FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ______ to_____
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 94-2838567
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1450 Fashion Island Boulevard
San Mateo, California 94404
(Address of principal executive offices) (Zip Code)
(415) 571-7171
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock July 21, 1995
--------------------- --------------
$0.01 par value per share 51,328,502
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
- ------------------------------ -----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
June 30, 1995 and March 31, 1995 3
Consolidated Statements of Income for
the Three Months Ended June 30, 1995 and 1994 4
Consolidated Statements of Cash Flows for
the Three Months Ended June 30, 1995 and 1994 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Part II - Other Information
- ---------------------------
Item 1. Legal Proceedings 25
Item 4. Submission of Matters to a Vote of
Security Holders 25
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
- ----------
2
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
June 30, March 31,
1995 1995
------------------------
(unaudited)
Current assets:
Cash and short-term investments $110,247 $174,121
Marketable securities 9,899 10,725
Receivables, less allowances of
$32,496 and $33,567, respectively 60,307 56,389
Inventories 11,984 12,358
Prepaid royalties 11,477 8,318
Deferred income taxes 3,747 3,142
Other current assets 9,001 6,707
-------- --------
Total current assets 216,662 271,760
Property and equipment, net 57,684 30,528
Prepaid royalties 8,397 6,633
Long-term investments 14,200 14,200
Investments in affiliates 20,625 13,397
Deferred income taxes 1 77
Other assets 6,988 4,644
------- -------
$324,557 $341,239
-------- --------
-------- --------
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $35,927 $34,247
Accrued liabilities 45,230 68,771
------- -------
Total current liabilities 81,157 103,018
Minority interest in consolidated
joint venture 1,163 1,148
Stockholders' equity:
Preferred stock, $0.01 par value.
Authorized 1,000,000 shares -- --
Common stock, $0.01 par value.
Authorized 70,000,000 shares; issued
and outstanding 51,155,848 and
50,863,455, respectively 512 509
Paid-in capital 81,925 77,144
Retained earnings 162,355 161,512
Unrealized depreciation of investments (2,032) (1,206)
Translation adjustment (523) (886)
------- -------
Total stockholders' equity 242,237 237,073
------- -------
$324,557 $341,239
-------- --------
-------- --------
See accompanying notes to consolidated financial statements.
3
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended
June 30,
1995 1994
-------------------
Net revenues $80,035 $77,951
Cost of goods sold 42,827 40,126
------- -------
Gross profit 37,208 37,825
------- -------
Operating expenses:
Marketing and sales 11,690 9,507
General and administrative 6,181 5,798
Research and development 19,315 14,772
------- ------
Total operating expenses 37,186 30,077
------- ------
Operating income 22 7,748
Interest and other income, net 1,152 9,346
------ ------
Income before provision for income
taxes and minority interest 1,174 17,094
Provision for income taxes 376 5,215
------ ------
Income before minority interest 798 11,879
Minority interest in consolidated
joint venture 45 54
------ ------
Net income $ 843 $11,933
------ ------
------ ------
Net income per share: $ .02 $ .23
------ ------
------ ------
Number of shares used in computation 53,220 51,997
------ ------
------ ------
See accompanying notes to consolidated financial statements.
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Three Months
Ended June 30,
--------------
1995 1994
----------------
Operating activities:
Net income $ 843 $ 11,933
Adjustments to reconcile net cash
provided by operating activities:
Minority interest in consolidated
joint venture (45) (54)
Depreciation and amortization 3,244 2,297
Loss on sale of fixed assets 64 12
Deferred rent (30) (19)
Change in assets and liabilities:
Receivables (3,918) 4,203
Inventories 374 (616)
Prepaid royalties, net (4,923) (4,186)
Other assets (4,728) (690)
Accounts payable 1,680 (13,004)
Accrued liabilities (23,511) (9,437)
Deferred income taxes (529) (10)
--------- --------
Net cash provided/(used) by
operating activities (31,479) (9,571)
--------- --------
Investing activities:
Proceeds from sales of furniture
and equipment 83 70
Capital expenditures (30,457) (2,582)
Investment in affiliates (7,228) (3,022)
Change in short-term investments 7,800 13,025
Adjustment for effects of poolings
in prior period -- (1,661)
--------- --------
Net cash provided (used) in
investing activities (29,802) 5,830
--------- --------
Financing activities:
Proceeds from issuance of common stock 3,508 304
Tax benefit from exercise of stock options 1,276 537
-------- ------
Net cash provided by financing
activities 4,784 841
--------- --------
Translation adjustment 363 1,169
Minority interest on translation adjustment 60 71
--------- --------
Decrease in cash and cash equivalents (56,074) (1,660)
Beginning cash and cash equivalents 143,421 93,918
--------- --------
Ending cash and cash equivalents 87,347 92,258
Short-term investments 22,900 23,375
--------- --------
Ending cash and short-term investments $110,247 $115,633
--------- --------
--------- --------
Supplemental cash flow information:
- -----------------------------------
Cash paid during the year for income
taxes $ 8,130 $ 125
--------- --------
--------- --------
Non-cash investing activities:
- ------------------------------
Unrealized depreciation of investments $ (826) $(2,375)
--------- --------
--------- --------
See accompanying notes to consolidated financial statements.
5
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements are unaudited and reflect
all adjustments (consisting only of normal recurring accruals)
that, in the opinion of management, are necessary for a fair
presentation of the results for the interim periods. The results
of operations for current interim periods are not necessarily
indicative of results to be expected for the current year or any
other period.
