SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the Fiscal Year Ended March 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ___ to ___
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
209 Redwood Shores Parkway
Redwood City, California 94065
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 628-1500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
(Title of class)
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 ___
Indicated by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Registrant's common stock, $.01 par value,
held by non-affiliates of the Registrant on June 1, 2000 was $2,269,355,144.
As of June 1, 2000 there were 64,638,382 shares of Registrant's common stock,
$.01 par value, outstanding.
Documents Incorporated by Reference
Portions of Registrant's definitive proxy statement (the "Proxy Statement") for
its 2000 Annual Meeting of Stockholders are incorporated by reference into Part
III hereof.
Portions of Registrant's definitive proxy statement for its Notice of Special
Stockholders Meeting and Proxy Statement dated March 22, 2000 are incorporated
by reference into Part I hereof.
This report consists of 80 sequentially numbered pages. The Exhibit Index is
located at sequentially numbered page 80.
Page 1 of 80
ELECTRONIC ARTS INC.
2000 FORM 10-K ANNUAL REPORT
Table of Contents
PAGE
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PART I
Item 1. Business 3
Item 2. Properties 12
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 4A. Executive Officers of the Registrant 14
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters 16
Item 6. Selected Financial Data 17
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 42
Item 8. Financial Statements and Supplementary Data 44
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosures 71
PART III
Item 10. Directors and Executive Officers of the Registrant 72
Item 11. Executive Compensation 72
Item 12. Security Ownership of Certain Beneficial Owners and Management 72
Item 13. Certain Relationships and Related Transactions 72
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 73
Signatures 78
Exhibit Index 80
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PART I
This Annual Report on Form 10-K, including Item 1 ("Business") and Item 7
("Management's Discussion and Analysis of Financial Condition and Results of
Operations"), contains forward-looking statements about circumstances that have
not yet occurred. All statements, trend analysis and other information contained
below relating to markets, our products and trends in revenue, as well as other
statements including words such as "anticipate", "believe" or "expect" and
statements in the future tense are forward-looking statements. These
forward-looking statements are subject to business and economic risks, and
actual events or our actual future results could differ materially from those
set forth in the forward-looking statements due to such risks and uncertainties.
We will not necessarily update this information if any forward looking statement
later turns out to be inaccurate. Risk and uncertainties that may affect our
future results and performance include, but are not limited to those discussed
under the heading "Risk Factors" below at pages 36 to 41.
ITEM 1: BUSINESS
Overview
Electronic Arts was initially incorporated in California in 1982. In
September 1991, we were reincorporated under the laws of Delaware. Our principal
executive offices are located at 209 Redwood Shores Parkway, Redwood City,
California 94065 and our telephone number is (650) 628-1500.
We operate in two principal business segments globally:
o EA Core business segment: creation, marketing and distribution of
entertainment software.
o EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online.
EA Core
We create, market and distribute interactive entertainment software for
a variety of hardware platforms. As of March 31, 2000, our business was
comprised of the following:
o Distribution of over 100 titles that we developed and/or published
under one of our brand names in North America, including older titles
marketed as "Classics" or "Publisher's Choice."
o Distribution of localized versions of our products in the rest of the
world.
o Distribution of approximately 20 additional titles developed by other
software publishers (that we refer to as Affiliated Labels) in North
America and titles we have assisted in the development with other
software publishers (referred to as Co-Published titles).
o Distribution of over 1,000 Affiliated Label and Co-Published titles in
the rest of the world.
Since our inception, we have developed products for 38 different hardware
platforms, including the following:
o IBM(R) PC and compatibles
o 16-bit Sega(TM) Genesis(TM) video game system
o 16-bit Super Nintendo Entertainment System(R)
o 32-bit Sony PlayStation(R)
o 64-bit Nintendo(R) 64
o 128-bit Sony PlayStation 2
Our product development methods and organization are modeled on those used
in the entertainment industry. We also market our products with techniques
borrowed from other entertainment companies such as record producers, magazine
publishers and video distributors. Employees whom we call "producers", who are
responsible for the development of one or more products, oversee product
development and direct teams comprised of both our employees and outside
contractors. Our designers regularly work with celebrities and organizations in
sports, entertainment and other areas to develop products that provide gaming
experiences that are as realistic and interactive as possible. 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, World Championship Wrestling Inc., Football Association Premier
League and Formula One. We maintain development studios in California, Canada,
United Kingdom, Florida, Texas, Japan, Washington, Maryland, Australia and
Nevada.
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We invest in the creation of state-of-the-art software tools and
utilities that are then used in product development. These tools allow for more
cost-effective product development and the ability to more efficiently convert
products from one hardware platform to another. We have also made investments in
facilities and equipment to facilitate the creation and editing of digital forms
of video and audio recordings and product development efforts for new hardware
platforms.
We distribute our products and those of our Affiliated Labels primarily
by direct sales to retail chains and outlets in the United States and Europe. In
Japan and the Asia Pacific region, we distribute products both directly to
retailers and through third party distributors. Our products are available in
over 79,000 retail locations worldwide. In fiscal 2000, approximately 40% of our
net revenues were generated by international operations, compared to 42% in
fiscal 1999 and 43% in fiscal 1998.
EA.com
On March 22, 2000, the stockholders of Electronic Arts voted on and
approved a proposal (the "Tracking Stock Proposal") to authorize the issuance of
a new series of common stock to be designated as Class B common stock ("Tracking
Stock"), intended to reflect the performance of Electronic Arts' online and
e-Commerce division ("EA.com"). As a result of the approval of the Tracking
Stock Proposal, Electronic Arts' existing common stock has been re-classified as
Class A common stock ("Class A Stock") and that stock will reflect the
performance of Electronic Arts' other businesses ("EA Core").
EA.com, a division of Electronic Arts Inc., represents Electronic Arts'
online and e-Commerce business. EA.com's online business includes subscription
revenues collected for Internet game play on our websites, sales of
Internet-based games and sales of Electronic Arts products sold through EA.com
websites. Electronic Arts began development of its initial online product,
Ultima Online during fiscal year 1996. We shipped Ultima Online during fiscal
year 1998, and began development of our online business during the same year.
EA.com's websites include EA.com, individual sites for Electronic Arts' games
and the Games Channel on America Online, which will be launched in the second
half of calendar 2000. Our goal is to be the leading online games site. To date,
the majority of our subscription revenues and packaged goods revenues for
online-only games have been generated by Ultima Online and Ultima Online: The
Second Age, (collectively referred to as Ultima Online). The packaged good
product is sold through our traditional distribution channel to various
retailers. The Ultima Online product is then sold by the retail channel to the
end customer who must sign up for EA.com's online service to enjoy online play
on a month-to-month subscription basis. For a more detailed description of
EA.com's online business, see Appendix IV of the Notice of Special Stockholders
Meeting and Proxy Statement dated March 22, 2000.
Investments and Joint Ventures
Acquisitions
Kesmai Corporation
On February 7, 2000, we acquired Kesmai Corporation (now referred to as
"Kesmai") from News America Corporation ("News Corp") in exchange for
$22,500,000 in cash and approximately 103,000 shares of Electronic Arts'
existing common stock valued at $8,650,000. The transaction was accounted for
under the purchase method. Kesmai(TM) is managed by EA.com and specializes in
the design and development of multiplayer games delivered directly to consumers
over the Internet and is a major provider of game content to the Games Channel
on the AOL service. The issuance of these shares was temporary, pending the
authorization of Class B common stock. Subsequently, on March 22, 2000, Class B
shares were authorized. The Company granted 5 percent of the initial equity
attributable to EA.com to News Corp, adjusting the total common stock
consideration relating to the acquisition by $703,000 to $9,353,000. The Company
has contributed Kesmai to the EA.com division. See note 13 of the Notes to the
Consolidated Financial Statements, included in item 8 hereof.
Westwood Studios
In September 1998, we completed the acquisition of Westwood Studios,
Inc. and certain assets of the Irvine, California-based Virgin Studios
(collectively "Westwood") for approximately $122,688,000 in cash, including
transaction expenses. The transaction was accounted for under the purchase
method. Westwood is best known for its successful PC franchises, Command and
Conquer and Lands of Lore. See note 13 of the Notes to the Consolidated
Financial Statements, included in item 8 hereof.
ABC Software
In July 1998, we acquired ABC Software AG, in Switzerland, and ABC
Software GmbH, in Austria (collectively "ABC"), independent distributors of
entertainment, edutainment and application software, for approximately
$9,466,000 in cash (net of cash
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acquired of $5,099,000) and $570,000 in other consideration. The transaction has
been accounted for under the purchase method. See note 13 of the Notes to the
Consolidated Financial Statements, included in item 8 hereof.
Other Business Combinations
Additionally, during fiscal 2000 and fiscal 1999, we acquired four
software development companies. See note 13 of the Notes to Consolidated
Financial Statements, included in item 8 hereof.
Joint Ventures
In May 1998, Electronic Arts and Square Co., Ltd. ("Square"), a leading
developer and publisher of entertainment software in Japan, completed the
formation of two new joint ventures, in North America and 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 PlayStation titles created by Square. We own a 30% minority
interest in this joint venture while Square owns 70%. Additionally, we have the
exclusive right to distribute in North America products published by this joint
venture.
In Japan, the companies established Electronic Arts Square KK ("EA
Square KK"), which localizes and publishes in Japan our properties originally
created in North America and Europe, as well as develops and publishes original
video games in Japan. We own a 70% majority interest, while Square owns 30%. See
note 13 of the Notes to the Consolidated Financial Statements, included in item
8 hereof.
Investments
We have made investments as part of our overall strategy and currently
hold minority equity interests in several companies. As of March 30, 2000, our
minority equity investments include investments in NovaLogic, Inc. and Firaxis
Software, Inc.
Market
Historically, no hardware platform or video game system has achieved
long-term dominance in the interactive entertainment market. In fiscal 2000,
Sony's PlayStation was the dominant hardware platform in our industry. In
addition, the installed base of multimedia-enabled home computers, including
those with Internet accessibility, has continued to grow as personal computer,
or PC, prices have declined and the quality and choices of software have
increased dramatically. We develop and publish products for multiple platforms,
and this diversification continues to be a cornerstone of our strategy.
The following table details select information on a sample of the
hardware platforms for which we have published titles:
- ------------------------------------------------------------------------------------------------------------------------------------
Video Game Console / Date Introduced Medium/
Manufacturer Platform Name in North America Product Base Technology
- ------------------------ -------------------------------------------- ----------------------- --------------------- ----------------
Sega Genesis 1989 Cartridge 16-bit
Nintendo Super NES(TM) 1991 Cartridge 16-bit
Matsushita 3DO(TM)Interactive Multiplayer(TM) 1993 Compact Disk 32-bit
Sega Saturn 1995 Compact Disk 32-bit
Sony PlayStation 1995 Compact Disk 32-bit
Nintendo Nintendo 64 1996 Cartridge 64-bit
- ------------------------------------------------------------------------------------------------------------------------------------
Sega
Sega launched DreamcastTM in Japan in December 1998 and in North
America in September 1999. Sega designed Dreamcast to combine features from the
console and PC platforms. We currently have no products in development for the
Sega Dreamcast. See Risk Factors - "New video game platforms create additional
technical and business model uncertainties".
Sony
Sony released the PlayStation 2 console in Japan in March 2000. Sony
has announced the release of the PlayStation 2 console in the United States and
Europe in the fall of 2000. The PlayStation 2 console is a 128-bit, Digital
Versatile Disk ("DVD") based system that is Internet and cable ready, as well as
backward compatible with the current PlayStation console software. We currently
have various products under development for the Sony PlayStation 2 console. See
Risk Factors - "New video game platforms create additional technical and
business model uncertainties".
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Nintendo
Nintendo announced that it will release a next generation system, code
named Dolphin, in the first half of 2001. Dolphin will offer a DVD drive.
Microsoft
Microsoft announced that it expects to release its first video game
system, code named Xbox(TM), in the fall of 2001.
New Entrants
New entrants into the interactive entertainment and multimedia
industries, such as cable television, telephone, and diversified media and
entertainment companies, in addition to a proliferation of new technologies,
such as online networks and the Internet, have increased the competition in our
markets. We are scheduled to release several online network gaming products
during fiscal 2001. See Risk Factors - "New video game platforms create
additional technical and business model uncertainties" and "The impact of
e-Commerce and online games on our business is not known ".
The early investment in products for the 32-bit market, including both
Compact Disk personal computer (or PC) and dedicated entertainment systems (that
we call video game systems or consoles), has been strategically important in
positioning us for the current generation of 32-bit and 64-bit machines. We
believe that such investment continues to be important. PlayStation has achieved
significant market acceptance in all geographical territories. However, as the
PlayStation console market has matured and the next generation consoles are
introduced, we expect sales of current PlayStation products to decline. In
addition, our revenues and earnings are dependent on our ability to meet our
product release schedule and our failure to meet those schedules could result in
revenues and earnings which fall short of analysts' expectations in any
individual quarter. See Risk Factors - "Product development schedules are
frequently unreliable and make predicting quarterly results difficult".
Online Games
According to the market research firm, Jupiter Communications, online
gamers (defined as individuals who have played online games within the past
year) are expected to grow to 26.8 million Internet users by 2002 up from 3.7
million Internet users in 1998. Jupiter expects total online gaming market
revenue to grow to $2 billion by 2002. We believe the expected increases in
online gaming will be primarily attributable to the following factors:
o Increasing popularity of PC gaming,
o Growing interest in multiplayer games,
o Growth in the number of households with PCs and Internet connections,
o General growth in internet usage, including the number of users,
communities and increased frequency of use by consumers,
o Rapid innovation of new online entertainment experiences,
o Mass market adoption of broadband technologies, and
o Decreasing costs of Internet access.
Competition
EA Core
See Risk Factors - "Our platform licensors are our chief competitors
and frequently control the manufacturing of our video game products".
EA.com
We believe EA.com faces substantial competition from a number of existing and
potential competitors including:
o Console & PC Game Publishers. Other game publishers including Sony
Computer Entertainment of America ("Sony"), Nintendo, Sega, Hasbro,
Mattel, Acclaim, Havas, Microsoft, Interplay, Infogrames and Eidos, are
each developing individual online games and games with online
components. Currently, Sony (including the online divisions of Sony
Entertainment) may have the broadest collection of online game
offerings, which includes the online game, Everquest, a virtual world
that directly competes with EA.com's Ultima Online game. In addition,
Sony operates the Sony Station, a site that offers family-oriented game
shows. Each of these competitors may compete with EA.com for
advertising, subscription and e-Commerce sales.
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o Portals. With respect to advertising and e-Commerce sales, EA.com will
also compete with general purpose consumer web sites such as Yahoo,
Excite, Lycos, and Microsoft Network. In addition, many of these
Internet portals offer gaming sites such as Yahoo Games Channel, Excite
Games Channel, Lycos Games Channel, and Microsoft Gaming Zone. Although
most of the game areas of these portals have attained modest reach,
their key placement on powerful portals makes them potentially
significant competitors for gaming subscriptions as well.
o Family Oriented Game Sites. A number of sites such as Uproar.com,
Gamesville.com, Disney's go.com, Shockwave.com and Pogo.com (formerly
TEN), have driven significant amounts of traffic to their sites by
offering unique games and entertainment content. In addition, several
of the sites offer frequent prizes with easy to play "gamettes". These
sites are typically monetizing their traffic by selling advertising.
o Aggregators. Aggregators such as Hearme.com, Pogo.coom, Microsoft
Gaming Zone and Heat.net, provide an aggregation of various types of
online games, including aggregation of games developed by independent
third parties. While these sites have been primarily focused on serving
the gaming community, they have since adjusted their strategy to
include games, such as parlor games, that reach a broader audience.
o Sports Sites. Sports content sites such as ESPN.com, Sportsline.com and
Foxsports.com typically feature fantasy league games and easy to play
sports "gamettes" in addition to their editorial content. Such fantasy
league games and sports "gamettes" typically appeal to the overall
sports fan, rather than the sports gamer. However, these sites have
significant financial and content resources at their disposal and will
provide competition for advertising and e-Commerce sales.
o Microsoft Gaming Zone ("MGZ"). Microsoft falls into a number of the
foregoing categories, as it is a portal, an aggregator, and a publisher
of PC Software Products, including game products. As such, Microsoft's
offerings are the closest parallel to the proposed offerings of EA.com.
