal with a significant percentage of our revenues occurring in the December quarter. In fiscal 2002, we expect these seasonal trends to bewere magnified by general industry factors, including the current 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. In addition, we are continuing to invest significantly in our
online operation, EA.com. Our business is also
cyclical; video game platforms have historically had a life cycle of four to six years, and decline as more advanced platforms are being introduced. As one group of platforms is reaching the end of its cycle and new platforms are emerging, buying patterns may change. Purchases of products for older platforms may slow at a faster rate than sales of new platforms. We are currently in suchhave been going through a platform transition.transition during the last 18 months and are now well into a new platform cycle. Sony shipped its PlayStation 2 console in Japan in March 2000, in North America in October 2000 and in Europe in calendar yearNovember 2000. Nintendo launched its new console system,the Nintendo GameCube console in Japan in September 2001, and in North America in November 2001 and announced its plans to
launch in Europe in May 2002. Microsoft launched its newthe Xbox console system, Xbox,in North America in November 2001, in North America and announced its plans to launch in Japan in February 2002 and in Europe in March 2002. Sales of our products for the N64 and Sony PlayStation platforms have already been adversely affected, and we expect this trend to continue.
The Impact of e-Commerce and Online Games on Our Business Is Not Known
While we do not currently derive significant revenues from online sales of our packaged products, we believe that such form of distribution will become a more significant factor in our business in the future. E-Commerce is becoming an increasingly popular method for conducting business with consumers. How that form of distribution will affect the more traditional retail distribution, at which we have historically had success, and over what time period, is uncertain. In addition, we expect the number and popularity of online games to increase and become a significant factor in the interactive games business generally. We do not know how that increase generally, or the emerging business of EA.com specifically, will affect the sales of packaged goods.
Our Business, Our Products, and Our Distribution Are Subject to Increasing Regulation of Content, Consumer Privacy and Online Delivery in Key Territories
Legislation is increasingly introduced which may affect the content of our products and their distribution. For example, privacy rules in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory while of course the Internet recognizes no geographical boundaries. Other countries such as Germany have adopted laws regulating content transmitted over the Internet that are stricter than current United States laws. In the United States, in response to recent events, the federal and several state governments are considering content restrictions on products such as those made by us as well as restrictions on distribution of such products. Any one or more of these factors could harm our business.
46
Risk Factors Relating to Our Online Business
Because of EA.com’s Limited Operating History, It Will Be Difficult To Evaluate its Business and Prospects
EA.com’s business is still in the developing stages, so evaluating its business and prospects will be more difficult than would be the case for a more mature business. We will continue to encounter the risks and difficulties faced in launching a new business, and we may not achieve our goals or may be compelled to change the manner in which we seek to develop the business. These uncertainties as to the future operations of EA.com will increase the difficulty we face in completing and pursuing the essential plans for the development of the business and will also make it more difficult for our stockholders and securities analysts to predict the operating results of this business.
EA.com Has a History of Losses and Expects To Continue To Incur Losses and May Never Achieve Profitability
EA.com has incurred substantial losses to date, including the current fiscal year. We expect EA.com to continue to incur losses as it builds its business. EA.com will be required to maintain the significant support, service and product enhancement demands of online users, and we cannot be certain that EA.com will produce sufficient revenues from its operations to support these costs. Even if profitability is achieved, EA.com may not be able to sustain it over a period of time.
Our Agreements with America Online May Not Prove Successful to the Development of EA.com’s Business
We have 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 productMajestic and 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 as part of EA.com’s restructuring plan. Similarly, we have limited experience in predicting usage patterns for our games. Because of our inexperience in this area, we may not be effective in achieving success that may otherwise be attainable from offering our games online.
Online Games Have Risks That Are Not Associated with Our Traditional Business
Online games, particularly multiplayer games, pose risks to player enjoyment that do not generally apply to packaged goods games. Players frequently would not be acquainted with other players, which may adversely affect the playing experience. Social issues raised by a player’s conduct may impact the experience for other players. It is difficult to monitor player behavior that impairs the game experience. In addition, there are substantial technical challenges to be met both in the introduction of our games online and in maintaining an effective game playing environment over time. Also, hacking and spamming has become a serious problem for online sites, and significant hacking and spamming could seriously interfere with online game play. If these risks are not successfully controlled and technical challenges resolved, potential customers for our games may be unwilling to play in sufficient volume to allow us to attain or sustain profitability.