These consolidated financial statements should be read in
conjunction with the financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 1995 as filed with the Securities and
Exchange Commission on June 29, 1995.
Certain amounts in fiscal 1995 have been reclassified to conform
to fiscal 1996 presentation.
NOTE 2. CASH AND INVESTMENTS
Cash equivalents consist of highly liquid investments with
maturities of three months or less at the date of purchase.
The Company adopted the provisions of SFAS 115 (Statement of
Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities") for investments
held as of or acquired after April 1, 1994. The Company has
accounted for investments in debt securities as
"available-for-sale" under the provisions of SFAS 115 and has
stated applicable investments at fair value, with unrealized
gains and losses reported as a separate component of
stockholders' equity. The cost of securities sold is based upon
the specific identification method.
Cash and short-term investments at June 30, 1995 and March 31,
1995 consisted of (in thousands):
June 30, 1995 March 31, 1995
------------- --------------
Cash and cash equivalents $ 87,347 $143,421
Short-term investments 22,900 30,700
-------- --------
$110,247 $174,121
-------- --------
-------- --------
NOTE 3. MARKETABLE SECURITIES
Marketable securities consist of equity securities. The Company
has accounted for investments in equity securities as
"available-for-sale" and has stated applicable investments at
fair value with unrealized losses reported as a separate
component of stockholders' equity.
6
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 4. SOFTWARE DEVELOPMENT COSTS
To date, the Company has not capitalized any software development
costs in accordance with Statement of Financial Accounting
Standard (SFAS) No. 86 since the impact to the financial
statements for all periods presented has been immaterial.
NOTE 5. INVENTORIES
Inventories are stated at the lower of weighted average cost or
market. Inventories at June 30, 1995 and March 31, 1995
consisted of (in thousands):
June 30, 1995 March 31, 1995
------------- -------------
Raw materials and work in process $ 3,860 $ 2,799
Finished goods 8,124 9,559
-------- --------
$ 11,984 $ 12,358
-------- --------
-------- --------
NOTE 6. PROPERTY AND EQUIPMENT
In May 1995, the Company acquired two properties including one
building, in Austin, Texas to support the expansion of its
Texas-based development group. The building is being depreciated
using the straight line method over a period of 20 years.
NOTE 7. ACCRUED LIABILITIES
Accrued liabilities at June 30, 1995 and March 31, 1995 consisted
of (in thousands):
June 30, 1995 March 31, 1995
------------- --------------
Accrued expenses $24,790 $26,138
Accrued royalties 7,911 16,040
Accrued compensation and benefits 6,805 10,524
Accrued income taxes 5,724 16,069
------- -------
$45,230 $68,771
------- -------
------- -------
NOTE 8. NET INCOME PER SHARE
Net income per share is computed on the basis of the weighted
average number of common shares and common equivalent shares
outstanding and is adjusted for shares issuable upon exercise of
stock options. The computation assumes the proceeds from the
exercise of stock options were used to repurchase common shares
at the average market price of the Company's common stock during
each period. Such average shares outstanding for the three
months ended June 30, 1995 and 1994 were 53,220,000 and
51,997,000, respectively. There is no significant difference
between primary and fully diluted earnings per share.
7
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 9. INVESTMENT AND JOINT VENTURES
Investments in affiliates include the following investments:
The 3DO Company
- ---------------
The Company has an approximately 18% ownership interest in The
3DO Company ("3DO"). Other investors include Time Warner
Enterprises, a unit of Time Warner, Inc., Matsushita Electric
Industrial Co., Ltd., MCA, AT&T and two venture capital firms.
The investment is accounted for under the equity method.
Electronic Arts Victor, Inc.
- ----------------------------
The Company has a majority interest in a joint venture
corporation, Electronic Arts Victor, Inc. ("EAV"), for the
development and distribution of entertainment software products
in Japan as well as certain Asian countries. EAV is sixty-five
percent owned by the Company and thirty-five percent owned by
Victor Entertainment Industries, Inc. ("VEI") (formerly Victor
Musical Industries, Inc.), a wholly owned subsidiary of Victor
Company of Japan, Limited. The Company has consolidated 100% of
the assets, liabilities and results of operations for EAV. VEI's
35% interest in EAV and the loss therefrom has been reflected as
"Minority interest in consolidated joint venture" on the
Company's Consolidated Financial Statements.
Creative Wonders, Inc.
- ----------------------
In December 1994, the Company and Capital Cities/ABC, Inc.
announced the formation of a joint venture company to develop and
publish software for personal computers and new generation
entertainment machines. The new venture, Creative Wonders, Inc.,
(formerly ABC/EA Home Software, Inc.) publishes children's
edutainment and interactive entertainment multimedia titles as
well as reference products under the name Creative Wonders.
Under the terms of the agreement, each company will maintain a
50% ownership interest in the joint venture company. The
investment is accounted for under the equity method. Electronic
Arts is the exclusive distributor of any interactive titles sold
by the joint venture in the retail channel. As part of the
agreement, the Company contributed assets consisting primarily of
inventories, prepaid royalties and certain intangible assets.
8
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
NOTE 10: OPERATIONS BY GEOGRAPHIC AREAS
The Company operates in one industry segment. Information about
the Company's operations in North America, Europe, Australia and
Japan for the three months ended June 30, 1995 and 1994 is
presented below (in thousands). All intersegment sales among
North American entities (EA San Mateo, EA Canada Inc., EA Puerto
Rico Inc., EA Productions Inc. and Origin Systems, Inc.) have
been eliminated. Therefore, intersegment activity disclosed on
this schedule reflects only the transactions that have taken
place between the geographic segments disclosed below.