MGZ currently offers both family games and games directed towards the
more serious gamer and, at the same time, has the opportunity to
leverage these experiences with games sold at retail. At present, MGZ
offers matchmaking for about 80 games and offers approximately 20
playable online games, which consist primarily of card and parlor
games.
Relationships with Significant Hardware Platform Companies
Sony
In fiscal 2000, approximately 41% of our net revenues were derived from
sales of software for the PlayStation compared to 43% in fiscal 1999. During
fiscal 2000, we released 30 PlayStation games compared to 21 in fiscal 1999.
Among these releases were FIFA 2000, Tomorrow Never Dies, Madden NFL 2000, NBA
2000 and Knockout Kings(TM) 2000. The volume of sales of our PlayStation
products significantly increased in fiscal 2000 due to more titles being
released in the current fiscal year compared to the prior year. Sony has
announced the release of the PlayStation 2 console in the United States and
Europe in the fall of 2000. Although our PlayStation products will be playable
on the PlayStation 2 console, we expect sales of current PlayStation products to
decline in fiscal 2001. See Risk Factors - "Product development schedules are
frequently unreliable and make predicting quarterly results difficult".
Under the terms of a licensing agreement entered into with Sony
Computer Entertainment of America in July 1994 (the "Sony Agreement"), as
amended, we are authorized to develop and distribute CD-based software products
compatible with the PlayStation. Pursuant to the Sony Agreement, we engage Sony
to supply its PlayStation CDs for distribution by us. Accordingly, we have
limited ability to control our supply of PlayStation CD products or the timing
of their delivery. See Risk Factors - "Our platform licensors are our chief
competitors and frequently control the manufacturing of our video game
products".
Nintendo
During fiscal 2000, we released eight titles for the N64(R) compared to
nine titles in fiscal 1999. In fiscal 2000, approximately 8% of our net revenues
were derived from the sale of N64 products compared to 12% in 1999. The decrease
in N64 revenues for fiscal 2000 compared to the same period last year was due to
the weak market for N64 products as well as strong comparisons of World Cup 98
in the prior year. We expect revenues from N64 products to continue to decline
significantly in fiscal 2001.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture
our N64 cartridges for distribution by us. Accordingly, we have limited 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.
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In connection with our purchases of N64 cartridges for distribution in
North America, Nintendo requires us to provide irrevocable letters of credit
prior to Nintendo's acceptance of purchase orders from us for purchases of these
cartridges. For purchases of N64 cartridges for distribution in Japan and
Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo
maintains a policy of not accepting returns of N64 cartridges. Because of these
and other factors, the carrying of an inventory of cartridges entails
significant capital and risk. See Risk Factors - "Our platform licensors are our
chief competitors and frequently control the manufacturing of our video game
products".
Relationships with Internet Service Providers
America Online, Inc. ("AOL")
Our agreement with AOL establishes the basis for EA.com's creation of a
games site on the world wide web that will be available to AOL subscribers via
the Games Channel on the AOL's flagship ISP service and to other consumers who
use other AOL portals (AOL.com, CompuServe, Netscape/Netcenter, ICQ and Digital
City) as their base for navigating the web. Users will also be able to access
the EA.com website directly from the world wide web. EA.com will be AOL's
exclusive provider of a broad aggregation of online games and will program and
manage all of the Games Channel content within AOL's flagship ISP service in the
United States. In addition, EA.com will program and manage the game channels on
AOL.com, CompuServe, Netcenter/Netscape and ICQ. Within any of these AOL
properties, users will be able to find a games channel or area which will
provide the user access to EA.com games. According to the April 2000 Media
Metrix reports, the total number of unique monthly visitors to the AOL branded
properties that will have access to the EA.com games site was 53 million. Via an
anchor tenant location, EA.com will also be a non-exclusive provider of games on
AOL's Digital City property, the leading branded local content network and
community guide on the AOL service and the Internet. For the terms of the AOL
agreement, see Note 5 of the Notes to Consolidated Financial Statements,
included in item 8 hereof.
Products and Product Development
In fiscal 2000, we generated approximately 56% of our revenues from
products released during the year. See Risk Factors - "Product development
schedules are frequently unreliable and make predicting quarterly results
difficult". As of March 31, 2000, we were actively marketing over 100 titles,
comprising over 150 stock keeping units, or sku's, that were published by our
development divisions and subsidiaries, EA Studios. During fiscal 2000, we
introduced over 48 EA Studios titles, representing over 69 sku's, compared to 38
EA Studios titles, comprising over 59 sku's, in fiscal 1999.
The products published by EA Studios are designed and created by our
in-house designers and artists and by independent software developers
("independent artists"). We typically pay the independent artists royalties
based on the sales of the specific products, as defined in the related
independent artist agreements.
For fiscal 2000, 1999 and 1998, no title represented revenues greater
than 10% of the total fiscal 2000, 1999 and 1998 net revenues.
We publish products in a number of categories such as sports, action
and interactive movies, strategy, simulations, role playing and adventure, each
of which is becoming increasingly competitive. Our sports-related products,
marketed under the EA Sports brand name, accounted for a significant percentage
of net revenues in fiscal years 2000 and 1999. There can be no assurance that we
will be able to maintain our market share in the sports category.
The front line retail selling prices in North America of our products,
excluding older titles (marketed as "Classics" and "Publisher's Choice"),
typically range from $35.00 to $55.00. "Classics" and "Publisher's Choice"
titles have retail selling prices that range from $10.00 to $30.00. The retail
selling prices of EA titles outside of North America vary based on local market
conditions.
We currently develop or publish products for five different hardware
platforms. In fiscal 2000, our product releases were predominantly for
PlayStation, PC and N64. Our planned product introductions for fiscal 2001 are
predominantly for the PC, PlayStation, PlayStation 2, online Internet play and
N64. See Risk Factors - "Product development schedules are frequently unreliable
and make predicting quarterly results difficult" and "New video game platforms
create additional technical and business model uncertainties".
Compact disks are the preferred medium for interactive entertainment,
education, and information software, therefore, we are continuing our investment
in the development of CD-ROM tools and technologies in fiscal 2001. We are also
investing in the development of DVD tools and technologies associated with the
introduction of the next generation video game console platforms. Our goal is to
be the market leader on the next generation of video game consoles. We are also
increasing the investment in the development of tools and technologies for
online Internet game play and wide-area network infrastructure. Our goal is to
be the leading provider of interactive entertainment on the Internet.
PlayStation has achieved significant market acceptance in all geographic
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territories, however, as the PlayStation console market has reached maturity, we
expect sales of current PlayStation products to decline in fiscal 2001. Most of
the console video game products will be convertible for use on multiple advanced
hardware systems. We had research and development expenditures of $260.8 million
in fiscal 2000, $199.1 million in fiscal 1999, and $145.7 million in fiscal
1998. See Risk Factors - "Product development schedules are frequently
unreliable and make predicting quarterly results difficult".
EA.com Web Site
Content. EA.com intends to offer games within three broad categories of
interest: sports, family entertainment, and avid gaming. Each channel will focus
on targeting and serving its specific consumer group by:
o Offering engaging and accessible online games;
o Building a community in which consumers can interact with one another
via chat, bulletin boards, events, and match-making services for
multi-player games and other contests;
o Delivering innovative content that continually entertains; and
o Establishing a direct relationship with each audience member through
personalization and customization of user experiences.
In addition, the product offering of each broad category will include
existing Electronic Arts franchises adapted for game play on the Internet, as
well as additional original games for online play. EA.com's products will be
offered to consumers within the appropriate "channels" on the site. It is
anticipated that the offerings will incorporate some or all of the following:
o Sports. EA.com intends to leverage existing Electronic Arts'
franchises, such as PGA(R) Tour/Tiger Woods Golf(R) and Knockout
Kings(TM), to develop a community of sports gamers. In addition, EA.com
will offer unique, original online sports gaming experiences, sports
game shows and support of existing EA packaged goods products with
services such as matchmaking, game updates, product downloads and game
tips.
o Family Entertainment. The EA.com family games offering will consist of
card games, board games, casino games, trivia games, game shows and
other products with mass-market appeal. This channel will leverage cash
prizes, merchandise prizes, tournaments and community.
o Avid Gaming. The general gaming offering will be directed at teens and
adults looking to participate in games made up of fantastic worlds,
characters, adventures or activities--big or small, real or imagined.
This offering will feature immersive experiences and sophisticated game
play appealing to dedicated gamers, as well as new forms of
cutting-edge Internet entertainment. This offering will capitalize on
the success of our existing Ultima Online product as well as Electronic
Arts' existing packaged goods franchises.
Marketing and Distribution
Electronic Arts Distribution
We distribute EA Studio, Affiliated Label and Co-Published products.
Affiliated Label products are delivered to us as completed products.
Co-Published products are titles we have assisted in developing with other
software publishers. As of March 31, 2000, we distributed approximately 20
Affiliated Label and Co-Published titles in North America and over 1,000
Affiliated Label and Co-Published titles in the rest of the world. No single
Affiliated Label Publisher has accounted for more than 10% of our net revenue in
any of the last three fiscal years.
In May 1998, Electronic Arts and Square Co., Ltd. formed a new joint
venture in North America, creating Square Electronic Arts, LLC ("Square EA") as
discussed in note 13 in the Notes to the Consolidated Financial Statements,
included in item 8 hereof. In conjunction with the formation of this joint
venture, we have the exclusive right in North America to distribute products
published by this joint venture. In fiscal 2000, Square EA published Final
Fantasy VIII for the PlayStation, which was a top five selling title for
Electronic Arts.
We generated approximately 90% of our North American net revenues from
direct sales to retailers through a field sales organization of professionals
and a group of telephone sales representatives. The remaining 10% of our North
American sales were made through a limited number of specialized and regional
distributors and rack jobbers in markets where we believe direct sales would not
be economical. For the fiscal years ended March 31, 2000 and March 31, 1999, we
had sales to one customer, Wal-Mart Stores, Inc., which represented 12% of total
net revenues. We had no sales to any one customer in excess of 10% of total net
revenues for the fiscal year ended March 31, 1998.
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The video game and PC businesses have become increasingly "hits"
driven, requiring significantly greater expenditures for marketing and
advertising, particularly for television advertising. There can be no assurance
that we will continue to produce "hit" titles, or that advertising for any
product will increase sales sufficiently to recoup those advertising expenses.
We 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 also typically provide
for price protection for our personal computer and video game system products
that, under certain conditions, allows the reseller a price reduction from us
for unsold products. We maintain a policy of exchanging products or giving
credits, but do not give cash refunds. Moreover, the risk of product returns may
increase as new hardware platforms become more popular or market factors force
us to make changes in our distribution system. We monitor and manage 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. We believe
that we provide 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 our products and other factors. We believe our current reserves
will be sufficient to meet return and price protection requirements for current
in-channel inventory. However, there can be no assurance that actual returns or
price protection will not exceed our reserves.
We also have a fulfillment group that sells product directly to
consumers through a toll-free number and through our websites listed in
advertising by us and our Affiliated Labels. This group is also responsible for
targeted direct mail marketing and sells product backups and accessories to
registered customers.
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 development of remote and
electronic delivery systems will create further changes. The bankruptcy or other
business difficulties of a distributor or retailer could render our accounts
receivable from such entity uncollectible, which could have an adverse effect on
our operating results and financial condition. In addition, an increasing number
of companies are competing for access to these channels. Our arrangements with
our distributors and retailers may be terminated by either party at any time
without cause. Distributors and retailers often carry products that compete with
ours. Retailers of our 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 our
products or provide our products with adequate levels of shelf space and
promotional support.
Segment Reporting
As a result of the approval of the Tracking Stock proposal to authorize issuance
of a new series of common stock designated as Class B common stock, intended to
reflect the performance of EA.com, management considers EA.com a separate
reportable segment. Accordingly, prior period information has been restated to
disclose separate segments. The Company operates in two principal business
segments globally:
o EA Core business segment: creation, marketing and distribution of
entertainment software.
o EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online.
Please see the discussion regarding segment reporting in the MD&A and Note 18 of
the Notes to Consolidated Financial Statements.
International Operations
We have wholly owned subsidiaries throughout the world, including
offices in the United Kingdom, France, Spain, Germany, Australia, Canada, South
Africa, Singapore, Sweden, Japan, Malaysia, Brazil and Holland. The amounts of
net revenues, operating profit and identifiable assets attributable to each of
our geographic regions for each of the last three fiscal years are set forth in
Note 18 of the Notes to the Consolidated Financial Statements, included in item
8 hereof.
International net revenues increased by 11% to $573,374,000, or 40% of
consolidated fiscal 2000 net revenues, compared to $516,865,000, or 42% of
consolidated fiscal 1999 net revenues due to the following:
o Europe's net revenues increased by 11% primarily due to an increase in
sales of PC titles including Command and Conquer: Tiberian Sun, Sim
City 3000 and The Sims as well as an increase in PlayStation revenues
due to the success of FIFA 2000,
10
Tomorrow Never Dies and F1 2000. These increases were partially offset
by an expected decline in sales of N64 products. Overall European
revenues were adversely impacted by a devaluation of the Euro compared
to the same period last year.
o Asia Pacific's net revenues increased 20% due to PC sales of Command
and Conquer: Tiberian Sun and Sim City 3000.
o Japan's net revenues were flat compared to the prior year. PC and
Affiliated Label revenues increased, offset by a decrease in
PlayStation product sales primarily due to strong sales of FIFA: Road
to World Cup and World Cup 98 in the prior year.
Though international revenues are expected to grow in fiscal 2001,
international revenues may not grow at as high a rate as in prior years. See
Risk Factors - "Our business, our products, and our distribution are subject to
increasing regulation in key territories" and "Foreign Sales and Currency
Fluctuations".
Manufacturing and Suppliers
Materials
In many instances, we are able to acquire materials on a
volume-discount basis. We have multiple potential sources of supply for most
materials, except with respect to our PlayStation and N64 products, as
previously mentioned. We also have alternate sources for the manufacture and
assembly of most of our products. To date, we have not experienced any material
difficulties or delays in production of our software and related documentation
and packaging. However, a shortage of components or other factors beyond our
control could impair our ability to manufacture, or have manufactured, our
products. See Risk Factors - "Our platform licensors are our chief competitors
and frequently control the manufacturing of our video game products".
Consultants
As of March 31, 2000, approximately 25% of the staff creating,
designing and developing the infrastructure of EA.com's website and network
interface is being provided by outside consultants such as Andersen Consulting
and Proxicom. See Risk Factors - "If we do not maintain our relationship with
outside consultants such as Andersen Consulting and Proxicom, our ability to
develop our online business will be impaired".
Backlog
We normally ship products within a few days after receipt of an order.
However, a backlog may occur for EA Studio and Affiliated Label products that
have been announced for release but not yet shipped. We do not consider backlog
to be an indicator of future performance.