Development of EA.com’s Business Will Require Significant Capital, and We Cannot Be Assured That It Will Be Available
EA.com will not be successful if it does not continue to receive substantial financing that is required to continue to build its business. Electronic Arts has agreed to provide a limited amount of funding to EA.com, but this financing alone may not be sufficient for the development of EA.com’s
business. Any additional funding that is obtained from Electronic Arts may either be treated as a debt arrangement or would increase Electronic Arts’ retained interest in EA.com and correspondingly decrease the interest of the holders of outstanding shares of Class B common stock. The attraction of additional equity or debt financing for EA.com from third parties may not be possible or may only be possible on terms that result in significant dilution to Class A and Class B common stockholders or incremental interest payments and debt-related restrictions on the operation of the business. To date, nearly all funding (except warrants and cash from revenues) has been provided by Electronic Arts.
If Use of the Internet Does Not Continue To Develop and Reliably Support the Demands Placed on It by Electronic Commerce, EA.com’s Business Will Be Harmed
EA.com’s success depends upon growth in the use of the Internet as a medium for playing games. The use of the Internet for sophisticated games like ours is relatively new. Our business would be seriously harmed if:
| § | | use of the Internet does not continue to increase or increases more slowly than expected, |
| § | | the infrastructure for the Internet does not effectively support online game play, |
| § | | concerns over the secure transmission of confidential information over public networks inhibit the growth of the Internet as a means of conducting commercial transactions, or |
| § | | government regulations regarding Internet content, privacy or other conditions impede the effectiveness of the Internet to users. |
Capacity Restraints May Restrict the Use of the Internet as a Forum for Game Play, Resulting in Decreased Demand for Our Products
The Internet infrastructure may not be able to support the demands placed on it by increased usage or the limited capacity of networks to transmit large amounts of data. Other risks associated with commercial use of the Internet could slow its growth, including:
| § | | outages and other delays resulting from the inadequate reliability of the network infrastructure, |
| § | | slow development of enabling technologies and complementary products, and |
| § | | limited availability and adoption by consumers of cost-effective, high speed access. |
Delays in the development or adoption of new equipment standards or protocols required to handle increased levels of Internet activity, or increased governmental regulation, would cause the Internet to fail to gain, or lose, viability as a means of game playing. If these or any other factors cause use of the Internet for commerce to slow or decline, the Internet may not prove viable as a commercial marketplace. This, in turn, would result in decreased demand for EA.com’s products and services.
To Become and Remain Competitive, EA.com Must Continually Develop New Content. This Is Inherently Risky and Expensive.
EA.com’s success depends on 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. Currently, the release of several products such asThe Sims Online andEarth & Beyond for which we expect to generate subscription revenue, have been delayed due to longer than anticipated development schedules. Similarly, the online productMajestic achieved only limited
commercial success due in part to the length of time it took to download the online software component. Accordingly, we discontinuedMajestic on May 1, 2002.
We May Not Be Able To Respond to Rapid Technological Change
The market for Internet products and services is characterized by rapid technological change and evolving industry standards. We will be required to continually improve performance, features, reliability and capacity of our network infrastructure. We cannot assure you that we will be successful in responding rapidly or in a cost effective manner to such developments.
Increasing Governmental Regulation of the Internet Could Limit the Market for Our Products
As Internet commerce continues to evolve, we expect that federal, state and foreign governments will adopt laws and regulations covering issues such as user privacy, taxation of goods and services provided over the Internet, pricing, content and quality of products and services. It is possible that legislation could expose companies involved in electronic commerce to liability, taxation or other increased costs, any of which could limit the growth of electronic commerce generally. Legislation could dampen the growth in Internet usage and decrease its acceptance as a communications and commercial medium. If enacted, these laws and regulations could limit the market for EA.com’s products.
Our Revenues Have Been Heavily Dependent on a Single Product and Would Be Adversely Affected if That Product’s Popularity Were To Decline
In the near term, EA.com’s 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 Online to decline. In addition, popularity ofUltima Online could decline over time simply because of consumer preference for new game experiences.
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, we will continue to invest in the technologies, tools and network infrastructure that are necessary for us to launch and support our key products,The Sims Online andEarth & Beyond. Accordingly, there are no assurances that the revenues from these products 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 broad 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 Significant 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 large 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 cannot assure you that further reductions will not occur.