NORTH
THREE MONTHS ENDED JUNE 30, 1995 AMERICA EUROPE AUSTRALIA JAPAN ELIMINATIONS TOTAL
- -------------------------------- ------- ------ --------- ----- ------------ -----
Net revenues from unaffiliated
customers $ 46,715 $22,312 $ 3,287 $ 7,721 $ -- $80,035
Intersegment net revenues 6,921 1,398 -- -- (8,319) --
-------- -------- -------- ------- -------- --------
Total net revenues $ 53,636 $23,710 $ 3,287 $ 7,721 $ (8,319) $80,035
-------- -------- -------- ------- -------- --------
-------- -------- -------- ------- -------- --------
Operating income/(loss) $ (5,253) $ 4,929 $ 610 $ (264) $ -- $ 22
Identifiable assets $262,701 $45,037 $ 5,872 $10,944 $ -- $324,557
THREE MONTHS ENDED JUNE 30, 1994
- --------------------------------
Net revenues from unaffiliated
customers $ 51,904 $15,232 $ 1,687 $ 9,128 $ -- $ 77,951
Intersegment net revenues 4,527 561 7 -- (5,095) --
-------- -------- -------- ------- -------- --------
Total net revenues $ 56,431 $15,793 $ 1,694 $ 9,128 $ (5,095) $ 77,951
-------- -------- -------- ------- -------- --------
-------- -------- -------- ------- -------- --------
Operating income/(loss) $ 5,110 $ 2,491 $ 249 $ (102) $ -- $ 7,748
Identifiable assets $193,717 $44,629 $ 3,152 $19,617 $ -- $261,115
9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following information should be read in conjunction with the
consolidated financial data and the notes thereto included in
Item 1 of this Quarterly Report and Management's Discussion and
Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 1995 as filed with the Securities and
Exchange Commission on June 29, 1995.
NET REVENUES June 30, June 30,
1995 1994 % change
-------- -------- --------
CONSOLIDATED NET REVENUES
Three Months Ended $80,035,000 $77,951,000 2.7
NORTH AMERICA NET REVENUES
Three Months Ended 46,715,000 51,904,000 (10.0)
as a percentage of net revenues 58.4% 66.6%
INTERNATIONAL NET REVENUES
Three Months Ended 33,320,000 $26,047,000 27.9
as a percentage of net revenues 41.6% 33.4%
The Company derives revenues from shipments of EA Studio cartridge
products, EA Studio CD and floppy-disk personal computer products,
EA Studio CD products on dedicated entertainment and educational
systems, licenses of EA Studio products and shipments of Affiliated
Label and other branded publisher floppy-disk and CD products.
Overall, North American net revenues decreased 10.0% for the three
months ended June 30, 1995 compared to the same period last year
due to the decrease in volume of sales in the mature 16-bit
cartridge market. This decrease was partially offset by the
significant increase in shipments of CD based products for both
personal computers and dedicated entertainment systems.
International net revenues increased 27.9% for the three months
ended June 30, 1995 compared to the same period last year,
primarily due to an increase of 46.5% in revenues in Europe
consisting of higher sales of CD-ROM titles and strong sales of
Sega 16-bit cartridge products. Also included in international
revenues was an increase in sales of CD-ROM products in Japan and
South Asia Pacific, mitigated by a decrease in revenues from the
sale of Gameboy products in Japan.
10
EA STUDIO NET REVENUES:
16-BIT VIDEOGAME PRODUCT NET REVENUES June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended 26,566,000 $41,261,000 (35.6)
as a percent of net revenues 33.2% 52.9%
The Company released three new 16-bit videogame titles during the
first quarter of fiscal 1996 consisting of THEME PARK and TRIPLE
PLAY `96 for the Sega Genesis and JUNGLE STRIKE for the SNES. Sega
cartridge sales were $20,074,000 the three months ended June 30,
1995 compared to $30,069,000 for the same period in the prior year.
SNES sales were $6,492,000 for the three months ended June 30,
1995 compared to $11,192,000 for the same period last year.
Since the 16-bit videogame market has matured, growth rates have
slowed and sales of the related software have declined and are
expected to continue to do so. The Company's net revenues derived
from 16-bit videogames declined 35.6% during the first quarter of
fiscal 1996 compared to the same period in the prior year.
Additionally, as the 16-bit cartridge market has become more
"hits-driven", the Company will continue to ship fewer cartridge
products in fiscal 1996 than in fiscal 1995 and expects to release
a higher percentage of these products in the December quarter.
Under the terms of a licensing agreement entered into with Sega
Enterprises, Ltd., ("Sega") in July 1992 ("the Sega Agreement"),
the Company is authorized to develop and distribute ROM-cartridge
software products compatible with the Sega Genesis system through
December 1995. Additionally, the Company may continue to
distribute remaining products in its inventory or in process of
manufacture at December 1995 for an additional six months. Genesis
cartridges are manufactured by the Company in Puerto Rico and by a
third party manufacturer under terms of the Sega Agreement. A
shortage of components, or other factors outside the control of the
Company could impair the Company's ability to obtain an adequate
supply of cartridges.