Seasonality
Our business is highly seasonal. We typically experience our 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. In our 2001 fiscal year,
and particularly in the June and September quarters, we expect these seasonal
trends to be magnified by general industry factors, including the current
platform transition and the concentration of our product releases in the second
half of fiscal 2001. In addition, we are continuing to invest significantly in
our online operation, EA.com. Accordingly, we expect significant operating
losses in the first half of fiscal 2001. See Risk Factors - "Platform
transitions such as the one now occurring typically depress the market for video
game software until new platforms achieve a wide market acceptance" and "Our
business is both seasonal and cyclical".
Employees
As of March 31, 2000, we employed approximately 3,100 people, of whom
over 1,300 were outside the United States. Of this amount, there were
approximately 300 EA.com full-time employees. We believe that our ability to
attract and retain qualified employees is an important factor in our growth and
development and that our future success will depend, in large measure, on our
ability to continue to attract and retain qualified employees. To date, we have
been successful in recruiting and retaining sufficient numbers of qualified
personnel to conduct our business successfully. See Risk Factors - "We face
intense competition for talent from highly valued Internet companies" and
"Because of the intense competition for qualified technical, creative, marketing
and other personnel, we may not be able to attract and retain the personnel
necessary for our business".
11
ITEM 2: PROPERTIES
Our principal administrative, sales and marketing, research and
development, and support facility is located in two modern buildings in Redwood
City, California, 20 miles south of San Francisco. We moved into this facility
in October 1998. We presently occupy approximately 350,000 sq. ft. in these
buildings under an operating lease for the buildings and certain adjoining land
that will expire on December 1, 2001. Monthly lease payments vary based upon the
London InterBank Offered Rate. We have the option to purchase the property for
the unamortized financed balance at any time after the non-cancelable lease
term, or we may terminate the lease at any time after the non-cancelable term by
arranging a third party sale or by making a termination payment. In April 1999,
we exercised our option to purchase a parcel of land under the lease and sold it
to a third party. The proceeds will mitigate a portion of the occupancy costs
for this facility. Should we elect to terminate the lease, we will guarantee a
residual value of up to 85% of the unamortized value of the property. As part of
the agreement, we must also comply with certain financial covenants.
Our North American distribution is supported by a newly centralized and
expanded warehouse facility in Louisville, Kentucky occupying 250,000 sq. ft.
The Hayward distribution center was closed in fiscal 2001 in conjunction with
the expansion of our Louisville, Kentucky facility. We also occupy sales offices
in the metropolitan areas of Toronto, Chicago, Dallas and New York.
In addition to our Redwood City development studio, we own a 206,000
sq. ft. development facility in Burnaby, British Columbia, Canada and rent a
33,000 sq. ft. facility in Seattle, Washington. The move to the new Canadian
offices was completed in June 1999. We also own a 180,000 sq. ft. development
facility in Austin, Texas, and lease development facilities in Walnut Creek and
Carlsbad, California and Charlottesville, Virginia.
We own a 101,000 sq.ft. administrative and sales facility in Chertsey,
England, which our United Kingdom subsidiary moved into in March 2000. In
Europe, we also lease a distribution hub in Heerlen, Holland and an
administrative and sales facilities in Germany, as well as sales and
distribution facilities in: Madrid, Spain; Johannesburg, South Africa; and
Sennwald Switzerland. Additionally, we have sales and administrative offices
throughout Europe.
In Asia and the South Pacific, we maintain a 5,500 sq. ft. sales and
distribution facility in Brisbane, Australia. We also have sales and
distribution facilities in Singapore, Malaysia and Taiwan, and representative
offices in Beijing, Hong Kong and Shanghai, China. We also maintain a 27,000 sq.
ft. sales and development office in Tokyo, Japan. See Notes 4 and 11 of the
Notes to the Consolidated Financial Statements, included in Item 8 hereof.
We believe that these facilities are adequate for our current needs. We
believe that suitable additional or substitute space will be available as needed
to accommodate our future needs.
12
ITEM 3: LEGAL PROCEEDINGS
We are subject to pending claims and litigation. Management, after
review and consultation with counsel, considers that any liability from the
disposition of such lawsuits would not have a material adverse effect upon our
consolidated financial condition or results of operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Special Meeting of Stockholders, held on March 22,
2000, the following matters were voted upon by the Stockholders:
Amendment and Restatement of the Certificate of Incorporation (Tracking Stock
Proposal).
Votes
-----------------------------------------------------------------------
For Against Abstain
---------- --------- ---------
44,913,392 1,053,403 6,989,594
To approve Electronic Arts Inc. 2000 Class B Equity Incentive Plan.
Votes
-----------------------------------------------------------------------
For Against Abstain
---------- --------- ---------
30,491,221 15,829,074 6,636,094
To approve Electronic Arts Inc. 2000 Class A Equity Incentive Plan.
Votes
-----------------------------------------------------------------------
For Against Abstain
---------- --------- ---------
36,883,249 16,044,180 28,960
13
ITEM 4A: EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the executive
officers of Electronic Arts, who are chosen by and serve at the discretion of
the Board of Directors:
Name Age Position
---- --- --------
Lawrence F. Probst III 50 Chairman and Chief Executive
Officer
Don A. Mattrick 36 President, Worldwide Studios
John S. Riccitiello 40 President and Chief Operating
Officer
William B. Gordon 50 Executive Vice President and
Chief Creative Officer
E. Stanton McKee, Jr. 55 Executive Vice President and
Chief Financial and
Administrative Officer
Nancy L. Smith 47 Executive Vice President and
General Manager, North
American Publishing
Ruth A. Kennedy 45 Senior Vice President, General
Counsel and Secretary
J. Russell Rueff, Jr. 38 Senior Vice President, Human
Resources
David L. Carbone 49 Vice President, Finance
Mr. Probst has been a director of Electronic Arts since January 1991
and currently serves as Chairman and Chief Executive Officer. He was elected as
Chairman in July 1994. Mr. Probst has previously served as President of
Electronic Arts; as Senior Vice President of EA Distribution, Electronic Arts'
distribution division, from January 1987 to January 1991; and from September
1984, when he joined Electronic Arts, until December 1986, served as Vice
President of Sales. Mr. Probst holds a B.S. degree from the University of
Delaware.
Mr. Mattrick has served as President of Worldwide Studios since
September 1997. Prior to this, he served as Executive Vice President, North
American Studios, since October 1996. From July 1991 to October 1996, he served
as Senior Vice President, North American Studios, Vice President of Electronic
Arts and Executive Vice President/General Manager for EA Canada. Mr. Mattrick
was founder and former chairman of Distinctive Software Inc. from 1982 until it
was acquired by us in 1991.
Mr. Riccitiello has served as President and Chief Operating Officer
since October 1997. Prior to joining Electronic Arts, Mr. Riccitiello served as
President and Chief Executive Officer of the worldwide bakery division at Sara
Lee Corporation. Before joining Sara Lee, he served as President and CEO of
Wilson Sporting Goods Co. and has also held executive management positions at
Haagen-Dazs, PepsiCo, Inc. and The Clorox Company. Mr. Riccitiello holds a
degree in Economics and Marketing from the University of California, Berkeley.
Mr. Gordon has served as Executive Vice President and Chief Creative
Officer since March 1998. Prior to this, he served as Executive Vice President,
Marketing since October 1995. From August 1993 to October 1995, he served as
Executive Vice President of EA Studios and as Senior Vice President of
Entertainment Production since February 1992. He also served as Senior Vice
President of Marketing, as General Manager of EA Studios, as Vice President of
Marketing, as Director of Advertising and as Vice President of our former
entertainment division while employed by us. Mr. Gordon holds a B.A. degree from
Yale University and an M.B.A. degree from Stanford University.
Mr. McKee joined Electronic Arts in March 1989 and is currently
Executive Vice President and Chief Financial and Administrative Officer. Prior
to October 1996, he served as Senior Vice President and Chief Financial and
Administrative Officer. Mr. McKee holds B.A. and M.B.A. degrees from Stanford
University and is also a Certified Public Accountant.
Ms. Smith has served as Executive Vice President and General Manager,
North American Publishing since March 1998. Prior to this, she served as
Executive Vice President, North American Sales since October 1996. She
previously held the position of
14
Senior Vice President of North American Sales and Distribution from July 1993 to
October 1996 and as Vice President of Sales from 1988 to 1993. Ms. Smith has
also served as Western Regional Sales Manager and National Sales Manager since
she joined Electronic Arts in 1984. Ms. Smith holds a B.S. degree in management
and organizational behavior from the University of San Francisco.
Ms. Kennedy has been employed by Electronic Arts since February 1990.
She served as Corporate Counsel until March 1991 and is currently Senior Vice
President, General Counsel and Secretary. Prior to October 1996, she served as
Vice President, General Counsel and Secretary. Ms. Kennedy was elected Secretary
in September 1994. Ms. Kennedy is a member of the State Bars of California and
New York and received her B.A. degree from William Smith College and her Juris
Doctor from the State University of New York.
Mr. Rueff has served as Senior Vice President of Human Resources since
October of 1998. Prior to joining Electronic Arts, Mr. Rueff held various
positions with the PepsiCo companies for over 10 years, including: Vice
President, International Human Resources; Vice President, Staffing and
Resourcing at Pepsi-Cola International; Vice President, Restaurant Human
Resources for Pizza Hut; and also various other management positions within the
Frito-Lay Company. Mr. Rueff holds a M.S. degree in Counseling and a B.A. degree
in Radio and Television from Purdue University in Indiana.
Mr. Carbone has been with Electronic Arts since February 1991 as Vice
President, Finance. He was elected Assistant Secretary of the Company in March
1991. Mr. Carbone holds a B.S. degree in accounting from King's College and is a
Certified Public Accountant.
15
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is traded on the National Market under the symbol "ERTS". The
following table sets forth the quarterly high and low closing sales prices of
our Common Stock from April 1, 1998 through March 31, 2000. Such prices
represent prices between dealers and does not include retail mark-ups,
mark-downs or commissions and may not represent actual transactions.
Closing Sales Prices
-------------------------
High Low
---------- ---------
Fiscal Year Ended March 31, 1999:
First Quarter $ 54.81 $ 41.63
Second Quarter 55.56 38.13
Third Quarter 56.00 33.88
Fourth Quarter 52.19 38.25
Fiscal Year Ended March 31, 2000:
First Quarter $ 54.81 $ 45.63
Second Quarter 76.19 52.88
Third Quarter 120.94 66.44
Fourth Quarter 102.19 69.00
There were approximately 2000 holders of record of our Common Stock as of June
1, 2000. We believe that a significant number of beneficial owners of our Common
Stock hold their shares in street names.
Dividend Policy
We have not paid any cash dividends and do not anticipate paying cash
dividends in the foreseeable future.
16
ITEM 6: SELECTED FINANCIAL DATA
ELECTRONIC ARTS AND SUBSIDIARIES
SELECTED FIVE-YEAR FINANCIAL DATA
Years Ended March 31 (In thousands, except per share data)
INCOME STATEMENT DATA 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 1,420,011 $ 1,221,863 $ 908,852 $ 673,028 $ 587,299
Cost of goods sold 705,808 627,823 481,233 328,943 291,491
------------------------------------------------------------------------------
Gross profit 714,203 594,040 427,619 344,085 295,808
Operating expenses:
Marketing and sales 188,628 163,407 128,308 102,072 85,771
General and administrative 92,502 76,219 57,838 48,489 37,711
Research and development 260,759 199,141 145,732 130,755 108,043
Charge for acquired in-process technology 6,539 44,115 1,500 -- 2,232
Merger costs -- -- 10,792 -- --
Amortization of intangibles 11,989 5,880 -- -- --
------------------------------------------------------------------------------
Total operating expenses 560,417 488,762 344,170 281,316 233,757
------------------------------------------------------------------------------
Operating income 153,786 105,278 83,449 62,769 62,051
Interest and other income, net 16,028 13,180 24,811 13,279 7,514
------------------------------------------------------------------------------
Income before provision for income taxes and
minority interest 169,814 118,458 108,260 76,048 69,565
Provision for income taxes 52,642 45,414 35,726 26,003 22,584
------------------------------------------------------------------------------
Income before minority interest 117,172 73,044 72,534 50,045 46,981
Minority interest in consolidated
joint venture (421) (172) 28 1,282 (304)
------------------------------------------------------------------------------
Net income $ 116,751(a) $ 72,872(b) $ 72,562(c) $ 51,327 $ 46,677(d)
------------------------------------------------------------------------------
Net income per share amounts:
Basic $ 1.86(a) $ 1.20(b) $ 1.23(c) $ 0.89 $ 0.84(d)
Diluted $ 1.76(a) $ 1.15(b) $ 1.19(c) $ 0.86 $ 0.80(d)
Number of shares used in computation:
Basic 62,830 60,748 58,867 57,544 55,685
Diluted 66,371 63,272 60,958 59,557 58,190
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA AT FISCAL YEAR END
- ------------------------------------------------------------------------------------------------------------------------------------
Cash, cash equivalents and short-term
investments $ 339,804 $ 312,822 $ 374,560 $ 268,141 $ 190,873
Marketable securities 236 4,884 3,721 5,548 37,869
Working capital 440,021 333,256 408,098 284,863 247,001
Long-term investments 8,400 18,400 24,200 34,478 30,319
Total assets 1,192,312 901,873 745,681 584,041 489,496
Total liabilities 265,302 236,209 181,713 136,237 108,668
Minority interest 3,617 2,733 -- 28 1,277
Total stockholders' equity 923,393 662,931 563,968 447,776 379,551
Note: The selected five-year financial data has been restated to reflect the
acquisition of Maxis, Inc. which was accounted for as a pooling of interest.
<FN>
(a) Net income and net income per share include one-time acquisition related
charges of $4.5 million, net of taxes, incurred in connection with the
acquisition of Kesmai and other business combinations made during the year
as well as goodwill amortization of $8.3 million, net of taxes.
(b) Net income and net income per share include one-time acquisition related
charges of $37.5 million, net of taxes, incurred in connection with the
acquisition of Westwood Studios and other business combinations made during
the year as well as goodwill amortization of $4.0 million, net of taxes.
(c) Net income and net income per share include one-time acquisition related
charges of $1.0 million, net of taxes, incurred in connection with the
acquisition of the remaining minority ownership interest in Electronic Arts
Victor, Inc. as well as merger costs of $7.2 million, net of taxes,
associated with the merger with Maxis, offset by a one-time gain on sale of
Creative Wonders, LLC in the amount of $8.5 million, net of taxes.
(d) Net income and net income per share include one-time acquisition related
charges of $1.5 million, net of taxes, incurred in connection with the
acquisition of Cinematronics LLC made by Maxis prior to the Maxis merger
with Electronic Arts.
</FN>
Please refer to Management's Discussion and Analysis of Financial Condition and
Results of Operations for discussions of EA Core and EA.com proforma financial
statements.
17
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements about circumstances
that have not yet occurred. All statements, trend analysis and other information
contained below relating to markets, our products and trends in revenue, as well
as other statements including words such as "anticipate", "believe" or "expect"
and statements in the future tense are forward-looking statements. These
forward-looking statements are subject to business and economic risks and actual
events or our actual future results could differ materially from those set forth
in the forward-looking statements due to such risks and uncertainties. We will
not necessarily update information if any forward-looking statement later turns
out to be inaccurate. Risks and uncertainties that may affect out future results
and performance include, but are not limited to those discussed under the
heading "Risk Factors" at pages 36 to 41 of this Annual Report on Form 10-K.