The advertising revenue outlook for EA.com may be adversely affected by an environment where the supply of advertising inventory exceeds advertisers’ demand. Under these circumstances, Web publishers tend to remove ad space from their Web sites in an effort to correct the supply-demand imbalance; other publishers may cut back on their Web presence or go out of business. Faced with smaller budgets, advertisers and ad agencies purchase less advertising inventory and tend not to experiment with newer advertising media, like the Internet. Consequently, the number of ad impressions delivered by EA.com may decline or fail to grow, which would adversely affect our revenues.
We cannot assure you that further reductions in advertising spending will not occur. We also cannot assure you that if economic conditions improve, marketing budgets and advertising spending will increase from current levels. A continued decline in the economic prospects of advertisers or the economy in general could alter current or prospective advertisers’ spending priorities or increase the time it takes to close a sale with a customer. As a result, our revenues from advertisements and advertising services may decline significantly in any given period.
Online Product Development Schedules Are Unreliable and Make Predicting Quarterly Results Difficult
Online product development schedules, particularly for Internet based games are difficult to predict because they involve creative processes, use of new development tools, Internet latency issues, a learning process to better understand Internet based game mechanics, and research and experimentation associated with development for new online technologies. Additionally, development risks for Internet based products can cause particular difficulties in predicting quarterly results because of the challenges associated with game testing, live Beta testing, integration into network servers and integration on to the Games web site and may impact the release (“go live”) dates of products during a particular quarter. Several online products currently under development such asThe Sims Online andEarth & Beyond have experienced development delays and will be released later than planned. Our revenues and operating costs are dependent on our ability to meet our product “go live” schedules, and our failure to meet those schedules could result in revenues falling short of analysts’ expectations, resulting in increased operating losses for EA.com.
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 are outside of our control. Many of the service providers in the internet infrastructure space 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 expect 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 impact our operating results.
General Risk Factors
Because of the Competition for Qualified Technical, Creative, Marketing and Other Personnel, We May Not Be Able To Attract and Retain the Personnel Necessary for our Businesses
The market for technical, creative, marketing and other personnel essential to the development of online businesses and management of our online and core businesses continues to be competitive, although current market conditions have made it less difficult to attract and retain the employees we need. In the last fiscal year, notwithstanding the downturn of the economy generally, competitive recruiting efforts aimed at Electronic Arts’ employees and executives continued. Electronic Arts’ leading position within the interactive entertainment industry makes us a prime target for recruiting of executives and key creative talent to assist in the consolidation that the interactive entertainment industry is experiencing. In addition, the cost of real estate in the San Francisco Bay area the location of our headquarters and largest studio 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 Competitors and Frequently Control the Manufacturing of and/or Access To Our Video Game Products
Our agreements with hardware licensors, which are also our chief competitors, typically give significant control to the licensor over the approval and manufacturing of our products. This fact could, in certain circumstances, leave us unable to get our products approved, manufactured and shipped to customers. In most events, control of the approval and manufacturing process by the platform licensors increases both our manufacturing lead times and costs as compared to those we can achieve independently. For example, in prior years, we experienced delays in obtaining approvals for and manufacturing of PlayStation products which caused delays in shipping those products. The potential for additional delay or refusal to approve or manufacture our products continues with our platform licensors. Such occurrences would harm our business and adversely affect our financial performance. Additionally, we have not negotiated a final publishing agreement with Nintendo for the Nintendo GameCube platform and although we do not know whetherare currently operating under an understanding with Nintendo, we cannot be assured that the final terms of thisthe formal agreement 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. 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 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.com business. As these capabilities become more significant, the failure or refusal of our licensors to approve our products, or the successful deployment by these licensors of services competitive to EA.com, may harm our business.
Proliferation and Assertion of Patents Poses Serious Risks to our Business
Many patents have been issued that may apply to widely used game technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of existing games. Several such patents have been asserted against us. 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.
Risk Factors Relating to Our Online Business
Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate
its Business and Prospects
EA.com's business is still in the developing stages, so evaluating its
business and prospects will be more difficult than would be the case for a more
mature business. We will continue to encounter the risks and difficulties faced
in launching a new business, and we may not achieve our goals or may be
compelled to change the manner in which we seek to develop the business. These
uncertainties as to the future operations of EA.com will increase the difficulty
we face in completing and pursuing the essential plans for the development of
the business and will also make it more difficult for our stockholders and
securities analysts to predict the operating results of this business.