Under the terms of its licensing agreement with Nintendo, the
Company engages Nintendo to manufacture its SNES cartridges for
distribution. The Company has little ability to control its supply
of cartridges or the timing of their delivery. A shortage of
microchips, or other factors outside the control of the Company
could impair the Company's ability to obtain an adequate supply of
cartridges. Nintendo maintains a policy of not accepting returns.
Considering these and other factors, the carrying of an inventory
of cartridges entails additional investments and risks. Videogame
cartridges, particularly SNES, are more expensive to produce than
floppy disks and CD-ROM's and are produced in higher volumes.
Accordingly, if Electronic Arts' sales mix of SNES videogame
products increases, it will be exposed to greater inventory costs
and increased risks of unexpected returns of unsold products.
11
32-BIT VIDEOGAME PRODUCT NET REVENUES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $5,874,000 $3,855,000 52.4
as a percentage of net revenues 7.3% 4.9%
The Company released two new CD-ROM based 32-bit videogame products
during the first quarter of fiscal 1996, WING COMMANDER III and
SYNDICATE, both of which were for the 3DO Interactive Multiplayer.
All 32-bit CD-ROM based revenues for the first quarter related to
sales of 3DO products. There were no new 3DO titles released in Q1
of fiscal 1995.
As a result of the videogame market's current transition to 32-bit
hardware platforms, the Company's sales of the related software for
these CD based dedicated entertainment systems is expected to
increase as the Company continues to focus its development efforts
on supporting these new platforms.
COMPUTER-BASED CD PRODUCT NET REVENUES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $21,082,000 $4,903,000 330.0
as a percentage of net revenues 26.3% 6.3%
The Company released four new CD based titles in the first quarter
of the current fiscal year, three for the IBM personal computer and
one for the Macintosh, compared to none for the same period last
year. As mentioned above and elsewhere in this report, the
significant increase in both absolute dollars and as a percentage
of total net revenues reflects the market transition from 16-bit
cartridge systems to CD platforms and the Company's strategy to
focus its development efforts on CD based platforms. The Company
expects revenues from CD products to grow but as revenues for CD
products increase, the Company does not expect these percentage
growth rates to continue.
FLOPPY-DISK PRODUCT NET REVENUES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $1,330,000 $8,949,000 (85.1)
as a percentage of net revenues 1.7% 11.5%
The Company released no new floppy-disk based personal computer
titles in the first quarter of the current fiscal year, compared to
six for the same period in the prior year. The decrease in net
revenues derived from shipments of EA Studio floppy-disk based
personal computer products reflects the market trend toward CD
based personal computer products.
12
LICENSE/OEM NET REVENUES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $5,604,000 $2,638,000 112.4%
as a percentage of net revenues 7.0% 3.4%
The increase in license/OEM net revenues for the three months ended
June 30, 1995 compared to the same period last year was primarily a
result of an increase in licensing of personal computer products
in the United States.
AFFILIATED LABEL NET REVENUES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $17,930,000 $8,555,000 109.6%
as a percentage of net revenues 22.4% 11.0%
The increase in Affiliated Label net revenues for the three months
ended June 30, 1995 compared to the prior year period reflects the
significant expansion of the distribution business, mainly in North
America. Affiliated Label CD based net revenues represented
approximately 80% of total Affiliated Label net revenues for the
period, compared to 44% in the comparable period in the prior year.
In addition to the traditional Affiliated Labels distributed by the
Company, the Company also derived revenues from the distribution of
PC products to key accounts on behalf of other third party
publishers. There were no such sales in the same period of the
prior year.
OTHER REVENUES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $1,649,000 $7,790,000 (78.8%)
as a percentage of net revenues 2.1% 10.0%
Other revenues for the three months ended June 30, 1995 consisted of
sales of products for Gameboy and the Sega 32X platform. The Company
released one title for the Sega 32X during the period. The net revenues
generated in the comparable period of the prior year related mainly to
products for Gameboy and the Sega CD platform. The Company does not
plan to release any new titles for hand-held equipment or the Sega CD in
fiscal 1996 and accordingly, revenues for these platforms are expected
to continue to decline.
13
COST OF GOODS SOLD
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $42,827,000 $40,126,000 6.7%
as a percentage of net revenues 53.5% 51.5%
The increase in cost of goods sold, as a percentage of net
revenues, for the three months ended June 30, 1995 compared to the
same period last year was primarily due to the impact of the
significant increase of lower margin Affiliated Label and third
party publisher net revenues, as a percentage of total net
revenues, partially offset by the increase of higher margin EA
Studio CD net revenues and license/OEM net revenues. Additionally,
margins on 16-bit software were eroded as a result of the
maturation of that segment of the business which promoted an
overall reduction in sales price of classic videogame titles and
higher costs of goods sold resulting from the larger cartridge
configurations.
MARKETING AND SALES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $11,690,000 $9,507,000 23.0%
as a percentage of net revenues 14.6% 12.2%
The increase in marketing and sales expenses was primarily
attributable to higher trade show expenses resulting from the
Company's participation in the May Electronic Entertainment
Exposition, and increased headcount resulting from the expansion of
the worldwide distribution business.
GENERAL AND ADMINISTRATIVE
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $6,181,000 $5,798,000 6.6
as a percentage of net revenues 7.7% 7.4%
The slight increase in general and administrative expenses resulted
primarily from an increase in payroll and occupancy costs due to
the opening of additional international offices. This increase was
partially offset by the decrease in bad debt reserves compared to
the prior year's quarter which reflected the increased provision
for bad debts on certain uncollectible accounts in Japan.