RESULTS OF OPERATIONS
Comparison of Fiscal 2000 to 1999:
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 and Nintendo 64), EA Studio
personal computer products (or PC), and Affiliated Label (or AL) products that
are published by third parties and distributed or co-published by us. We also
derive revenues from licensing of EA Studio products and Affiliated Label
products through hardware companies (or OEMs) and online subscription revenues.
Information about our net revenues for North America and foreign areas for
fiscal 2000 and 1999 is summarized below (in thousands):
2000 1999 Increase % change
---------------------------------------------------------------------------
North America $ 846,637 $ 704,998 $ 141,639 20.1%
---------------------------------------------------------------------------
Europe 492,430 443,937 48,493 10.9%
Asia Pacific 47,573 39,560 8,013 20.3%
Japan 33,371 33,368 3 0.0%
---------------------------------------------------------------------------
International 573,374 516,865 56,509 10.9%
---------------------------------------------------------------------------
Consolidated Net Revenues $1,420,011 $1,221,863 $ 198,148 16.2%
===========================================================================
North America Net Revenues
The increase in North America net revenues for fiscal 2000 compared to fiscal
1999 was primarily attributable to:
o A 52% increase in PC revenues due to strong sales of Command and
Conquer: Tiberian Sun, Sim City 3000 as well as the fourth quarter
shipment of The Sims in fiscal 2000.
o A 20% increase in PlayStation revenues due to more titles released
during fiscal 2000 including Madden NFL 2000, NBA 2000 and Tomorrow
Never Dies as compared to fiscal 1999.
o A 17% increase in AL revenues primarily due to the shipment of titles
published by Square EA offset by the loss of an affiliate, Accolade,
due to its acquisition by a third party in the first quarter of the
current fiscal year.
o These increases were partially offset by an expected decline in sales
of Nintendo 64 ("N64") products.
International Net Revenues
The increase in international net revenues for fiscal 2000 compared to fiscal
1999 was attributable to the following:
o Europe's net revenues increased by 11% primarily due to an increase in
sales of PC titles including Command and Conquer: Tiberian Sun, Sim
City 3000 and The Sims as well as an increase in PlayStation revenues
due to the success of FIFA 2000, Tomorrow Never Dies and F1 2000. These
increases were partially offset by an expected decline in sales of N64
products. Overall European revenues were adversely impacted by a
devaluation of the Euro compared to the same period last year.
18
o Asia Pacific's net revenues increased 20% due to PC sales of Command
and Conquer: Tiberian Sun and Sim City 3000.
o Japan's net revenues were flat compared to the prior year. PC and
Affiliated Label revenues increased, offset by a decrease in
PlayStation product sales primarily due to strong sales of FIFA: Road
to World Cup and World Cup 98 in the prior year.
Information about our net revenues by product line for fiscal 2000 and 1999 is
presented below (in thousands):
Increase/
2000 1999 (Decrease) % change
--------------------------------------------------------------------------
EA Studio:
PlayStation $ 586,821 $ 519,830 $ 66,991 12.9%
PC 397,777 270,793 126,984 46.9%
N64 120,415 152,349 (31,934) (21.0)%
Online Subscriptions 16,771 12,570 4,201 33.4%
License, OEM and Other 22,894 18,216 4,678 25.7%
--------------------------------------------------------------------------
1,144,678 973,758 170,920 17.6%
Affiliated Label: 275,333 248,105 27,228 11.0%
--------------------------------------------------------------------------
Consolidated Net Revenues $1,420,011 $1,221,863 $ 198,148 16.2%
==========================================================================
Personal Computer Product Net Revenues
We released 31 PC titles in fiscal 2000 compared to 29 PC titles in fiscal 1999.
The worldwide increase in sales of PC revenues was primarily attributable to an
increase in sales in North America and Europe due to the success of Command and
Conquer: Tiberian Sun released in the second quarter of fiscal 2000 and
continued strong catalog sales of Sim City 3000 released in the fourth quarter
of fiscal 1999. Other key titles in the current year include The Sims and FIFA
2000.
We expect revenues from PC products to grow in fiscal 2001, but as revenues for
these products increase, they may not grow at the current rate.
PlayStation Product Net Revenues
We released 30 new PlayStation titles in fiscal 2000 compared to 21 in fiscal
1999. The increase in PlayStation product sales was attributable to more titles
released in the current fiscal year compared to the same period last year. Key
releases for the year include FIFA 2000, Tomorrow Never Dies, Madden NFL 2000,
NBA 2000 and Knockout Kings(TM) 2000.
Sony has announced the release of the PlayStation 2 console in the United States
and Europe in the fall of 2000. Although our PlayStation products will be
playable on the PlayStation 2 console, we expect sales of current PlayStation
products to decline in fiscal 2001.
Under the terms of a licensing agreement entered into with Sony Computer
Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are
authorized to develop and distribute software products compatible with the
PlayStation. Pursuant to the Sony Agreement, we engage Sony to manufacture
PlayStation Compact Disks for distribution by us. Accordingly, we have limited
ability to control our supply of PlayStation products or the timing of their
delivery.
Affiliated Label Product Net Revenues
AL product sales increased due to higher sales in North America. The increase in
Affiliated Label revenues compared to the same period last year was due to the
distribution of titles by Square EA, including Final Fantasy(R) VIII, partially
offset by the termination of our distribution agreement with Accolade, which was
acquired by a third party.
N64(R) Product Net Revenues
The expected decrease in N64 revenues for fiscal 2000 compared to the same
period last year was due to the weak market for N64 products as well as strong
comparisons of World Cup 98 in the prior year. We released eight titles in
fiscal 2000, including WCW(TM) Mayhem, compared to nine titles in fiscal 1999.
We expect revenues from N64 products to decline significantly in fiscal 2001.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64
cartridges for distribution by us. Accordingly, we have little ability to
control our supply of N64 cartridges or the timing of their delivery. A shortage
of microchips or other factors outside our control could impair our ability to
obtain an adequate supply of cartridges.
19
In connection with our purchases of N64 cartridges for distribution in North
America, Nintendo requires us to provide irrevocable letters of credit prior to
Nintendo's acceptance of purchase orders from us for purchases of these
cartridges. For purchases of N64 cartridges for distribution in Japan and
Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo
maintains a policy of not accepting returns of N64 cartridges. Because of these
and other factors, the carrying of an inventory of cartridges entails
significant capital and risk.
Online Subscription Revenues
Online subscription revenues are revenues collected for Internet game play on
our websites. The increase in online revenues for fiscal 2000 as compared to
fiscal 1999 was attributable to the following:
o The average number of paying customers for Ultima Online increased to
over 140,000 for fiscal 2000 as compared to over 105,000 in fiscal
1999.
o The increase in paying customers was due to continued strong sales of
Ultima Online, the addition of new events within the Ultima worlds and
the release of Ultima Online: The Second Age(TM) in October 1998.
Ultima Online: The Second Age added features including new worlds,
monsters and an in-game chat feature.
o We established servers for Ultima Online in Europe in June 1999 and in
Japan in October 1998. This local dial-in capability resulted in new
customers in those territories for the fiscal 2000, as compared to
fiscal 1999.
License, OEM and Other Revenues
The increase in license, OEM and other revenues was primarily due to the
following:
o License/OEM revenues increased due to the sales of Gameboy(R) Color
titles in the current fiscal year.
o Other revenues decreased primarily due to decreases in 32-bit products,
other than PlayStation, as we are no longer publishing games for those
platforms.
Operations by Segment
As a result of the approval of the Tracking Stock proposal (see Note 2) to
authorize issuance of a new series of common stock designated as Class B common
stock, intended to reflect the performance of EA.com, management considers
EA.com a separate reportable segment. Accordingly, prior period information has
been restated to disclose this separate segment. We operate in two principal
business segments globally:
o Electronic Arts core ("EA Core") business segment: creation, marketing
and distribution of entertainment software.
o EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online.
EA.com, a division of Electronic Arts Inc., represents Electronic Arts' online
and e-Commerce businesses. EA.com's business includes subscription revenues
collected for Internet game play on our websites, sales of packaged goods for
Internet-only based games and sales of Electronic Arts games sold through EA.com
websites. The statement of income includes all revenues and costs directly
attributable to EA.com, including charges for shared facilities, functions and
services used by EA.com and provided by Electronic Arts. Certain costs and
expenses have been allocated based on management's estimates of the cost of
services provided to EA.com by Electronic Arts.
20
Information about our operations by segment for fiscal 2000 and 1999 is
presented below (in thousands):
Year Ended March 31, 2000
--------------------------------------------------------------------
EA Core Adjustments and Electronic
(excl. EA.com) EA.com Eliminations Arts
- --------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $ 1,399,093 $ 20,918 $ -- $ 1,420,011
Group sales 2,014 -- (2,014)(a) --
--------------------------------------------------------------------
Total net revenues 1,401,107 20,918 (2,014) 1,420,011
--------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 700,024 5,784 -- 705,808
Group cost of goods sold -- 2,014 (2,014) --
--------------------------------------------------------------------
Total cost of goods sold 700,024 7,798 (2,014) 705,808
--------------------------------------------------------------------
Gross profit 701,083 13,120 -- 714,203
Operating expenses:
Marketing and sales 185,714 2,914 -- 188,628
General and administrative 87,513 4,989 -- 92,502
Research and development 205,933 34,775 20,051(b) 260,759
Network development and support -- 20,051 (20,051) --
Charge for acquired in-process technology 2,670 3,869 -- 6,539
Amortization of intangibles 10,866 1,123 -- 11,989
--------------------------------------------------------------------
Total operating expenses 492,696 67,721 -- 560,417
--------------------------------------------------------------------
Operating income (loss) 208,387 (54,601) -- 153,786
Interest and other income, net 16,017 11 -- 16,028
--------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 224,404 (54,590) -- 169,814
Provision for income taxes 52,642 -- -- 52,642
--------------------------------------------------------------------
Income (loss) before minority interest 171,762 (54,590) -- 117,172
Minority interest in consolidated joint venture (421) -- -- (421)
--------------------------------------------------------------------
Net income (loss) $ 171,341 $ (54,590) $ -- $ 116,751
--------------------------------------------------------------------
21
Year Ended March 31, 1999
--------------------------------------------------------------------
EA Core Adjustments and Electronic
(excl. EA.com) EA.com Eliminations Arts
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $ 1,204,689 $ 17,174 $ -- $ 1,221,863
Group sales 985 -- (985)(a) --
--------------------------------------------------------------------
Total net revenues 1,205,674 17,174 (985) 1,221,863
--------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 624,252 3,571 -- 627,823
Group cost of goods sold -- 985 (985) --
--------------------------------------------------------------------
Total cost of goods sold 624,252 4,556 (985) 627,823
--------------------------------------------------------------------
Gross profit 581,422 12,618 -- 594,040
Operating expenses:
Marketing and sales 161,029 2,378 -- 163,407
General and administrative 74,995 1,224 -- 76,219
Research and development 181,245 8,050 9,846(b) 199,141
Network development and support -- 9,846 (9,846) --
Charge for acquired in-process technology 44,115 -- -- 44,115
Amortization of intangibles 5,880 -- -- 5,880
--------------------------------------------------------------------
Total operating expenses 467,264 21,498 -- 488,762
--------------------------------------------------------------------
Operating income (loss) 114,158 (8,880) -- 105,278
Interest and other income, net 13,180 -- -- 13,180
--------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 127,338 (8,880) -- 118,458
Provision for income taxes 45,414 -- -- 45,414
--------------------------------------------------------------------
Income (loss) before minority interest 81,924 (8,880) -- 73,044
Minority interest in consolidated joint venture (172) -- -- (172)
--------------------------------------------------------------------
Net income (loss) $ 81,752 $ (8,880) $ -- $ 72,872
--------------------------------------------------------------------
<FN>
(a) Represents elimination of intercompany sales of Electronic Arts
packaged goods products to EA.com; and represents elimination of
royalties paid to Electronic Arts by EA.com for intellectual property
rights.
(b) Represents reclassification of Network Development and Support to
Research and Development.
</FN>
The increase in net revenues for EA.com for fiscal 2000 as compared to fiscal
1999 was attributable to the following:
o Higher online revenues from increased subscriptions to Ultima Online.
o Higher internet-based e-Commerce revenues.
o Partially offset by lower Ultima Online packaged product revenues due
to the decrease in the average selling price.
22
The following table presents pro-forma results of operations allocating taxes
between EA Core and EA.com. Consolidated taxes have been allocated to EA Core
and EA.com on a pro rata basis based on the consolidated effective tax rates,
thereby giving EA.com the tax benefit of its losses which is utilized by the
consolidated group. Such tax benefit could not be recognized by EA.com on a
stand-alone basis. The sum of tax expense and tax benefit for EA Core and EA.com
is the same as consolidated tax expense. This presentation represents how
management analyzes each segment of the business (in thousands):
Year Ended March 31, 2000
---------------------------------------------------------
EA Core Adjustments and Electronic
excl. EA.com) EA.com Eliminations Arts
- -----------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest $ 224,404 $ (54,590) $-- $ 169,814
Provision (benefit) for income taxes 69,565 (16,923) -- 52,642
---------------------------------------------------------
Income (loss) before minority interest 154,839 (37,667) -- 117,172
Minority interest in consolidated joint venture (421) -- -- (421)
---------------------------------------------------------
Net income (loss) $ 154,418 $ (37,667) $-- $ 116,751
---------------------------------------------------------
Year Ended March 31, 1999
------------------------------------------------------------
EA Core Adjustments and Electronic
excl. EA.com) EA.com Eliminations Arts
- -----------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest $ 127,338 $ (8,880) $-- $ 118,458
Provision (benefit) for income taxes 48,256 (2,842) -- 45,414
------------------------------------------------------------
Income (loss) before minority interest 79,082 (6,038) -- 73,044
Minority interest in consolidated joint venture (172) -- -- (172)
------------------------------------------------------------
Net income (loss) $ 78,910 $ (6,038) $-- $ 72,872
------------------------------------------------------------
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income
Information about our costs and expenses, interest and other income, net, income
taxes and net income for fiscal 2000 and 1999 is presented below:
Percent of Net
Revenues
----------------
2000 1999
---- ----
Cost of goods sold 49.7% 51.4%
Marketing and sales 13.3 13.4
General and administrative 6.5 6.2
Research and development (includes network
development and support) 18.4 16.3
Charge for acquired in-
process technology 0.5 3.6
Amortization of intangibles 0.8 0.5
Interest and other income, net 1.1 1.1
Income taxes - effective tax rate 31.0 38.3
Net income 8.2% 6.0%
Cost of Goods Sold. Cost of goods sold as a percentage of revenues decreased in
fiscal 2000 due to:
o An increase in sales of higher margin PC titles as a percentage of
revenues.
o An increase in sales of higher margin AL co-published titles which make
up a greater amount of total AL revenues as compared to the prior year.
23
o A decrease in sales of lower margin N64 titles.
o Higher average margin for PC sales due to higher percentage of revenues
from internally developed and Intellectual Property owned titles, such
as Command and Conquer: Tiberian Sun, Sim City 3000 and The Sims.
o Partially offset by a decrease, as a percentage of revenues, of
PlayStation products.
Marketing and Sales. Marketing and sales expenses increased in absolute dollars
by 15% primarily attributed to:
o Increased print, Internet and television advertising to support new
releases.
o Increased cooperative advertising associated with higher revenues in
North America and Europe as compared to the prior year.
o Additional headcount related to the continued expansion of our
worldwide distribution business.