EA.com Has a History of Losses and Expects To Continue To Incur Losses and May
Never Achieve Profitability
EA.com has incurred substantial losses to date, including the first three
quarters of fiscal year 2002. We expect EA.com to continue to incur losses as it
develops its business. EA.com will be required to maintain the significant
support, service and product enhancement demands of online users, and we cannot
be certain that EA.com will produce sufficient revenues from its operations to
support these costs. Even if profitability is achieved, EA.com may not be able
to sustain it over a period of time.
47
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 Very Limited Experience with Online Games and May Not Be Able To Operate
This Business Effectively
Offering games solely for online play is a substantial departure from our
traditional business of selling packaged software games. We have employed
various pricing models, including subscription fees, "pay to play fees" and
advertising. We have very little experience with developing optimal pricing
strategies for online games. For example, our product Majestic and our Sports
package, each of which launched with a monthly subscription pricing model , have
obtained only limited commercial success to date. Accordingly, we have
discontinued our Sports package and have announced that we will discontinue
Majestic on May 1, 2002. Similarly, we are inexperienced in predicting usage
patterns for our games. Because of our inexperience in this area, we may not be
effective in achieving success that may otherwise be attainable from offering
our games online.
Online Games Have Risks That Are Not Associated with Our Traditional Business
Online games, particularly multiplayer games, pose risks to player
enjoyment that do not generally apply to packaged game sales. Players frequently
would not be acquainted with other players, which may adversely affect the
playing experience. Social issues raised by a player's conduct may impact the
experience for other players. We have not determined whether or how we might
monitor or proctor player behavior that impairs the game experience. In
addition, there are substantial technical challenges to be met both in the
introduction of our games online and in maintaining an effective game playing
environment over time. Also, hacking and spamming has become a serious problem
for online sites, and significant hacking and spamming could seriously interfere
with online game play. If these risks are not successfully controlled and
technical challenges resolved, potential customers for our games may be
unwilling to play in sufficient volume to allow us to attain or sustain
profitability.
Proliferation and Assertion of Patents Poses Serious Risks to the Business of
EA.com
Many patents have been issued that may apply to widely used Internet
technologies. Additionally, many recently issued patents are now being asserted
against Internet implementations of older technologies. Several such patents
have been asserted against us. Such claims can harm our business. We will incur
substantial expenses in evaluating and defending against such claims, regardless
of the merits of the claims. In the event that there is a determination that we
have infringed a third party patent, we could incur significant monetary
liability and be prevented from using the rights in the future.
Development of EA.com's Business Will Require Significant Capital, and We Cannot
Be Assured That It Will Be Available
EA.com will not be successful if it does not continue to receive
substantial financing that is required to develop its business. Electronic Arts
has agreed to provide a limited amount of funding to
48
EA.com, but this financing alone may not be sufficient for the development of
EA.com's business. Any additional funding that is obtained from EA may either be
treated as a revolving credit advance or would increase EA's retained interest
in EA.com and correspondingly decrease the interest of the holders of
outstanding shares of Class B common stock. The attraction of additional equity
or debt financing for EA.com from third parties may not be possible or may only
be possible on terms that result in significant dilution to Class A and Class B
common stockholders or interest or other costs and debt-related restrictions on
the operation of the business. To date, nearly all funding (except warrants and
cash from revenues) has been provided by EA.
If Use of the Internet Does Not Continue To Develop and Reliably Support the
Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed
EA.com's success depends upon growth in the use of the Internet as a medium
for playing games. The use of the Internet for sophisticated games like ours is
relatively new. Our business would be seriously harmed if:
. use of the Internet does not continue to increase or increases more
slowly than expected,
. the infrastructure for the Internet does not effectively support online
game play,
. concerns over the secure transmission of confidential information over
public networks inhibit the growth of the Internet as a means of
conducting commercial transactions, or
. government regulations regarding Internet content, privacy or other
conditions impede the effectiveness of the Internet to users.