14
RESEARCH AND DEVELOPMENT
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $19,315,000 $14,772,000 30.8%
as a percentage of net revenues 24.1% 19.0%
The increase in research and development expenses was primarily due
to additional headcount, continued investment in development for
new CD platforms the higher average development costs for these
platforms, and more in-house development. Additional investments
were made in new interactive movie production facilities which
utilize digitized audio and video information and product
development for new hardware platforms.
OPERATING INCOME
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $22,000 $7,748,000 (99.7%)
as a percentage of net revenues -- 9.9%
Operating income decreased for the three months ended June 30, 1995
compared to the same period last year due to increased research and
development, increased marketing and sales expenses and a slight
decrease in gross profit margins, as noted above.
INTEREST AND OTHER INCOME, NET
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $1,152,000 $9,346,000 (87.7)
as a percentage of net revenues 1.4% 12.0%
Interest and other income, net decreased for the three months ended June
30, 1995 compared to the same period last year primarily due to a one
time payment of $8,600,000 associated with the termination of a merger
agreement in the comparable period of the prior year.
INCOME TAXES
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $376,000 $5,215,000 (92.8)
effective tax rate 32.0% 30.5%
The Company's effective tax rate increased for the three months
ended June 30, 1995 compared to the same period last year primarily
due to the impact of the reduced level of manufacturing in Puerto
Rico.
15
MINORITY INTEREST IN CONSOLIDATED JOINT VENTURE
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $45,000 $54,000 (16.7)
as a percentage of net revenue 0.1% 0.1%
The Company has a majority interest in a joint venture corporation,
Electronic Arts Victor, Inc. ("EAV"), in Japan for the development
and distribution of entertainment software products in Japan as
well as certain Asian countries. EAV is sixty-five percent owned
by the Company and thirty-five percent owned by Victor
Entertainment Industries, Inc. ("VEI"), (formerly Victor Musical
Industries, Inc.) a wholly owned subsidiary of Victor Company of
Japan, Limited. The minority interest represents VEI's 35%
interest in EAV. The decrease in impact from the minority
interest for the three months ended June 30, 1995 is due to lower
reported losses for EAV compared to the same period in the prior
year.
NET INCOME
June 30, June 30,
1995 1994 % change
-------- --------- --------
Three Months Ended $843,000 $11,933,000 (92.9)
as a percentage of net revenue 1.1% 15.3%
The decrease in net income as compared to the prior year period was
primarily related to slightly higher revenues offset by lower gross
profit margins, higher operating expenses and a higher effective
tax rate in the current year period, combined with the impact of
the after-tax net gain of approximately $6,000,000 from a one time
payment of a merger termination fee, in the same period of the
prior year.
16
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1995, the Company's working capital was $135,505,000
compared to $168,742,000 at March 31, 1995. Cash and short term
investments decreased by approximately $63,874,000 during the
quarter as the Company used $31,479,000 of cash in operations
primarily due to payment of accrued liabilities.
During the quarter ended June 30, 1995, the Company invested
approximately $21,200,000 in the purchase of land and buildings in
Austin, Texas in which it plans to house its expanding Texas-based
development group. Additionally, the Company made a strategic
investment in Novalogic, a Southern California based developer of
entertainment software.
Reserves for bad debts and sales returns decreased from $33,567,000
at March 31, 1995 to $32,496,000 at June 30, 1995. 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.
Inventory levels at June 30, 1995 decreased slightly compared to
March 31, 1995 as the levels of videogame cartridge inventory fell
in North America. This was partially offset by a build-up in
videogame cartridge components in Puerto Rico in anticipation of
the upcoming holiday season.
In connection with the Company's purchases of cartridges to be
distributed in Japan, Nintendo of Japan requires cash deposits in
lieu of letters of credit. At June 30, 1995, EAV had no remaining
cash deposits for purchases of Nintendo cartridges. In lieu of
letters of credit, EAV utilizes a line of credit to fund these
deposits and purchases of Nintendo cartridges. At June 30, 1995,
EAV had an outstanding balance on this line of approximately
$4,151,000.
The Company's principal source of liquidity is $110,247,000 in cash
and short-term investments. Management believes the existing cash,
cash equivalents, short-term investments, marketable securities and
cash generated from operations will be sufficient to meet cash and
investment requirements for the foreseeable future.
17
RISK FACTORS
The Company's business is subject to a number of risks. Some of
those risks are described below. Other risks are presented
elsewhere in this report.
RAPID TECHNOLOGICAL CHANGE
Currently, the interactive software industry is undergoing
another significant change due in part to the introduction or
planned introduction of new hardware platforms, as well as remote
and electronic delivery systems. The new generation of systems are
based on 32-bit and 64-bit microprocessors that incorporate
dedicated graphics chipsets. Many of these systems utilize CD-ROM
drives. The Company began development of 32-bit software products
over three years ago by creating the original software development
system for the first of these advanced products, the 3DO
Interactive Multiplayer, which began selling in calendar 1993.
Sega and Sony each began distribution of their next generation
hardware systems (named the "Saturn" and "PlayStation",
respectively) in Japan during the quarter ended December 1994.
Sega began limited shipment of the Saturn in North America in May
1995 and Sony has announced plans to begin shipping the PlayStation
in North America in September 1995. The team of Nintendo and
Silicon Graphics announced plans to manufacture and distribute the
Ultra 64 advanced system for initial shipment in the spring of
1996. The 3DO Company has announced its next generation system,
the M2, with the first shipment scheduled in the first half of
calendar year 1996.