General and Administrative. General and administrative expenses increased in
absolute dollars by 21% primarily due to:
o An increase in payroll and occupancy costs to support the increase in
growth in North America and Europe.
o Increased general and administrative spending for EA.com. EA.com
expanded its staff and incurred additional administrative related costs
required to support growth of the business. We anticipate a continued
increase in the absolute dollars spent on general and administrative
related expenses for EA.com.
Research and Development. The increase in absolute dollars by 31% for research
and development expenses (including Network Development and Support) was due to:
o Increased research and development spending due to the ongoing
investment in our online business. EA.com increased the number of
online projects in development and increased development staff. We
believe that continued spending for EA.com game development is critical
to the growth of the business and to meet certain targeted launch
commitments. EA.com intends to increase the number of online games in
development and significantly increase development and production
staff. As a result, research and development expenses are expected to
increase in absolute dollars.
o Additional headcount-related expenses attributable to the increased
in-house development capacity and a higher number of SKUs released in
fiscal 2000.
o An increase in development spending for next generation console
products including development for the PlayStation 2 console.
We released a total of 69 new products in fiscal 2000 compared to 59 in fiscal
1999.
Network Development and Support. The increase in network development and support
expenses was due to:
o The ongoing investment in our online business.
o EA.com's network and development support expenses increased due to
increased spending for network infrastructure in preparation for new
online products and the EA.com game site. In addition, we incurred
higher infrastructure costs related to increased server capacity for
Ultima Online, allowing EA.com to serve a higher number of active
subscribers.
We expect network development and support expenses to increase in absolute
dollars in the future.
Charge for Acquired In-Process Technology.
Fiscal 2000:
o In connection with the acquisition of Kesmai by EA.com in the fourth
fiscal quarter of fiscal 2000, we allocated and expensed $3,869,000 of
the purchase price to acquired in-process technology. Kesmai had
various projects in progress at the time of the acquisition. As of the
acquisition date, costs to complete Kesmai projects acquired were
expected to be approximately $10,550,000 in future periods. We believe
there have been no significant changes to these estimates as of March
31, 2000. We currently expect to complete the development of these
projects at various dates through fiscal 2002 and to publish the
projects upon completion. In conjunction with the merger of Kesmai, we
accrued approximately $200,000 related to direct transaction and other
related costs. At March 31, 2000 there were $133,000 in accruals
remaining related to these items.
o In connection with the acquisitions of two development companies by EA
Core, made in the 2nd and 4th quarters of fiscal 2000, we allocated and
expensed $2,670,000 of the purchase price to acquired in-process
technology.
Fiscal 1999:
o In connection with the acquisition of Westwood by EA Core in September
1998, we allocated and expensed $41,836,000 of the purchase price to
acquired in-process technology.
o Additionally, in connection with the acquisition of two software
development companies by EA Core, in the first quarter of fiscal 1999,
we incurred a total charge of $2,279,000 for acquired in-process
technology.
24
These charges were made after we concluded that the in-process technology had
not reached technological feasibility and had no alternative future use after
taking into consideration the potential for usage of the software in different
products and resale of the software.
Amortization of Intangibles. The amortization of intangibles results primarily
from the acquisitions of Westwood, Kesmai, ABC Software and other acquisitions
made in fiscal 2000. Amortization of intangibles was $10,866,000 for EA Core and
$1,123,000 for EA.com.
Interest and Other Income, Net. Interest and other income, net, increased in
absolute dollars primarily due to realized gains on sales of marketable
securities and the sale of our interest in an affiliate. Those gains were
partially offset by a write-off of a note receivable from an affiliate in the
current year as well as a gain on sale of land recognized in the prior year.
Income Taxes. Our effective tax rate was 31.0% for fiscal 2000 and 38.3% for
fiscal 1999. The effective tax rate was lower than the comparable prior year
period (excluding the effect of the one-time charges in the prior year)
primarily as a result of a higher portion of international income for fiscal
2000 subject to a lower foreign tax rate as compared to the prior year. Our
effective tax rate for fiscal 1999 was negatively affected as there was no tax
benefit recorded for a portion of the charges related to the acquired in-process
technology. Excluding the effect of these charges, the effective tax rate for
fiscal 1999 would have been 32.0%.
Net Income. In absolute dollars, reported net income increased by 60% primarily
related to higher revenues and gross profits as compared to the same period last
year. The increase was also due to significant one-time charges for acquired
in-process technology in the prior year. This was partially offset by higher
costs incurred by EA.com for the development of online projects, the network
infrastructure development and higher infrastructure costs for Ultima Online and
Ultima Online: The Second Age. Excluding the one-time charges relating to
acquired in-process technology of $4,512,000, net of taxes, in the current year,
net income would have been $121,263,000. Excluding the one-time charges relating
to acquired in-process technology of $37,506,000, net of taxes in the prior
year, net income would have been $110,378,000.
Excluding one-time charges related to acquired in-process technology and
goodwill amortization, net income would have been $129,535,000 for fiscal 2000.
Excluding one-time charges relating to acquired in-process technology and
goodwill amortization, net income would have been $114,376,000 for fiscal 1999.
Comparison of Fiscal 1999 to 1998:
Revenues
Information about our net revenues for North America and foreign areas for
fiscal 1999 and 1998 is summarized below (in thousands):
Increase/
1999 1998 (Decrease) % change
------------------------------------------------
North America $ 704,998 $ 519,423 $ 185,575 35.7%
------------------------------------------------
Europe 443,937 325,938 117,999 36.2%
Asia Pacific 39,560 41,494 (1,934) (4.7)%
Japan 33,368 21,997 11,371 51.7%
------------------------------------------------
International 516,865 389,429 127,436 32.7%
------------------------------------------------
Consolidated Net Revenues $1,221,863 $ 908,852 $ 313,011 34.4%
================================================
North America Net Revenues
The increase in North America net revenues was mainly attributable to:
o Strong growth in N64 and PlayStation systems. Net revenues from
PlayStation and N64 increased 51% due to a larger market and greater
installed base for these platforms as well as more title releases for
N64 in comparison to the prior year.
o AL sales increased 53% compared to the prior year primarily due to the
distribution of products published by Square EA.
o PC revenues increased 11% due to key title releases during the year.
25
International Net Revenues
The increase in international net revenues for fiscal 1999 compared to fiscal
1998 was attributable to the following:
o Europe's net revenues increased primarily due to an increase in sales
of PlayStation and Affiliated Label products.
o Japan's net revenues increased primarily due to the sales of FIFA: Road
to World Cup 98.
o Offset by a decrease in Asia Pacific net revenues due to the weakness
in Asian currencies. In local currency, in spite of weak economies, net
revenues for Asia Pacific increased compared to the prior year.
Information about our net revenues by product line for fiscal 1999 and 1998 is
presented below (in thousands):
Increase/
1999 1998 (Decrease) % change
------------------ -------------------- ----------------- --------------
EA Studio:
PlayStation $ 519,830 $380,299 $139,531 36.7%
PC 270,793 231,034 39,759 17.2%
N64 152,349 56,677 95,672 168.8%
Online subscriptions 12,570 4,451 8,119 182.4%
License, OEM and Other 18,216 50,526 (32,310) (63.9)%
------------------ -------------------- ----------------- --------------
973,758 722,987 250,771 34.7%
Affiliated Label: 248,105 185,865 62,240 33.5%
------------------ -------------------- ----------------- --------------
Consolidated Net Revenues $1,221,863 $908,852 $313,011 34.4%
================== ==================== ================= ==============
PlayStation Product Net Revenues
We released 21 new PlayStation titles in fiscal 1999 compared to 25 in fiscal
1998. The increase in PlayStation product sales was attributable to the greater
installed base of PlayStation game consoles and the releases of key titles for
this platform including FIFA 99, World Cup 98 and Madden NFL 99.
Personal Computer Product Net Revenues
We released 29 PC titles in fiscal 1999 compared to 30 PC titles in fiscal 1998.
The worldwide increase in sales of PC products was primarily attributable to an
increase in sales in Europe and North America due to the related releases of key
titles for this platform including SimCity 3000.
N64 Product Net Revenues
The increase in N64 revenues was primarily due to more title releases for this
platform compared to the prior year and a larger N64 market. We released nine
titles in fiscal 1999, including NASCAR(R) 99, compared to two titles in fiscal
1998.
Affiliated Label Product Net Revenues
AL product sales increased due to higher sales in North America and Europe. This
increase was primarily attributable to the distribution of products published by
Square EA in North America and the acquisition of ABC Software in Switzerland.
Online Subscription Revenues
The increase in online revenues for fiscal 1999 as compared to fiscal 1998 was
attributable to the following:
o The average paying customers for Ultima Online increased to over
105,000 for fiscal 1999 as compared to over 74,000 for fiscal 1998, due
to continued strong sales of Ultima Online and the release of Ultima
Online: The Second Age in the third quarter of fiscal 1999. Ultima
Online: The Second Age added features such as new worlds, monsters and
in-game chat features.
o EA.com established servers providing local dial-in capability for
Ultima Online in Japan in the third quarter of fiscal 1999. We only had
servers in North America in fiscal 1998.
License, OEM and Other Revenues
The decrease in license, OEM, online and other revenues was primarily due to the
following:
o Net revenues derived from 32-bit products other than PlayStation
decreased primarily due to lower sales of Sega Saturn(R) products. We
released no new Sega Saturn titles in fiscal 1999 compared to eight in
fiscal 1998.
o Net revenues generated by 16-bit video game cartridge-based products
decreased in fiscal 1999 as compared to fiscal 1998. As the 16-bit
video game market has been replaced by 32-bit and 64-bit systems, we
did not release any new titles in fiscal 1999.
26
o Licensing of EA Studio products increased primarily as a result of an
increase in the revenues generated by licensing of our products in
Europe.
Operations by Segment
Information about our operations by segment for fiscal 1999 and 1998 is
presented below (in thousands):
Year Ended March 31, 1999
--------------------------------------------------------------------
EA Core Adjustments and Electronic
(excl. EA.com) EA.com Eliminations Arts
--------------------------------------------------------------------
Net revenues from unaffiliated customers $ 1,204,689 $ 17,174 $ -- $ 1,221,863
Group sales 985 -- (985)(a) --
--------------------------------------------------------------------
Total net revenues 1,205,674 17,174 (985) 1,221,863
--------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 624,252 3,571 -- 627,823
Group cost of goods sold -- 985 (985) --
--------------------------------------------------------------------
Total cost of goods sold 624,252 4,556 (985) 627,823
--------------------------------------------------------------------
Gross profit 581,422 12,618 -- 594,040
Operating expenses:
Marketing and sales 161,029 2,378 -- 163,407
General and administrative 74,995 1,224 -- 76,219
Research and development 181,245 8,050 9,846(b) 199,141
Network development and support -- 9,846 (9,846) --
Charge for acquired in-process technology 44,115 -- -- 44,115
Amortization of intangibles 5,880 -- -- 5,880
--------------------------------------------------------------------
Total operating expenses 467,264 21,498 -- 488,762
--------------------------------------------------------------------
Operating income (loss) 114,158 (8,880) -- 105,278
Interest and other income, net 13,180 -- -- 13,180
--------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 127,338 (8,880) -- 118,458
Provision for income taxes 45,414 -- -- 45,414
--------------------------------------------------------------------
Income (loss) before minority interest 81,924 (8,880) -- 73,044
Minority interest in consolidated joint venture (172) -- -- (172)
--------------------------------------------------------------------
Net income (loss) $ 81,752 $ (8,880) $ -- $ 72,872
--------------------------------------------------------------------
27
Year Ended March 31, 1998
-------------------------------------------------------------
EA Core Adjustments and Electronic
(excl. EA.com) EA.com Eliminations Arts
- ------------------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $897,877 $ 10,975 $ -- $908,852
Group sales 538 -- (538)(a) --
-------------------------------------------------------------
Total net revenues 898,415 10,975 (538) 908,852
-------------------------------------------------------------
Cost of goods sold from unaffiliated customers 478,967 2,266 -- 481,233
Group cost of goods sold -- 538 (538) --
-------------------------------------------------------------
Total cost of goods sold 478,967 2,804 (538) 481,233
-------------------------------------------------------------
Gross profit 419,448 8,171 -- 427,619
Operating expenses:
Marketing and sales 125,711 2,597 -- 128,308
General and administrative 57,650 188 -- 57,838
Research and development 137,360 5,352 3,020(b) 145,732
Network development and support -- 3,020 (3,020) --
Charge for acquired in-process technology 1,500 -- -- 1,500
Merger costs 10,792 -- -- 10,792
-------------------------------------------------------------
Total operating expenses 333,013 11,157 -- 344,170
-------------------------------------------------------------
Operating income (loss) 86,435 (2,986) -- 83,449
Interest and other income, net 24,811 -- -- 24,811
-------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 111,246 (2,986) -- 108,260
Provision for income taxes 35,726 -- -- 35,726
-------------------------------------------------------------
Income (loss) before minority interest 75,520 (2,986) -- 72,534
Minority interest in consolidated joint venture 28 -- -- 28
-------------------------------------------------------------
Net income (loss) $ 75,548 $ (2,986) $ -- $ 72,562
-------------------------------------------------------------
<FN>
(a) Represents elimination of intercompany sales of Electronic Arts
packaged goods products to EA.com; and represents elimination of
royalties paid to Electronic Arts by EA.com for intellectual property
rights.
(b) Represents reclassification of Network Development and Support to
Research and Development.
</FN>
The increase in net revenues for EA.com for fiscal 1999 as compared to fiscal
1998 was mainly attributable to the following:
o Higher online revenues from subscriptions for Ultima Online: The Second
Age, the upgrade to Ultima Online.
o Mitigated by lower product revenues from Ultima Online for fiscal 1999
as compared to fiscal 1998.
28
The following table presents pro-forma results of operations allocating taxes
between EA Core and EA.com. Consolidated taxes have been allocated to EA Core
and EA.com on a pro rata basis based on the consolidated effective tax rates,
thereby giving EA.com the tax benefit of its losses which is utilized by the
consolidated group. Such tax benefits 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. This presentation represents how
management analyzes each segment of the business (in thousands):
Year Ended March 31, 1999
-----------------------------------------------------------
EA Core Adjustments and Electronic
(excl. EA.com) EA.com Eliminations Arts
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest $ 127,338 $ (8,880) $-- $ 118,458
Provision (benefit) for income taxes 48,256 (2,842) -- 45,414
-----------------------------------------------------------
Income (loss) before minority interest 79,082 (6,038) -- 73,044
Minority interest in consolidated joint venture (172) -- -- (172)
-----------------------------------------------------------
Net income (loss) $ 78,910 $ (6,038) $-- $ 72,872
-----------------------------------------------------------
Year Ended March 31, 1998
-----------------------------------------------------------
EA Core Adjustments and Electronic
(excl. EA.com) EA.com Eliminations Arts
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest $ 111,246 $ (2,986) $-- $ 108,260
Provision (benefit) for income taxes 36,711 (985) -- 35,726
-----------------------------------------------------------
Income (loss) before minority interest 74,535 (2,001) -- 72,534
Minority interest in consolidated joint venture 28 -- -- 28
-----------------------------------------------------------
Net income (loss) $ 74,563 $ (2,001) $-- $ 72,562
-----------------------------------------------------------
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income
Information about our costs and expenses, interest and other income, net, income
taxes and net income for fiscal 1999 and 1998 is presented below:
Percent of Net
Revenues
----------------
1999 1998
---- ----
Cost of goods sold 51.4% 52.9%
Marketing and sales 13.4 14.1
General and administrative 6.2 6.4
Research and development (includes network
development and support) 16.3 16.0
Charge for acquired in-
process technology 3.6 0.2
Amortization of intangibles 0.5 --
Merger costs -- 1.2
Interest and other income, net 1.1 2.7
Income taxes - effective tax rate 38.3 33.0
Net income 6.0% 8.0%
29
Cost of Goods Sold. Cost of goods sold as a percentage of revenues decreased in
fiscal 1999 primarily due to lower artist royalties, including savings related
to an acquisition of a software development company during fiscal 1999,
partially offset by higher sales of lower margin N64 products.