Capacity Restraints May Restrict the Use of the Internet as a Forum for Game
Play, Resulting in Decreased Demand for Our Products
The Internet infrastructure may not be able to support the demands placed
on it by increased usage or the limited capacity of networks to transmit large
amounts of data. Other risks associated with commercial use of the Internet
could slow its growth, including:
. outages and other delays resulting from the inadequate reliability of
the network infrastructure,
. slow development of enabling technologies and complementary products,
and
. limited availability of cost-effective, high speed access.
Delays in the development or adoption of new equipment standards or
protocols required to handle increased levels of Internet activity, or increased
governmental regulation, would cause the Internet to fail to gain, or lose,
viability as a means of game playing. If these or any other factors cause use of
the Internet for commerce to slow or decline, the Internet may not prove viable
as a commercial marketplace. This, in turn, would result in decreased demand for
EA.com's products and services.
To Become and Remain Competitive, EA.com Must Continually Develop and Expand New
Content. This Is Inherently Risky and Expensive.
EA.com's success depends on our ability to develop products and services
for the EA.com site and our ability to continually expand the content on that
site. Our agreement with AOL requires us to develop new games under our
relationship with AOL. We cannot assure you that products will be developed on
time, in a cost effective manner, or that they will be successful. Currently,
the release of
49
several products such as The Sims Online and Earth and Beyond for which we
expect subscription revenue, have been delayed due to slipping development
schedules. Similarly, the online product Majestic achieved only limited
commercial success due in part to the difficulties of delivering the product
online. Accordingly, we have announced that we will discontinue Majestic on May
1, 2002.
We May Not Be Able To Respond to Rapid Technological Change
The market for Internet products and services is characterized by rapid
technological change and evolving industry standards. Both in completing the
design and implementation of our network infrastructure and thereafter, we will
be required to continually improve performance, features, reliability and
capacity of our network infrastructure. We cannot assure you that we will be
successful in responding rapidly or in a cost effective manner to such
developments.
Increasing Governmental Regulation of the Internet Could Limit the Market for
Our Products
As Internet commerce continues to evolve, we expect that federal, state and
foreign governments will adopt laws and regulations covering issues such as user
privacy, taxation of goods and services provided over the Internet, pricing,
content and quality of products and services. It is possible that legislation
could expose companies involved in electronic commerce to liability, taxation or
other increased costs, any of which could limit the growth of electronic
commerce generally. Legislation could dampen the growth in Internet usage and
decrease its acceptance as a communications and commercial medium. If enacted,
these laws and regulations could limit the market for EA.com's products.
Our Revenues Have Been Heavily Dependent on a Single Product and Would Be
Adversely Affected if That Product's Popularity Were To Decline
In the near term, EA.com's subscription revenues to date have consisted
primarily of revenues from sales of our online product Ultima Online, and we
would be adversely affected if revenues from that product were to decline for
any reason and not be replaced. We expect the online game market to become
increasingly competitive, and it is possible that other producer's current or
future games could cause our revenue from Ultima Online to decline. In addition,
popularity of Ultima Online could decline over time simply because of consumer
preference for new game experiences.
We Invest Very Heavily in Research and Development and Network Technology and
Operations for EA.com, and We Cannot Be Assured That We Will Achieve Revenues
That Validate This Level of Spending
We have invested, and expect to continue to invest, very heavily in
research and development and network technology and operations for our website
and online games. We will need to expand EA.com's revenues substantially for it
to achieve profitability with these levels of expenditure being required, and we
may not be able to do so. If we cannot increase revenues to profitable levels,
the value of EA.com will be impaired. In order to develop the broad game
offerings that we envision for our online operations it will be necessary to
engage in significant developmental efforts both to adapt existing EA games to
the online format and to create new online games. Our agreements with AOL
require us to maintain a substantial commitment to online game development and
we cannot be assured that we will realize acceptable returns from this
investment.
Online Product Development Schedules Are Unreliable and Make Predicting
Quarterly Results Difficult
Online product development schedules, particularly for Internet based games
are difficult to predict because they involve creative processes, use of new
development tools, Internet latency issues,
50
a learning process to better understand Internet based game mechanics, and
research and experimentation associated with development for new online
technologies. Additionally, development risks for Internet based products can
cause particular difficulties in predicting quarterly results because of the
challenges associated with game testing, live Beta testing, integration into
network servers and integration on to the Games web site and may impact the
release ("go live") dates of products during a particular quarter. Several
online products currently under development such as The Sims Online and Earth
and Beyond have experienced development delays and will be released later than
planned. Our revenues and operating costs are dependent on our ability to meet
our product "go live" schedules, and our failure to meet those schedules could
result in revenues falling short of analysts' expectations, with no
corresponding decrease in expenses, resulting in increased operating losses for
EA.com.