New entrants in the interactive entertainment and multimedia
industries, such as cable television, telephone and diversified
media and entertainment companies, and a proliferation of new
technologies, such as on-line networks and the Internet, are making
market forecasting and prediction of financial results increasingly
difficult for the Company. However, in the near term, the Company
expects that the transition from 16-bit cartridge-based game
machines to the advanced systems described above will continue to
adversely affect the near term financial results of the Company.
An increasing portion of the Company's new product releases in its
1996 fiscal year will be for advanced platforms, including the IBM
PC-CD and compatibles, the Sega Saturn and Sony PlayStation, which
will, in the near term, have substantially smaller installed bases
than the current 16-bit videogame systems. In the near term, the
increase in unit sales of advanced platforms may be less than the
decline in unit sales of 16-bit systems. As a result, while the
Company expects to release more titles during fiscal 1996 than
during fiscal 1995, the majority of these new products will be
directed to the 32-bit systems and the Company's potential market
during this transition period may be smaller. This set of
circumstances will continue to adversely affect the financial
results of the Company in fiscal 1996, particularly through the
second quarter of fiscal 1996, before Sega's full roll-out of the
Saturn and Sony's expected launch of the PlayStation in North
America.
18
As the 16-bit cartridge market matures, hardware sales have
declined and will continue to decline. Accordingly, software sales
for the 16-bit cartridge systems are declining rapidly as a
percentage of the Company's business and are expected to continue
to decline in fiscal 1996. In addition, sales in the 16-bit
software market have become more "hits" driven. Fewer products in
that market are successful and publishers of these games, including
the Company, must incur additional marketing and sales expenses to
promote retailers' sales of their 16-bit cartridge products. In
fiscal 1996, the Company plans to release even fewer products for
these platforms and to concentrate releases during the holiday
season, while focusing marketing efforts on promoting hit products.
The interactive software market has historically been a volatile
and highly dynamic industry affected by seasonality, changing
technology, limited hardware platform life cycles, hit products,
competition, component supplies, consumer spending and other
economic trends. Each of these factors affect the operating
results of the Company, often in combinations that make predicting
those operating results difficult. In particular, the Company
believes that consumer spending trends are adversely affecting the
interactive software market at this time, and that retailers, in
reaction to the rapidly declining 16-bit cartridge market, are
attempting to reduce their inventories by buying more cautiously.
These factors can be expected to continue to depress sales of the
Company's software products for the 16-bit market as it is
succeeded by the 32-bit market.
The Company believes that early investment in products for the
32-bit market is strategically important and the Company is
therefore continuing its aggressive development activities for
32-bit platforms. This investment in advanced technology
development, together with declining revenues in 16-bit products
during this period may result in slow or insignificant growth in
revenue and earnings for the 1996 fiscal year and reduced revenues
and earnings in the second quarter of fiscal 1996.
The eventual increase in the 32-bit market will in large part
depend on the successful launch of the new hardware platforms.
Delays by the hardware companies in the launch of these hardware
platforms in key territories, or slower than anticipated acceptance
by consumers, will slow the growth and prolong the transition from
the 16-bit to 32-bit platforms.
19
COMPETITION
The interactive consumer software market is highly
competitive. Important factors in marketing both entertainment and
educational software include content quality and entertainment
value, product features, manufacturing quality and reliability,
brand recognition, hardware compatibility, ease of understanding
and operation, dealer merchandising, access to existing
distribution channels and retail shelf space, advertising, pricing,
and availability and quality of support services. A variety of
companies offer products that compete directly with one or more of
Electronic Arts' products. These direct competitors vary in size
from very small companies with limited resources to companies with
financial, managerial and technical resources comparable to or
greater than those of Electronic Arts. Manufacturers of hardware
platform systems, videogame cartridges and CD-ROM's such as
Nintendo, Sega and Sony (together with their licensees) diversified
media and entertainment companies such as Disney, Viacom and
Time-Warner Inc. and publishers of personal computer software such
as Microsoft Corporation also compete directly with the Company in
providing interactive software products to consumers. In addition,
companies in industries such as cable television and
telecommunications, many of which have significant financial
resources, have begun to diversify or have announced plans to enter
the interactive software market. These new entrants have the
potential to become significant competitors.
PRODUCTS AND PRODUCT DEVELOPMENT
Interactive entertainment software products typically have
life spans of only 3 to 12 months. Accordingly, the Company must
constantly develop and bring to market new products that achieve
market acceptance quickly. The Company's future success will
depend in large part on its ability to develop and introduce new
products on a timely basis. New products must keep pace with
competitive offerings, adapt to new hardware platforms and emerging
industry standards and provide additional functionality. If the
Company were unable, due to resource constraints or technological
or other reasons, to develop and introduce such products in a
timely manner, this inability would have a material adverse effect
on its operating results and financial condition.
The Company currently develops or publishes products for 14
different hardware platforms and has from time to time developed
and marketed products on 32 different and incompatible platforms in
the past. The Company makes substantial investments in research
and development of products for operation on new hardware platforms
which the Company anticipates will become more popular. Such
investment occurs one to two years in advance of shipment of
products on such platforms. If the Company invests in a platform
that does not achieve significant market penetration, the Company's
planned revenues from those products will not be achieved and the
Company may not recover its development investment. Conversely, if
the Company does not choose to develop for a platform that achieves
significant market success, its revenue growth may also be
adversely affected. There can be no assurance that the Company
will correctly make such platform choices.