Marketing and Sales. Marketing and sales expenses increased 27% primarily
attributed to:
o Increased print, Internet and television advertising to support new
releases.
o Increased cooperative advertising associated with higher revenues in
North America and Europe as compared to the prior year.
o Additional headcount related to the continued expansion of our
worldwide distribution business.
o The acquisitions of ABC Software and Westwood Studios.
General and Administrative. General and administrative expenses increased 32%
primarily due to an increase in headcount and occupancy costs to support the
increase in growth in North America and Europe operations, including the opening
of additional international offices in Europe and the acquisition of ABC
Software.
Research and Development. The increase in absolute dollars for research and
development expenses (including Network Development and Support) was due to:
o Additional headcount-related expenses attributable to the acquisition
of Westwood Studios, Inc. and certain assets of the Irvine,
California-based Virgin Studio (collectively "Westwood") in September
1998 and Tiburon Entertainment, Inc. in April 1998.
o Higher development costs per title, as products are including more
content and are more complex and time consuming to develop.
o An increase in development costs for Ultima Online.
o A higher number of projects in development in fiscal 1999 as compared
to fiscal 1998 for EA.com
We released a total of 59 new products in fiscal 1999 compared to 71 in fiscal
1998.
Network Development and Support. The increase in network development and support
expenses for EA.com was due to higher design, engineering and software
maintenance costs associated with the Ultima Online worlds.
Charge for Acquired In-Process Technology. In connection with the purchase of
Westwood in September 1998, we allocated and expensed $41,836,000 of the
$122,688,000 purchase price to in-process research and development projects.
This allocation represents the estimated fair value based on risk-adjusted cash
flows related to the incomplete research and development projects. At the date
of acquisition, this amount was expensed as a non-recurring charge as the
in-process technology had not yet reached technological feasibility and had no
alternative future uses. Westwood had three major PC projects in progress at the
time of the acquisition including two in the best-selling franchise Command and
Conquer and one in the critically acclaimed Lands of Lore(TM) series. As of the
acquisition date, costs to complete the Westwood projects acquired were expected
to be approximately $9.1 million in fiscal 1999, $10.6 million in fiscal 2000
and $1.0 million in fiscal 2001. We believe there have been no significant
changes to these estimates. We currently expect to complete the development of
these projects at various dates through fiscal 2001 and to publish the products
upon completion.
The nature of the efforts required to develop the acquired in-process technology
into commercially viable products principally relate to the completion of all
planning, designing and testing activities necessary to establish that the
product can be produced to meet our design requirements including functions,
features and technical performance requirements. Though we currently expect that
the acquired in-process technology will be successfully developed, there can be
no assurance that commercial or technical viability of these products will be
achieved. Furthermore, future developments in the entertainment software
industry, changes in computer or video game console technology, changes in other
product offerings or other developments may cause us to alter or abandon these
plans.
The value assigned to purchased in-process technology was determined by
estimating the completion percentage of research and development efforts at the
acquisition date, forecasting risk adjusted revenues considering the completion
percentage, estimating the resulting net cash flows from the projects and
discounting the net cash flows to their present values. The completion
percentages were estimated based on cost incurred to date, importance of the
completed development tasks and the elapsed portion of the total project time.
The revenue projection used to value the in-process research and development is
based on unit sales forecasts for worldwide sales territories and adjusted to
consider only the revenue related to development achievements completed at the
acquisition date. Net cash flow estimates include cost of goods sold and sales,
marketing and general and administrative expenses and taxes forecasted based on
historical operating characteristics. In addition, net cash flow estimates were
adjusted to allow for fair return on working capital and fixed assets, charges
for franchise and technology leverage and return on other intangibles.
Appropriate risk adjusted
30
discount rates ranging from 20% to 22.5% were used to discount the net cash
flows back to their present value. The remaining identified intangibles will be
amortized on a straight-line basis over two to twelve years based on expected
useful lives of franchise tradenames, existing products and technologies,
retention of workforce, and other intangible assets. If these projects are not
successfully developed, we may not realize the value assigned to the in-process
research and development projects. In addition, the value of other acquired
intangible assets may also become impaired.
In conjunction with the merger of Westwood, we accrued approximately $1,500,000
related to direct transaction costs and other related accruals. At March 31,
2000, there were $500,000 in accruals remaining related to these items.
Additionally, for fiscal 1999, the charge for in-process research and
development also included write-offs of $2,279,000 associated with the
acquisition of two software development companies in the first quarter.
For fiscal 1998, we incurred a charge of $1,500,000 for acquired in-process
technology in connection with the acquisition of the remaining 35% minority
ownership interest in Electronic Arts Victor, Inc. in December 1997. This charge
was made after we concluded that the in-process technology had no alternative
future use after taking into consideration the potential for usage of the
software in different products and resale of the software.
Amortization of Intangibles. Amortization of intangibles results from the
acquisitions of Westwood and ABC Software in the second quarter of fiscal 1999.
Merger Costs. On July 25, 1997, we completed a merger with Maxis, Inc.
("Maxis"). In conjunction with the merger, we recorded costs of $10,792,000
which included direct transaction fees and costs associated with integrating the
operations of the two companies. At March 31, 1999, there were no accruals
remaining related to these merger costs.
Operating Income. Operating income increased due to:
o Higher net revenues and related gross profit partially offset by
increased operating expenses including the charges for acquired
in-process technology of $44,115,000 in the current fiscal year.
o Partially offset by merger costs of $10,792,000 and a charge for
acquired in-process technology of $1,500,000 related to the
acquisitions in the prior fiscal year.
Excluding one-time items in both years, as noted above, operating income would
have been $149,393,000 in fiscal 1999 and $95,741,000 in fiscal 1998.
Interest and Other Income, Net. The decrease in interest and other income, net,
was primarily attributable to the sale of our 50% ownership interest in Creative
Wonders, LLC in December 1997. The sale resulted in a gain in the prior year of
$12,625,000.
Income Taxes. Electronic Arts' effective tax rate was 38.3% for fiscal 1999 and
33.0% for fiscal 1998. Our effective tax rate for fiscal 1999 was negatively
affected as there was no tax benefit recorded for a portion of the charges
related to the acquired in-process technology. Excluding the effect of these
charges, the effective tax rate for fiscal 1999 would have been 32.0% as
compared to a 33.0% tax rate for fiscal 1998. The lower rate of 32.0% results
primarily from a higher portion of international income subject to a lower
foreign tax rate as compared to the prior year and an increase in the federal
research and experimental credit.
Minority Interest in Consolidate Joint Venture.
o In the first quarter of fiscal 1999, we formed EA Square KK which is
seventy percent owned by us and thirty percent owned by Square Co. Ltd.
("Square"), a leading developer and publisher of entertainment software
in Japan. Minority interest for fiscal 1999 represents Square's 30%
interest in the net income of EA Square KK.
o For fiscal 1998, the minority interest represented the 35% interest in
Electronic Arts Victor, Inc. ("EAV") owned by Victor Entertainment
Industries, Inc. ("VEI"). We acquired the remaining 35% minority
ownership interest in EAV held by VEI in December 1997.
Net Income. In absolute dollars, reported net income was flat due to the
one-time charges related to acquisitions offsetting significantly higher
operating income. The increase in net income, excluding one-time charges, was
due to higher revenues and gross profits, partially offset by higher spending on
development of online projects, higher support costs for Ultima Online and
Ultima Online: The Second Age, and higher network infrastructure costs
associated with Ultima Online worlds.
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o For fiscal 1998, net income included a one-time gain on sale of
Creative Wonders, LLC in the amount of $8,459,000, net of taxes, offset
by Maxis merger costs and a charge for acquired in-process developments
of $8,236,000, net of taxes.
o For fiscal 1999, net income included one-time charges for acquired
in-process technology of $37,506,000, net of taxes.
Excluding one-time items in both years, as noted above, net income increased to
$110,378,000 in fiscal 1999 from $72,339,000, or 53% over fiscal 1998.
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LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, our working capital was $440,021,000 compared to
$333,256,000 at March 31, 1999. Cash, cash equivalents and short-term
investments increased by approximately $26,982,000 in fiscal 2000. We generated
$45,336,000 of cash from operations in fiscal 2000 which was reduced by a
payment of $36,000,000 to AOL as discussed below. In addition, $85,589,000 was
provided through the sale of equity securities under our stock plans and
$20,000,000 was provided through the sale of shares of Class B common stock and
warrants to AOL.
Reserves for bad debts and sales returns decreased from $72,850,000 at
March 31, 1999 to $65,067,000 at March 31, 2000. Reserves have been charged for
returns of product and price protection credits issued for products sold in
prior periods. Management believes these reserves are adequate based on
historical experience and its current estimate of potential returns and
allowances.
During fiscal 2000, we invested $22,500,000 in cash for the acquisition
of Kesmai and $22,096,000 for other acquisitions made during the year. In
addition, we invested approximately $37,400,000 for new facilities in Europe and
Canada and $61,400,000 in computer equipment worldwide.
Our principal source of liquidity is $339,804,000 in cash, cash
equivalents and short-term investments. Management believes the existing cash,
cash equivalents, short-term investments, marketable securities and cash
generated from operations will be sufficient to meet cash and investment
requirements of Electronic Arts and EA.com for the next twelve months and the
foreseeable future.
Included in the amounts above is the following for the EA.com business:
o To date EA.com has been funded solely by Electronic Arts (including
proceeds from the sale of stock to AOL in the amount of $20,000,000).
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.
o During fiscal 2000, EA.com used $68,329,000 of cash in operations
(including payments to AOL of approximately $36,000,000), $37,605,000
in capital expenditures for computer equipment, network infrastructure,
internal use software and related third party software, $1,499,000 for
an investment in a 3rd party developer, $32,539,000 for the acquisition
of Kesmai and another acquisition, offset by $140,410,000 provided
through capital contributions from Electronic Arts.
o During fiscal 1999, EA.com used $9,086,000 of cash in operations and
$1,881,000 in capital expenditures for computer equipment, network
infrastructure and related software, offset by $10,967,000 provided
through the capital contribution from Electronic Arts.
EA.com is required to pay $50,000,000 to AOL as a carriage fee
(including certain advertising fees of which $604,000 was expensed in the twelve
months ended March 31, 2000) under the AOL agreement. Of this amount,
$25,000,000 was paid upon signing the agreement and the remainder is due in four
equal annual installments on the first four anniversaries of the initial
payment. Payment of the first annual installment of $6,250,000 will be
accelerated to June 1, 2000 since certain launch requirements will not be met by
that date. EA.com is also required to pay to AOL $31,000,000 as an advance of a
minimum guaranteed revenue share for revenues generated by subscriptions and
other certain commercial transactions on the EA.com site. Of this amount,
$11,000,000 was paid upon signing of the agreement and the remainder is due in
four equal annual installments on the first anniversary of the initial payment.
EA.com also made a commitment to spend $15,000,000 in offline media
advertisements promoting our online games, including those on the AOL service,
during the term of the AOL agreement.
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.
Impact of Recently Issued Accounting Standards
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101("SAB 101"), "Revenue Recognition," which outlines
the basic criteria that must be met to recognize revenue and provides guidance
for
33
presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with the SEC. SAB 101 is effective for
fiscal years beginning after December 15, 1999, except, as amended by SAB 101A,
registrants with fiscal years that begin between December 16, 1999 and March 15,
2000 may report a change in accounting principle no later than the second
quarter of fiscal years beginning after December 15, 1999. We believe the
adoption of SAB 101 will not have a material impact on our financial position
and results of operations.
In March 2000, the Emerging Issues Task Force issued No. 00-02 ("EITF 00-02"),
"Accounting for Web Site Development Costs". EITF 00-02 states that all costs
relating to software used to operate a web site and relating to development of
initial graphics and web page design should be accounted for using Statement of
Position ("SOP") 98-1. Under this SOP, costs incurred in the preliminary project
stage should be expensed as incurred, as should most training and data
conversion costs. External direct costs of materials and services and internal
direct payroll-related costs should be capitalized once certain criteria are
met. EITF 00-02 is effective for all fiscal quarters beginning after June 30,
2000. We do not expect a significant impact on our consolidated results of
operations, financial position or cash flows on the EITF's effective date.
In March 2000, the Emerging Issues Task Force issued No. 00-03 ("EITF 00-03"),
"Application of AICPA SOP 97-2, "Software Revenue Recognition," to Arrangements
That Include the Right to Use Software Stored on Another Entity's Hardware",
which discusses the effect on revenue recognition of a software vendor's
obligation to host its software that previously was licensed to a customer. The
EITF has reached the conclusion that, if the customer is unable to utilize the
software on the customer's hardware or contract with another party unrelated to
the vendor to host the software, then the arrangement with the customer is
outside the scope of SOP 97-2 and should be treated as a service contract. We
may be required to change the timing of our revenue recognition related to
product revenues. We believe the adoption of EITF 00-03 will not have a material
impact on our financial position and results of operations.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities", which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
is effective as of the beginning of the first quarter of the fiscal year
beginning after June 15, 2000. We are determining the effect of SFAS 133 on our
financial statements.
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". SOP 98-1 requires that consulting, hardware,
software and direct payroll-related costs associated with the implementation of
customized internal-use software be capitalized and amortized over the estimated
useful life of the software. These costs relate to game site application and
infrastructure design and development, as well as costs related to providing
customer account management and building in e-Commerce functionality and
interfaces. SOP 98-1 is effective for financial statements issued for fiscal
years beginning after December 15, 1998. As of March 31, 2000, we have
capitalized $26,318,000 of these costs associated with the effort to build and
support the EA.com game sites at launch.
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YEAR 2000 READINESS DISCLOSURE
Year 2000 Status
As of the date of this filing, we have not incurred any significant
business disruptions as a result of Year 2000 issues. However, while no such
occurrence has developed, Year 2000 issues that may arise related to key
suppliers and service providers may not become apparent immediately. We have
received assurances of Year 2000 compliance from key suppliers. We have also
received assurances from key service providers such as financial institutions,
our payroll service provider, and our retirement plan administrator as to their
Year 2000 readiness. We will continue to monitor our own systems and our
business partners to identify and address any potential risk situations related
to the Year 2000. We can provide no assurance that we will not be adversely
affected by these suppliers and service providers due to noncompliance in the
future.
EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union established fixed conversion rates between their existing
currencies (the "legacy currency") and the one common legal currency known as
the "Euro". From January 1, 1999 through June 30, 2002 the countries will be
able to use their legacy currencies or the Euro to transact business. By July 1,
2002, at the latest, the conversion to the Euro will be complete at which time
the legacy currencies will no longer be legal tender. The fixed conversion rates
between their existing currencies have eliminated exchange rate risk among the
member countries.
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The conversion to the Euro has reduced the number of forward contracts
that we use to hedge the exchange rate risk. The forward contracts that were
used to hedge the individual legacy currencies have been replaced by a single
Euro hedge contract and the intercompany transactions among subsidiaries within
the European Union are no longer subject to exchange rate risk.
We do not anticipate any material impact from the Euro conversion on
our financial information systems which currently accommodate multiple
currencies. Computer software changes necessary to comply with the Year 2000
issue are generally compliant to the Euro conversion issue. Due to numerous
uncertainties, we cannot reasonably estimate the effect that the Euro conversion
issue will have on our pricing or market strategies, and the impact, if any, it
will have on our financial condition and results of operations.