General Risk Factors
Because of the Competition for Qualified Technical, Creative, Marketing and
Other Personnel, We May Not Be Able To Attract and Retain the Personnel
Necessary for our Businesses
The market for technical, creative, marketing and other personnel essential
to the development of online businesses and management of our online and core
businesses continues to be competitive, although current market conditions have
made it less difficult to attract and retain the employees we need. In addition,
the cost of real estate in the San Francisco Bay area - the location of our
headquarters and largest studio 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.
Foreign Sales and Currency Fluctuations
For the ninethree months ended December 31, 2001June 30, 2002, international net revenues comprised 38%48% of total consolidated net revenues. For the fiscal year ended March 31, 2001,2002, international net revenues comprised 37% of total consolidated net revenues. We expect foreign sales to continue to account for a significant and growing portion of our revenues. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies which may fluctuate. While we hedge against foreign currency fluctuations, we cannot control translation issues. For example, our revenues in Japan and Asia Pacific revenues in the first three quartersquarter of fiscal 20022003 were adversely impacted by a devaluation of the Yen and Australian
Dollar as compared to the prior year. The devaluation had an adverse effect for the quarter and nine months ended December 31, 2001 on our net revenues and net income. Any of these factors may significantly harm our business.
Increased Difficulties in Forecasting Results
During platform transition periods, where the success of our products is significantly impacted by the changing market for our products, forecasting our revenues and earnings is more difficult than in more stable or rising product markets. The demand for our products may decline during a transition faster than we anticipate, negatively impacting both revenues and earnings. 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 Microsoft or Nintendo do not ship the number of units planned for the Xbox and Nintendo GameCube, our sales of these products may be adversely affected in fiscal
2002.
51
We cannot predict2003.The Current Legislative and Regulatory Environment Affecting Accounting Principles Generally Accepted in the impactUnited States of recentAmerica is Uncertain and Volatile, and Significant Changes in Current Principles Could Affect Our Financial Statements Going Forward.
Recent actions and comments by the Securities
and Exchange Commission (SEC) and FASB
Recent actions andpublic comments from the SEC have focused on the integrity of financial reporting.reporting generally. Similarly, Congress has considered a variety of bills that could affect certain accounting principles. In addition, the 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 that our financial statements have 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.
Fluctuations in Stock Price
Due to analysts'analysts’ expectations of continued growth and other factors, any shortfall in earnings could have an immediate and significant adverse effect on the trading price of our common stock in any given period. As a result of the factors discussed in this report and other factors that may arise in the future, the market price of our common stock historically has been, and we expect will continue to be, subject to significant fluctuations over a short period of time. These fluctuations may be due to factors specific to us, to changes in analysts'analysts’ earnings estimates, or to factors affecting the computer, software, Internet, entertainment, media or electronics businesses. In addition, fluctuations may be due to uncertainties in the securities markets in general. For example, during the fiscal year ended March 31, 2001,2002, the price per share of our Class A common stock ranged from $26.59 to $56.13 and $42.40 to $66.01 and $53.98 to $66.88 during the ninethree months ended December 31, 2001.
June 30, 2002.
World Events
The terrorist attacks of September 11, 2001 in the UnitesUnited States, the subsequent US military action, and the continuing concerns over potential additional terrorist attacks against US interests and citizens pose serious uncertainties in our business. Consumer spending, consumer preferences in entertainment, and the securities markets 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.
52
Item 3:3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
- -----------
MARKET RISK
We are exposed to various market risks, including the changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from changes in market rates and prices. Foreign exchange contracts used to hedge foreign currency exposures and short-term investments are subject to market risk. We do not consider our cash and cash equivalents to be subject to interest rate risk due to their short maturities. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rate Risk
We utilize foreign exchange contracts to hedge foreign currency exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies, thereby, limiting our risk. Gains and losses on foreign exchange contracts are reflected in the Condensed Consolidated StatementStatements of Earnings.Operations. At December 31, 2001,June 30, 2002, we had foreign exchange contracts, all with maturities of less than three monthsone month to purchase and sell approximately $393,699,000$137,125,000 in foreign currencies, primarily British Pounds, European Currency Units ("Euros"(“Euros”), Canadian Dollars, Swedish KronaJapanese Yen and other currencies.