20
The Company's current and planned product introductions are
predominantly for 32-bit platforms such as the IBM PC and
compatibles, the Apple Macintosh, the 3DO Interactive Multiplayer,
the Sega Saturn and the Sony PlayStation and 16-bit platforms such
as the SNES and the Genesis videogame systems.
The Company anticipates that compact discs will emerge as the
preferred medium for interactive entertainment, education, and
information software for the next several years. The Company has
continued its investment in the development of CD-ROM tools and
technologies and has 85 titles in development for CD-ROM platforms,
including the IBM PC and compatibles, the Apple Macintosh, the 3DO
Interactive Multiplayer, the Sega Saturn and the Sony PlayStation.
Most of these products will be convertible for use on multiple
advanced hardware systems.
Product development schedules, particularly for new hardware
platforms, are difficult to predict because they involve creative
processes, use of new development tools for new platforms and the
learning process associated with development for new technologies,
as well as other factors. Floppy-disk and CD-ROM products
frequently include more content and are more complex,
time-consuming and costly to develop than cartridge products and,
accordingly, cause additional development and scheduling risk. In
addition, these development risks for floppy-disk and CD-ROM
products can cause particular difficulties in predicting quarterly
results because brief manufacturing lead times allow finalization
of products and projected release dates late in a quarter. Failure
to meet product development schedules may cause a shortfall in
shipments in any quarter and may cause the operating results for
such quarter to fall significantly below anticipated levels.
As noted above, one of the advanced 32-bit platforms currently
supported by the Company is the 3DO Interactive Multiplayer. The
Company currently owns approximately 18% of the Common Stock of
3DO. The Company has achieved a leading position in 3DO software
sales and has generated profits from sales of 3DO products in
fiscal 1995 and 1996. However, the Company's 3DO products have not
achieved the sales levels of the Company's Genesis products
primarily because the 3DO Interactive Multiplayer has not achieved
market acceptance comparable to the Genesis and SNES platforms.
The Company believes that its development methods for the 3DO
platform are not materially different from those the Company uses
to develop products for other CD-ROM based platforms and therefore
a substantial portion of its development activities for the 3DO
platform is portable to other platforms. Furthermore, the Company
believes that through its 3DO development efforts it has gained
valuable early experience in developing products for advanced
32-bit platforms. However, there can be no assurance that the 3DO
platform or 3DO as a company will be successful. Because of the
Company's equity stake in and historical association with 3DO, a
material adverse effect on the business or prospects of 3DO or a
substantial adverse change in the stock price of 3DO could have a
material adverse effect on the Company's stock price.
21
Additionally, the Company produces film and videotape to include
in certain products pursuant to agreements between certain of the
company's subsidiaries with SAG, AFTRA and Equity. However, the
costs of video production are significantly higher than for
software production, and for products which include a substantial
amount of video (such as products in the interactive movie
category), the costs of producing the video component is
significantly higher than the cost of developing the software
component, resulting in higher overall development costs for such
products. Accordingly, significantly more units of such products
must be sold to recoup the development and production costs.
Extensive use of video in some of the Company's products,
particularly its products in the interactive movie category, are
experimental product development efforts for the Company and there
can be no assurance that the significantly higher sales levels
required to make these products successful will be achieved.
MARKETING AND DISTRIBUTION
As discussed above, the 16-bit videogame business has become
increasingly "hits" driven, requiring significantly greater
expenditures for advertising, particularly for television
advertising. There can be no assurance that the Company will
continue to produce hit products or that advertising expenditures
will increase sales sufficiently to recoup the advertising
expenditures.
The Company has stock-balancing programs for its personal
computer products (whether provided on floppy-disk or CD-ROM) that,
under certain circumstances and up to a specified amount, allow for
the exchange of personal computer products by resellers. The
Company also typically provides for price protection for its
personal computer and videogame system products that, under certain
conditions, allows the reseller a price reduction from the Company
for unsold products. The Company maintains a policy of exchanging
products or giving credits, but does not give cash refunds. The
risk of price protection requirements is increasing as a result of
the maturing and the increasingly hit-based nature of the 16-bit
video cartridge market. Moreover, the risk of product returns may
increase as new hardware platforms become more popular or market
factors force the Company to make changes in its distribution
system. The Company monitors and manages the volume of its 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. The Company believes that it provides adequate reserves
for returns and price protection which are based on estimated
future returns of products, taking into account promotional
activities, the timing of new product introductions, distributor
and retailer inventories of the Company's products and other
factors, and that its current reserves will be sufficient to meet
return and price protection requirements for the foreseeable
future. However, there can be no assurance that actual returns or
price protection will not exceed the Company's reserves.
22
The distribution channels through which consumer software
products are sold have been characterized by change, including
consolidations and financial difficulties of certain distributors
and retailers and the emergence of new retailers such as general
mass merchandisers. The bankruptcy or other business difficulties
of a distributor or retailer could render Electronic Arts' accounts
receivable from such entity uncollectible, which could have an
adverse effect on the operating results and financial condition of
the Company. In addition, an increasing number of companies are
competing for access to these channels. Electronic Arts'
arrangements with its distributors and retailers may be terminated
by either party at any time without cause. Distributors and
retailers often carry products that compete with those of the
Company. Retailers of Electronic Arts' products typically have a
limited amount of shelf space and promotional resources for which
there is intense competition. There can be no assurance that
distributors and retailers will continue to purchase Electronic
Arts' products or provide Electronic Arts' products with adequate
levels of shelf space and promotional support.