35
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RISK FACTORS
Electronic Arts' business is subject to many risks and uncertainties
which may affect our future financial performance. Some of those important risks
and uncertainties which may cause our operating results to vary or which may
materially and adversely affect our operating results are as follows:
Risk Factors Relating to Our Core Business
Platform Transitions Such as the One Now Occurring Typically Depress the Market
for Video game Software Until New Platforms Achieve a Wide Market Acceptance
When new video game platforms are announced or introduced into the
market, consumers typically reduce their purchases of video games for current
platforms in anticipation of new platforms being available. During that period
sales of our video game products can be expected to slow or even decline until
new platforms have achieved a wide market and consumer acceptance. We are
currently in such a transition. Sony expects to ship its PlayStation 2 product
in the fall of 2000. Nintendo and Microsoft have also announced that their new
console systems will be released in calendar year 2001. Current sales of our
products for the existing PlayStation and Nintendo 64 platforms have been
adversely affected. We expect this trend to continue until one or more of these
new consoles achieve a wide installed base of consumers.
New Video Game Platforms Create Additional Technical and Business Model
Uncertainties
Large portions of our revenues are derived from the sale of products
for play on proprietary video game platforms such as the Sony PlayStation and
Nintendo 64. The success of our products is significantly affected by acceptance
of the new video game hardware systems and the life span of older hardware
platforms and our ability to accurately predict which platforms will be most
successful.
Sometimes we will spend development and marketing resources on products
designed for new video game systems that have not yet achieved large installed
bases or will continue product development for older hardware platforms that may
have shorter life cycles than we expected. Conversely, if we do not develop for
a platform that achieves significant market acceptance, or discontinue
development for a platform that has a longer life cycle than expected, our
revenue growth may be adversely affected.
For example, the Sega Dreamcast console launched in Japan in early 1999
and in the United States in September of 1999. We have no products under
development for this platform. Should this platform achieve wide market
acceptance, our revenue growth may be adversely affected. Similarly, we intend
to launch a variety of products for the new Sony platform, the PlayStation 2,
expected to be released in the United States in the fall of 2000. Should that
platform not achieve wide acceptance by consumers, we will have spent a
disproportionate amount of our resources for this platform. Additionally, we
have not negotiated publishing agreements with Sony, Sega or Nintendo for their
next generation platforms, and we do not know whether the terms of those
agreements will be favorable.
Product Development Schedules Are Frequently Unreliable and Make Predicting
Quarterly Results Difficult
Product development schedules, particularly for new hardware platforms
and high-end multimedia personal computers, or PCs, are difficult to predict
because they involve creative processes, use of new development tools for new
platforms and the learning process, research and experimentation associated with
development for new technologies. For example, Tiberian Sun, which was expected
to ship in fiscal 1999 at the time of our acquisition of Westwood Studios, was
not released until the second quarter of fiscal 2000 due to development delays.
Additionally, development risks for CD-ROM products can cause particular
difficulties in predicting quarterly results because brief manufacturing lead
times allow finalizing products and projected release dates late in a quarter.
Our revenues and earnings are dependent on our ability to meet our product
release schedules, and our failure to meet those schedules could result in
revenues and earnings which fall short of analysts' expectations for any
individual quarter and the fiscal year.
Our Business Is Both Seasonal and Cyclical
Our business is seasonal with a significant percentage of our revenues
occurring in the December quarter. Our business is also cyclical; video game
platforms have historically had a life cycle of four to six years, and decline
as more advanced platforms are being introduced. As one group of platforms is
reaching the end of its cycle and new platforms are emerging, buying patterns
may
36
change. Purchases of products for older platforms may slow at a faster rate than
sales of new platforms. We are currently beginning such a platform transition.
Sega introduced its latest platform in the United States in September 1999, and
Sony expects to ship its PlayStation 2 product in the fall of 2000. Nintendo and
Microsoft have also announced that their new console systems will be released in
calendar year 2001. Sales of our current products for the current Nintendo and
Sony platforms have already been adversely affected, and we expect this trend to
continue until one or more new platforms achieves a wide installed base of
consumers.
The Impact of e-Commerce and Online Games on Our Business Is Not Known
While we do not currently derive significant revenues from online sales
of our packaged products, we believe that such form of distribution will become
a more significant factor in our business in the future. E-commerce is becoming
an increasingly popular method for conducting business with consumers. How that
form of distribution will affect the more traditional retail distribution, at
which we have historically had success, and over what time period, is uncertain.
In addition, we expect the number and popularity of online games to increase and
become a significant factor in the interactive games business generally. We do
not know how that increase generally, or the emerging business of EA.com
specifically, will affect the sales of packaged goods.
Our Business, Our Products, and Our Distribution Are Subject to Increasing
Regulation in Key Territories
Legislation is increasingly introduced which may affect the content of
our products and their distribution. For example, privacy rules in the United
States and Europe impose various restrictions on our web sites. Those rules vary
by territory while of course the Internet recognizes no geographical boundaries.
Other countries such as Germany have adopted laws regulating content transmitted
over the Internet that are stricter than current United States laws. In the
United States, in response to recent events, the federal and several state
governments are considering content restrictions on products such as those made
by us as well as restrictions on distribution of such products. Any one or more
of these factors could harm our business.
Our Platform Licensors Are Our Chief Competitors and Frequently Control the
Manufacturing of Our Video Game Products
Our agreements with hardware licensors, which are also our chief
competitors, typically give significant control to the licensor over the
approval and manufacturing of our products. This fact could, in certain
circumstances, leave us unable to get our products approved, manufactured and
shipped to customers. In most events, control of the approval and manufacturing
process by the platform licensors increases both our manufacturing lead times
and costs as compared to those we can achieve independently. For example, in
prior years, we experienced delays in obtaining approvals for and manufacturing
of PlayStation products which caused delays in shipping those products. The
potential for additional delay or refusal to approve or manufacture our products
continues with our platform licensors. Such occurrences would harm our business
and adversely affect our financial performance.
Proliferation and Assertion of Patents Poses Serious Risks to our Business
Many patents have been issued that may apply to widely used game
technologies. Additionally, many less recently issued patents are now being
asserted against Internet implementations of existing games. Several such
patents have been asserted against us. For example, we currently have a lawsuit
pending regarding our publication of games that can be played both alone and
with others over the Internet in which the patent holder has moved to enjoin the
sale of EA personal computer products that can be played alone and over the
Internet. Such claims can harm our business. We will incur substantial expenses
in evaluating and defending against such claims, regardless of the merits of the
claims. In the event that there is a determination that we have infringed a
third party patent, we could incur significant monetary liability and be
prevented from using the rights in the future.
Risk Factors Relating to Our Online Business
Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate
its Business and Prospects
EA.com's business is still in the developing stages, so evaluating its
business and prospects will be more difficult than would be the case for a more
mature business. We will continue to encounter the risks and difficulties faced
in launching a new business, and we may not achieve our goals or may be
compelled to change the manner in which we seek to develop the business. These
uncertainties as to the future operations of EA.com will increase the difficulty
we face in completing and pursuing the essential plans for the development of
the business and will also make it more difficult for our stockholders and
securities analysts to predict the operating results of this business.
37
EA.com Has a History of Losses and Expects To Continue To Incur Losses and May
Never Achieve Profitability
EA.com has incurred substantial losses to date, including the current
fiscal year. We expect EA.com to continue to incur losses as it develops its
business. EA.com will be required to maintain the significant support, service
and product enhancement demands of online users, and we cannot be certain that
EA.com will produce sufficient revenues from its operations to support these
costs. Even if profitability is achieved, EA.com may not be able to sustain it
over a period of time.
Our Agreements with America Online May Not Prove Successful to the Development
of EA.com's Business
We have announced a series of agreements with America Online for the
offering of our games through AOL for online play. These agreements require that
we make substantial guaranteed payments to AOL and that we commit our resources
to 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.
Further, we are required under our agreement with AOL to launch our game site
within a specified time period or be subject to certain penalties, including
AOL's right to terminate the agreement. We were not successful in meeting a June
1, 2000 initial launch target and we may not be successful in achieving other
specified launch targets. See additional discussion relating to our agreements
with AOL in Note 5 of the Notes to Consiolidated Financial Statements, included
in item 8 hereof. The success for us of the AOL agreements will also be a result
of AOL's performance under the agreements, a factor over which we will have very
little control.
We Have Very Limited Experience with Online Games and May Not Be Able To Operate
This Business Effectively
Offering games solely for online play is a substantial departure from
our traditional business of selling packaged software games. We anticipate
employing various pricing models, including subscription fees, "pay to play
fees" and advertising. We have very little experience with developing optimal
pricing strategies for online games and no experience in "pay to play" pricing
or in securing advertising revenue for online services. Similarly, we are
inexperienced in predicting usage patterns for our games. Because of our
inexperience in this area, we may not be effective in achieving success that may
otherwise be attainable from offering our games online.
Online Games Have Risks That Are Not Associated with Our Traditional Business
Online games, particularly multiplayer games, pose risks to player
enjoyment that do not generally apply to packaged game sales. Players frequently
would not be acquainted with other players, which may adversely affect the
playing experiencing. Social issues raised by a player's conduct may impact the
experience for other players. We have not determined whether or how we might
monitor or proctor player behavior to mitigate behavior that impairs the game
experience. In addition, there are substantial technical challenges to be met
both in the introduction of our games online and in maintaining an effective
game playing environment over time. If these risks are not successfully
controlled and technical challenges resolved, potential customers for our games
may be unwilling to play in sufficient volume to allow us to attain or sustain
profitability.
We May Not Be Able To Obtain the Required Licenses To Offer Our Games Online
If we are unable to reach terms with certain licensors for our games,
we will not be able to offer certain of our games for online play. Many of
Electronic Arts' most popular games feature characters, trademarks, people or
concepts for which we have licenses from third parties. As an example, our EA
SPORTS products typically contain content licensed from a sports and players'
association. In certain instances the terms of these licenses will not allow us
to offer the games for online play without negotiating an additional license. We
cannot be certain that the licensors will be amenable to a license for online
games involving their content or, even if they are, that we will be able to
reach terms with them for such use. We may be forced to agree to terms that
ultimately materially impair the economic value to us of the online game market.
Proliferation and Assertion of Patents Poses Serious Risks to the Business of
EA.com.
Many patents have been issued that may apply to widely used Internet
technologies. Additionally, many less recently issued patents are now being
asserted against Internet implementations of older technologies. Several such
patents have been asserted against us. For example, we currently have a lawsuit
pending regarding our publication of games that can be played both alone and
with others over the Internet in which the patent holder has moved to enjoin the
sale of EA personal computer products that can be played alone and over the
Internet. Such claims can harm our business. We will incur substantial expenses
in evaluating and defending against such claims, regardless of the merits of the
claims. In the event that there is a determination that we have infringed a
third party patent, we could incur significant monetary liability and be
prevented from using the rights in the future.
38
Development of EA.com's Business Will Require Significant Capital, and We Cannot
Be Assured That It Will Be Available
EA.com will not be successful if it does not receive the very
substantial financing that will be required to launch its business. Electronic
Arts has agreed to provide a limited amount of funding to EA.com, but this
financing alone will not be sufficient for the development of EA.com's business.
Any additional funding that is obtained from EA may either be treated as a
revolving credit advance or would increase EA's retained interest in EA.com and
correspondingly decrease the interest of the holders of outstanding shares of
Class B common stock. The attraction of additional equity or debt financing for
EA.com from third parties may not be possible or may only be possible on terms
that result in significant dilution to Class A and Class B common stockholders
or interest or other costs and debt-related restrictions on the operation of the
business.
If Use of the Internet Does Not Continue To Develop and Reliably Support the
Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed
EA.com's success depends upon growth in the use of the Internet as a
medium for playing games. Although the Internet is experiencing rapid growth in
the number of users, this growth is a recent phenomenon and may not continue.
Furthermore, despite this growth in usage, the use of the Internet for
sophisticated games like ours is relatively new. Our business would be seriously
harmed if:
o use of the Internet does not continue to increase or increases more
slowly than expected,
o the infrastructure for the Internet does not effectively support online
game play,
o concerns over the secure transmission of confidential information over
public networks inhibit the growth of the Internet as a means of
conducting commercial transactions, or
o government regulations regarding Internet content, privacy or other
conditions impede the effectiveness of the Internet to users.
Capacity Restraints May Restrict the Use of the Internet as a Forum for Game
Play, Resulting in Decreased Demand for Our Products
The Internet infrastructure may not be able to support the demands
placed on it by increased usage or the limited capacity of networks to transmit
large amounts of data. Other risks associated with commercial use of the
Internet could slow its growth, including:
o outages and other delays resulting from the inadequate reliability of
the network infrastructure,
o slow development of enabling technologies and complementary products,
and
o limited availability of cost-effective, high speed access.
Delays in the development or adoption of new equipment standards or
protocols required to handle increased levels of Internet activity, or increased
governmental regulation, would cause the Internet to fail to gain, or lose,
viability as a means of game playing. If these or any other factors cause use of
the Internet for commerce to slow or decline, the Internet may not prove viable
as a commercial marketplace. This, in turn, would result in decreased demand for
EA.com's products and services.
To Become and Remain Competitive, EA.com Must Continually Develop and Expand New
Content. This Is Inherently Risky and Expensive.
EA.com's success depends on our ability to develop products and
services for the initial launch of the EA.com site and our ability to
continually expand the content on that site. Our agreement with AOL requires us
to develop new games under our relationship with AOL. We cannot assure you that
products will be developed on time, in a cost effective manner, or that they
will be successful.
39
We May Not Be Able To Respond to Rapid Technological Change.
The market for Internet products and services is characterized by rapid
technological change and evolving industry standards. Both in completing the
design and implementation of our network infrastructure and thereafter, we will
be required to continually improve performance, features, reliability and
capacity of our network infrastructure. We cannot assure you that we will be
successful in responding rapidly or in a cost effective manner to such
developments.
Increasing Governmental Regulation of the Internet Could Limit the Market for
Our Products
As Internet commerce continues to evolve, we expect that federal, state
and foreign governments will adopt laws and regulations covering issues such as
user privacy, taxation of goods and services provided over the Internet,
pricing, content and quality of products and services. It is possible that
legislation could expose companies involved in electronic commerce to liability,
taxation or other increased costs, any of which could limit the growth of
electronic commerce generally. Legislation could dampen the growth in Internet
usage and decrease its acceptance as a communications and commercial medium. If
enacted, these laws and regulations could limit the market for EA.com's
products.
If We Do Not Maintain Our Relationship with Outside Consultants Such as Andersen
Consulting and Proxicom, Our Ability To Develop Our Online Business Will Be
Impaired
Because approximately 20% of the staff creating, designing, and
developing the infrastructure for EA.com's website and network interface is
being provided by outside consultants such as Andersen Consulting and Proxicom,
losing the business relationship with such consultants would cause EA.com to
lose an important component of its website implementation team. Given the
intense competition for qualified technical consultants, EA.com may not be able
to retain these consultants or, if necessary, replace them. If it cannot do so,
its ability to develop its business will be impaired.
Our Revenues Have Been Heavily Dependent on a Single Product and Would Be
Adversely Affected if That Product's Popularity Were To Decline
EA.com's revenues to date have consisted primarily of revenues from
sales of our online product Ultima Online, and we would be adversely affected if
revenues from that product were to decline for any reason and not be replaced.
We expect the online game market to become increasingly competitive, and it is
possible that other producer's current or future games could cause our revenue
from Ultima Online to decline. In addition, popularity of Ultima Online could
decline over time simply because of consumer preference for new game
experiences.