Fair value represents the difference in value of the contracts at the spot rate and the forward rate. The counterparties to these contracts are substantial and creditworthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts are not considered to be material. Notwithstanding our efforts to manage foreign exchange risks, there can be no assurances that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations.
The following table
below provides information about our foreign currency forward exchange contracts at
December 31, 2001.June 30, 2002. 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
Contract Amount Contract Rate Fair Value
- -----------------------------------------------------------------------------------------------------------
(In thousands) (In thousands)
Foreign currency to be sold under contract:
British Pound $199,253 1.4502 $ 462
Euro 102,423 0.9000 1,865
Canadian Dollar 21,502 1.5812 183
Swedish Krona 10,327 10.5543 3
Japanese Yen 7,296 116.9100 784
Norwegian Krone 6,707 8.9462 71
Danish Krone 6,384 8.3024 91
Australian Dollar 3,493 0.5137 19
South African Rand 3,179 0.0859 112
Swiss Franc 3,059 1.6346 75
Korean Won 770 1,299.0000 14
- -----------------------------------------------------------------------------------------------------------
Total $364,393 $3,679
- -----------------------------------------------------------------------------------------------------------
Foreign currency to be purchased under contract:
British Pound $ 29,306 $ 110
- -----------------------------------------------------------------------------------------------------------
Total $ 29,306 $ 110
- -----------------------------------------------------------------------------------------------------------
Grand total $393,699 $3,789
- -----------------------------------------------------------------------------------------------------------
53
|
|
|
|
|
|
|
| | | Contract Amount | | Weighted-Average Contract Rate | | Fair Value Gain/(Loss) | |
|
|
|
|
|
|
|
| | | (In thousands) | | | | (In thousands) | |
| Foreign currency to be sold under contract: | | | | | | | | | |
| British Pound | | $ | 78,011 | | 1.4554 | | $ | (4,056 | ) |
| Euro | | | 18,642 | | 0.9321 | | | (1,178 | ) |
| Japanese Yen | | | 6,151 | | 123.5500 | | | (220 | ) |
| Swedish Krona | | | 5,172 | | 9.0880 | | | 55 | |
| Norwegian Krone | | | 3,370 | | 7.4187 | | | 47 | |
| South African Rand | | | 2,842 | | 10.2051 | | | 66 | |
| Australian Dollar | | | 2,760 | | 0.5521 | | | (55 | ) |
| Danish Krone | | | 2,408 | | 7.4764 | | | 9 | |
|
|
|
|
|
|
|
| Total | | $ | 119,356 | | | | $ | (5,332 | ) |
|
|
|
|
|
|
|
| Foreign currency to be purchased under contract: | | | | | | | | | |
| British Pound | | $ | 17,769 | | 1.5335 | | $ | 186 | |
|
|
|
|
|
|
|
| Total | | $ | 17,769 | | | | $ | 186 | |
|
|
|
|
|
|
|
| Grand total | | $ | 137,125 | | | | $ | (5,146 | ) |
|
|
|
|
|
|
|
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'counterparties’ obligations exceed our obligations as these contracts can be settled on a net basis at our option. We control credit risk through credit approvals, limits and monitoring procedures.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We manage our interest rate risk by maintaining an investment portfolio primarily consisting of debt instruments of high credit quality and relatively short average maturities. We also manage our interest rate risk by maintaining sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity. At December 31, 2001,June 30, 2002, our cash equivalents short-term and long-termshort-term investments included debt securities of $391,304,000.$669,090,000. Notwithstanding our efforts to manage interest rate risks, there can be no assurances that we will be adequately protected against the risks associated with interest rate fluctuations.