SEASONALITY
The Company's business is highly seasonal. The Company
typically experiences its highest revenues and profits in the
calendar year-end holiday season and a seasonal low in revenues and
profits in the quarter ending in June. The Company expects these
seasonal trends to be magnified through the second quarter of
fiscal 1996 by general economic and industry factors, including the
current transition from 16-bit cartridge-based game machines to the
new 32-bit systems, and the concentration of the Company's product
releases in the second half of the fiscal year.
EMPLOYEES
The Company believes that its ability to attract and retain
qualified employees is an important factor in its growth and
development and that its future success will depend, in large
measure, on its ability to continue to attract and retain qualified
employees. To date, the Company has been successful in recruiting
and retaining sufficient numbers of qualified personnel to conduct
its business successfully. However, competition for employees in
the interactive software business is intense and increasing as
competition in the industry increases and there can be no assurance
that the Company will continue to be able to attract and retain
enough qualified employees in the future. None of the Company's
employees is subject to a collective bargaining agreement, and the
Company believes that its employee relations are excellent.
23
OTHER RISK FACTORS
In addition to those discussed above, the Company's business is
subject to a number of other risks. Some of those risks are
described below. Other risks are presented elsewhere in this
report.
A substantial majority of the total revenue of the Company in
any quarter typically results from orders received in that quarter
and products introduced in that quarter. The Company's expenses
are based, in part, on expected future revenues. Certain overhead
and product development expenses do not vary directly in relation
to revenues. As a result, the Company's quarterly results of
operations are difficult to predict, and small delays in product
deliveries may cause quarterly revenues, operating results and net
income to fall significantly below anticipated levels. The
Company's revenues and net income could also be materially and
adversely affected by cancellation of orders, changes in customer
base or product mix, and increased competition.
The Company typically receives orders shortly before shipments,
making backlog, particularly early in any quarter, an unreliable
indicator of quarterly results. Therefore, quarterly results may
be difficult to predict until the end of the quarter. A shortfall
in shipments at the end of any particular quarter may cause the
results of that quarter to fall significantly short of anticipated
levels. Due to analysts' expectations of continued growth and
other factors, any such shortfall in earnings could have an
immediate and significant adverse effect on the trading price of
the Company's common stock in any given period. As a result of the
foregoing factors and other factors that may arise in the future,
the market price of the Company's common stock may be subject to
significant fluctuations over a short period of time. These
fluctuations may be due to factors specific to the Company, to
changes in analysts' earnings estimates, or to factors affecting
the computer, software, entertainment, media or electronics
industries or the securities markets in general.
Because of the foregoing factors, as well as other factors
affecting the Company's 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.
24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to pending claims. Management, after review
and consultation with counsel, considers that any liability from
the disposition of such lawsuits in the aggregate would not have a
material adverse effect upon the consolidated financial position or
results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Stockholders, held on August 3,
1995, the stockholders elected the following individuals for
one-year terms to the Board of Directors: M. Richard Asher,
William J. Byron, Daniel H. Case III, Gary M. Kusin, Timothy Mott
and Lawrence F. Probst III. These individuals have received a
plurality of the votes eligible to vote, voting either in person or
by proxy.
In addition, the following matters were voted upon by the
Stockholders:
To approve an amendment to the Company's 1991 Stock Option Plan
(the "1991 Plan") to increase the number of shares of the Company's
common stock reserved for issuance under the 1991 Plan by 1,850,000
shares from a total of 8,050,000 shares to a total of 9,900,000
shares.
Votes
--------------------------------------------------------------------
For Against Abstain
--- ------- -------
30,888,089 14,669,574 167,443
To approve an amendment to the Company's Employee Stock Purchase
Plan (the "Purchase Plan") to increase the number of shares of the
Company's common stock reserved for issuance under the Purchase Plan
by 150,000 shares from a total of 900,000 shares to a total of
1,050,000 shares.
Votes
-------------------------------------------------------------------
For Against Abstain
--- ------- -------
43,660,699 1,906,787 157,996
To ratify the appointment of KPMG Peat Marwick LLP as independent
accountants for the Company for the current fiscal year.
Votes
--------------------------------------------------------------------
For Against Abstain
--- ------- -------
45,690,779 71,514 104,715
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The following exhibits are filed as part of this report:
Number Exhibit Title
- ------ -------------
10.01 Commerical Earnest Money Contract between Novell, Inc. and Origin
Systems, Inc. dated April 13, 1995.
10.02 First Amendment to Commercial Earnest Money Contract between
Novell, Inc. and Origin Systems, Inc. dated June 1, 1995.
(b) No reports on Form 8-K were filed by the Registrant during the three
months ended June 30, 1994.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRONIC ARTS INC.
(Registrant)
/s/E. STANTON MCKEE
-------------------
DATED: E. STANTON MCKEE
August 7, 1995 Senior Vice President and
Chief Financial and Administrative Officer
(Duly authorized officer)
27
EXHIBIT INDEX
NUMBER EXHIBIT TITLE PAGE
- ------ ------------- ----
10.01 Commercial Earnest Money Contract between Novell, Inc.
and Origin Systems Inc. dated April 13, 1995. 29
10.02 First Amendment to Commercial Earnest Money Contract
between Novell, Inc. and Origin Systems, Inc. dated
June 1, 1995 53
27.01 Financial Data Schedule 57
28