The table below presents the amounts and related weighted average interest rates of our investment portfolio at December 31, 2001:
- ----------------------------------------------------------------------
Average
Interest Rate Cost Fair Value
- ----------------------------------------------------------------------
(DollarsJune 30, 2002 (dollars in thousands)
Cash equivalents
Fixed rate 0.00% $ - $ -
Variable rate 2.46% $270,600 $270,600
Short-term investments
Fixed rate 4.14% $106,344 $107,289
Variable rate 1.60% $ 5,000 $ 5,015
Long-term investments
Fixed rate 0.00% $ - $ -
Variable rate 6.35% $ 8,400 $ 8,735
- ----------------------------------------------------------------------
:
| | | Average Interest Rate | | Cost | | Fair Value |
|
|
|
|
|
|
|
| Cash equivalents | | | | | | |
| Fixed rate | | 3.79% | | $ 30,204 | | $ 30,204 |
| Variable rate | | 1.98% | | $400,558 | | $400,558 |
| Short-term investments | | | | | | |
| Fixed rate | | 3.69% | | $226,998 | | $229,928 |
| Variable rate | | 6.35% | | $ 8,400 | | $ 8,649 |
|
|
|
|
|
|
|
Maturity
and call dates for short-term investments range from
1 month11 months to
930 months with call dates ranging from 0 months to 12 months.
54
PART II - 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.
At the Company’s Annual Meeting of Stockholders, held on August 1, 2002, the stockholders elected the following individuals for one-year terms to the Board of Directors: M. Richard Asher, William J. Byron, Leonard S. Coleman, Gary M. Kusin, Timothy Mott, Lawrence F. Probst III and Linda J. Srere. These individuals have received a plurality of the votes eligible to vote, voting either in person or by proxy.
In addition, the following matters were voted upon by the Stockholders:
To amend the 2000 Class A Equity Incentive Plan to increase by 5,500,000 the number of shares of the Company’s Class A common stock reserved for issuance under the Plan.
Votes
|
| For | | Against | | Abstain |
| |
| |
|
| 102,882,200 | | 24,127,424 | | 122,426 |
To ratify the appointment of KPMG LLP as our independent auditors for the current fiscal year.
Votes
|
| For | | Against | | Abstain |
| |
| |
|
| 121,957,885 | | 5,135,814 | | 38,351 |
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) | (a) | | Exhibits: The following exhibits are filed as part of this report: |
Exhibit Number
| | Title
|
| 10.54 | | Amendment No. 1 to Lease Agreement by and between Registrant and California Plaza of Walnut Creek, Inc., dated May 20, 2002. |
Exhibit Number
| | Title
|
| 10.55 | | Offer Letter for Employment at Electronic Arts Inc. to Warren Jenson, dated June 21, 2002. |
| 10.56 | | Full Recourse Promissory Note between Electronic Arts Inc. and Warren Jenson, dated July 19, 2002. |
| 10.57 | | Full Recourse Promissory Note between Electronic Arts Inc. and Warren Jenson, dated July 19, 2002. |
On July 2, 2002, the Company filed an 8-K under Item 5 announcing that due to the untimely death of Daniel H. Case III, who had been nominated for re-election to the Board of Directors of Electronic Arts at the Annual Meeting of Stockholders held on
Form 8-K: None
55
August 1, 2002, the Board of Directors had reduced the size of the Board from eight (8) to seven (7) members as of July 1, 2002. In addition, the Company announced that it did not intend to propose a substitute nominee for election to the Board of Directors at the Annual Meeting of Stockholders. On August 2, 2002, the Company filed an 8-K under Item 5 attaching its Sworn Statement under Oath of Principal Executive Officer and Principal Financial Officer pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934 as submitted to the Securities and Exchange Commission on August 1, 2002.
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) |
|
DATED: August 13, 2002 | | | | /s/ WARREN C. JENSON
|
| | | | | | WARREN C. JENSON Executive Vice President and Chief Financial Officer |
ELECTRONIC ARTS INC. (Registrant)
/s/E. STANTON MCKEE
-------------------
DATED: E. STANTON MCKEE
February 14,AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 Executive Vice President and
Chief Financial and Administrative Officer
56
EXHIBIT NUMBER
| | EXHIBIT TITLE
| | |
| 10.54 | | Amendment No. 1 to Lease Agreement by and between Registrant and California Plaza of Walnut Creek, Inc., dated May 20, 2002. | | |
| 10.55 | | Offer Letter for Employment at Electronic Arts Inc. to Warren Jenson, dated June 21, 2002. | | |
| 10.56 | | Full Recourse Promissory Note between Electronic Arts Inc. and Warren Jenson, dated July 19, 2002. | | |
| 10.57 | | Full Recourse Promissory Note between Electronic Arts Inc. and Warren Jenson, dated July 19, 2002. | | |
52