We Invest Very Heavily in Research and Development and Network Development and
Support for EA.com, and We Cannot Be Assured That We Will Achieve Revenues That
Validate This Level of Spending
We have invested, and expect to continue to invest, very heavily in
research and development and network development and support for our website and
online games. We will need to expand EA.com's revenues substantially for it to
achieve profitability with these levels of expenditure being required, and we
may not be able to do so. If we cannot increase revenues to profitable levels,
the value of EA.com will be impaired. In order to develop the broad games
offerings that we envision for our online operations it will be necessary to
engage in significant developmental efforts both to adapt existing EA games to
the online format and to create new online games. Our agreements with AOL
require us to maintain a substantial commitment to online game development and
we cannot be assured that we will realize acceptable returns from this
investment.
Online Product Development Schedules Are Unreliable and Make Predicting
Quarterly Results Difficult
Online product development schedules, particularly for Internet based
games are difficult to predict because they involve creative processes, use of
new development tools, Internet latency issues, a learning process to better
understand Internet based game mechanics, and research and experimentation
associated with development for new online technologies. Additionally,
development risks for Internet based products can cause particular difficulties
in predicting quarterly results because of the challenges associated with game
testing, live Beta testing, integration into network servers and integration on
to the Games web site and impact the "release, ("go live") dates of products
during a particular quarter. Our revenues and operating costs are dependent on
our ability to meet our product "go live" schedules, and our failure to meet
those schedules could result in revenues falling short of analysts'
expectations, with no corresponding decrease in expenses, resulting in increased
operating losses for EA.com
40
General Risk Factors
We Face Intense Competition for Talent from Highly Valued Internet Companies
Competition for employees in the interactive software business
continues to be intense. Recently, the most intense competition for recruiting
and retaining key employees is from Internet companies. The large equity
positions frequently offered to key executives and creative talent in such
companies and the actual or perceived opportunity for rapid stock price
appreciation of these companies make their compensation packages attractive to
those who are already working in more mature companies. This situation creates
difficulty for us to compete for the attraction and retention of executive and
key creative talent.
Because of the Intense Competition for Qualified Technical, Creative, Marketing
and Other Personnel, We May Not Be Able To Attract and Retain the Personnel
Necessary for our Businesses
The market for technical, creative, marketing and other personnel
essential to the development of online businesses and management of our online
and core businesses is extremely competitive, and we may not be able to attract
and retain the employees we need. In addition, the rising cost of real estate in
the San Francisco Bay area - the location of our headquarters and largest
studio, has increased dramatically, and has made recruiting from other areas and
relocating employees to our headquarters more difficult. If we cannot
successfully recruit and retain the employees we need, our ability to develop
and manage our businesses will be impaired.
Foreign Sales and Currency Fluctuations
For fiscal 2000 international net revenues comprised 40% of total
consolidated net revenues. We expect foreign sales to continue to account for a
significant and growing portion of our revenues. Such sales are subject to
unexpected regulatory requirements, tariffs and other barriers. Additionally,
foreign sales are primarily made in local currencies which may fluctuate. For
example, our European revenues in fiscal 2000 were adversely impacted by a
devaluation of the Euro as compared to the prior year. Our foreign currency
exposure may increase if this trend continues. Any of these factors may
significantly harm our business.
Increased Difficulties in Forecasting Results
During platform transition periods, where the success of our products
is significantly impacted by the changing market for our products, forecasting
our revenues and earnings is more difficult than in more stable or rising
product markets. The demand for our products may decline during a transition
faster than we anticipate, negatively impacting both revenues and earnings.
Fluctuations in Stock Price
Due to analysts' expectations of continued growth and other factors, any
shortfall in earnings could have an immediate and significant adverse effect on
the trading price of our common stock in any given period. As a result of the
factors discussed in this report and other factors that may arise in the future,
the market price of our common stock historically has been, and we expect will
continue to be subject to significant fluctuations over a short period of time.
These fluctuations may be due to factors specific to us, to changes in analysts'
earnings estimates, or to factors affecting the computer, software, Internet,
entertainment, media or electronics businesses or the securities markets in
general. For example, during fiscal year 2000, the price per share of our common
stock ranged from $45.63 to $120.94.
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.
41
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
Market Risk
We are exposed to various market risks, including the changes in foreign
currency exchange rates and interest rates. Market risk is the potential loss
arising from changes in market rates and prices. Foreign exchange contracts used
to hedge foreign currency exposures and short-term investments are subject to
market risk. We do not consider our cash and cash equivalents to be subject to
interest rate risk due to their short maturities. We do not enter into
derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rate Risk
We utilize foreign exchange contracts to hedge foreign currency exposures of
underlying assets and liabilities, primarily certain intercompany receivables
that are denominated in foreign currencies, thereby, limiting our risk. Gains
and losses on foreign exchange contracts are reflected in the income statement.
At March 31, 2000, we had foreign exchange contracts, all with maturities of
less than nine months to purchase and sell approximately $242,143,000 in foreign
currencies, primarily British Pounds, European Currency Units ("Euro"), Canadian
Dollars, Japanese Yen and other currencies.
Fair value represents the difference in value of the contracts at the spot rate
and the forward rate. 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 provides information about our foreign currency forward
exchange contracts at March 31, 2000. The information is provided in U.S. dollar
equivalents and presents the notional amount (forward amount), the weighted
average contractual foreign currency exchange rates and fair value.
- --------------------------------------------------------------------------------
Weighted-
Average
Contract Contract
Amount Rate Fair Value
- --------------------------------------------------------------------------------
(In thousands) (In thousands)
Foreign currency to be sold under contract:
British Pound $111,138 1.5877 $ (469)
Euro 59,378 0.9734 (273)
Japanese Yen 15,476 104.0300 410
Canadian Dollar 13,615 1.4689 (63)
Australian Dollar 6,058 0.6058 (27)
South African Rand 4,686 6.4023 56
Swedish Krona 2,326 8.5993 (19)
Norwegian Krone 1,312 8.3871 (15)
Danish Krone 1,304 7.6716 (6)
Brazilian Real 1,259 1.7480 (11)
Swiss Franc 899 1.6681 (25)
New Zealand Dollar 488 0.4876 (2)
- --------------------------------------------------------------------------------
Total $217,939 $ (444)
- --------------------------------------------------------------------------------
Foreign currency
to be purchased
under contract:
British Pound $ 24,204 1.5944 $ (75)
- --------------------------------------------------------------------------------
Total $ 24,204 $ (75)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Grand total $242,143 $ (519)
- --------------------------------------------------------------------------------
While the contract amounts provide one measurement of the volume of these
transactions, they do not represent the amount of our exposure to credit risk.
The amounts (arising from the possible inabilities of counterparties to meet the
terms of their contracts) are generally limited to the amounts, if any, by which
the counterparties' obligations exceed our obligations as these contracts can be
settled on a net basis at our option. We control credit risk through credit
approvals, limits and monitoring procedures.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio.
42
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 March 31, 2000, our cash equivalents,
short-term and long-term investments included debt securities of $194,769,000.
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 March 31, 2000:
- --------------------------------------------------------------------------------
Average Interest
Rate Cost Fair Value
- --------------------------------------------------------------------------------
(Dollars in thousands)
Cash equivalents(1)
Fixed rate 0.00% $ -- $ --
Variable rate 4.15% $92,830 $92,830
Short-term
investments(1)(2)
Fixed rate 4.05% $83,639 $83,539
Variable rate 6.87% $10,000 $10,000
Long-term
investments(1)
Fixed rate 0.00% $ -- $ --
Variable rate 6.35% $ 8,400 $ 8,162
- --------------------------------------------------------------------------------
(1) See definition in note 1 of the Notes to the Consolidated Financial
Statements.
(2) Maturity dates for short-term investments range from 6 months to 3 years.
43
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Report of Independent Auditors, Consolidated Financial Statements and Notes
to Consolidated Financial Statements follow below on pages 44 through 70.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Electronic Arts Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Electronic Arts
Inc. and subsidiaries as of March 31, 2000 and 1999, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years in the three-year period ended March 31, 2000. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Electronic Arts Inc.
and subsidiaries as of March 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the years in the three-year period
ended March 31, 2000, in conformity with accounting principles generally
accepted in the United States of America.
Mountain View, California KPMG LLP
April 28, 2000
44
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data) As of March 31, 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 339,804 $ 312,822
Marketable securities 236 4,884
Receivables, less allowances of $65,067 and $72,850, respectively 234,087 149,468
Inventories, net 22,986 22,376
Other current assets 108,210 79,915
------------------------------
Total current assets 705,323 569,465
Property and equipment, net 285,466 181,266
Long-term investments 8,400 18,400
Investment in affiliates 22,601 25,864
Goodwill and other intangibles, net 117,236 90,682
Other assets 53,286 16,196
------------------------------
$ 1,192,312 $ 901,873
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 97,703 $ 63,881
Accrued and other liabilities 167,599 172,328
------------------------------
Total current liabilities 265,302 236,209
Minority interest in consolidated joint venture 3,617 2,733
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 64,434,544 and 61,291,849 shares; outstanding
64,434,544 and 61,169,286 shares, respectively 644 613
Class B common stock, $0.01 par value. Authorized 100,000,000 shares;
issued and outstanding 6,000,000 shares in 2000 60 --
Paid-in capital 412,682 267,699
Treasury stock, at cost; 0 and 122,563 shares in 2000 and 1999, respectively -- (4,926)
Retained earnings 516,368 402,112
Accumulated other comprehensive loss (6,361) (2,567)
------------------------------
Total stockholders' equity 923,393 662,931
------------------------------
$ 1,192,312 $ 901,873
==============================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
45
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Years Ended March 31,
2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------
Net revenues $ 1,420,011 $ 1,221,863 $ 908,852
Cost of goods sold 705,808 627,823 481,233
-----------------------------------------------
Gross profit 714,203 594,040 427,619
Operating expenses:
Marketing and sales 188,628 163,407 128,308
General and administrative 92,502 76,219 57,838
Research and development 260,759 199,141 145,732
Charge for acquired in-process technology 6,539 44,115 1,500
Merger costs -- -- 10,792
Amortization of intangibles 11,989 5,880 --
-----------------------------------------------
Total operating expenses 560,417 488,762 344,170
-----------------------------------------------
Operating income 153,786 105,278 83,449
Interest and other income, net 16,028 13,180 24,811
-----------------------------------------------
Income before provision for income taxes and minority interest 169,814 118,458 108,260
Provision for income taxes 52,642 45,414 35,726
-----------------------------------------------
Income before minority interest 117,172 73,044 72,534
Minority interest in consolidated joint venture (421) (172) 28
-----------------------------------------------
Net income $ 116,751 $ 72,872 $ 72,562
===============================================
Net income per share:
Basic $ 1.86 $ 1.20 $ 1.23
Diluted $ 1.76 $ 1.15 $ 1.19
Number of shares used in computation:
Basic 62,830 60,748 58,867
Diluted 66,371 63,272 60,958
<FN>
See accompanying notes to consolidated financial statements, including segment information in note 18.
</FN>
46
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended March 31, 2000, 1999 and 1998
(In thousands)
Accumulated
Class A Class B Other
Common Stock Common Stock Comprehensive Treasury Stock
------------------------------------- Paid-In Retained Income ---------------------
Shares Amount Shares Amount Capital Earnings (Loss) Shares Amount Total
- ------------------------- ----------------------------------------------------------------------------------------------------------
Balances at March 31,
1997 58,263 $583 -- $-- $188,547 $257,978 $ 668 -- $ -- $447,776
Net income 72,562 72,562
Change in unrealized
appreciation of
investments, net 1,882 1,882
Reclassification
adjustment for gains
realized in net
income, net (2,745) (2,745)
Translation adjustment (1,273) (1,273)
--------
Comprehensive income
70,426
Proceeds from sales of
shares through stock
plans 1,897 19 37,729 37,748
Tax benefit related to
stock options 7,931 7,931
Repayment of notes
receivable 87 87
----------------------------------------------------------------------------------------------------------
Balances at March 31,
1998 60,160 602 -- -- 234,294 330,540 (1,468) -- -- 563,968
Net income 72,872 72,872
Change in unrealized
appreciation of
investments, net 2,533 2,533
Reclassification
adjustment for gains
realized in net
income, net (989) (989)
Translation adjustment (2,643) (2,643)
--------
Comprehensive income 71,773
Proceeds from sales of
shares through stock
plans 1,132 11 27,791 (1,300) 100 4,075 30,577
Purchase of treasury stock (223) (9,001) (9,001)
Tax benefit related to
stock options 5,614 5,614
----------------------------------------------------------------------------------------------------------
Balances at March 31,
1999 61,292 613 -- -- 267,699 402,112 (2,567) (123) (4,926) 662,931
==========================================================================================================
47
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (continued)
Years Ended March 31, 2000, 1999 and 1998
(In thousands)
Accumulated
Class A Class B Other
Common Stock Common Stock Comprehensive Treasury Stock
------------------------------------- Paid-In Retained Income ---------------------
Shares Amount Shares Amount Capital Earnings (Loss) Shares Amount Total
- ------------------------- ----------------------------------------------------------------------------------------------------------
Balances at March 31,
1999 61,292 613 - - 267,699 402,112 (2,567) (123) (4,926) 662,931
Net income 116,751 116,751
Change in unrealized
appreciation of
investments, net 1,739 1,739
Reclassification
adjustment for gains
realized in net
income, net (5,194) (5,194)
Translation adjustment (339) (339)
-----------
Comprehensive income
112,957
Proceeds from sales of
shares through stock
plans 3,143 31 83,127 (2,495) 123 4,926 85,589
Issuance of Class B
common stock 6,000 60 27,993 28,053
Issuance of Class B
stock warrant 1,300 1,300
Tax benefit related to
stock options 32,563 32,563
----------------------------------------------------------------------------------------------------------
Balances at March 31,
2000 64,435 $644 6,000 $60 $412,682 $516,368 $(6,361) - $ - $923,393
==========================================================================================================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
48
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended March 31,
(In thousands) 2000 1999 1998
-------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $116,751 $ 72,872 $ 72,562
Adjustments to reconcile net income to net cash provided by operating
activities:
Minority interest in consolidated joint venture 421 172 (28)
Equity in net (income) loss of affiliates (1,138) 155 1,162
Gain on sale of affiliate (842) - (12,625)
Depreciation and amortization 46,725 40,461 26,907
Loss on sale of fixed assets 31 729 1,813
Loss on disposition of assets related to merger - - 5,607
Gain on sale of marketable securities (7,528) (1,454) (4,098)
Provision for doubtful accounts 6,714 6,027 4,302
Charge for acquired in-process technology 6,539 44,115 1,500
Change in assets and liabilities, net of acquisitions:
Receivables (77,779) (11,702) (40,432)
Inventories (579) 1,282 (1,753)
Other assets (69,727) (24,266) (5,660)
Accounts payable 29,673 1,622 12,783
Accrued liabilities (6,919) 32,797 29,217
Deferred income taxes 2,994 (12,042) (12,264)
----------------------------------------------
Net cash provided by operating activities 45,336 150,768 78,993
----------------------------------------------
INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 444 8,281 25
Proceeds from sales of marketable securities, net 8,598 1,818 4,514
Proceeds from sale of affiliate 8,842 - -
Capital expenditures (134,884) (115,820) (45,238)
Investment in affiliates, net (4,099) (5,478) 16,579
Purchase of held-to-maturity securities - - (1,008)
Proceeds from maturity of securities - 17,306 13,338
Change in short-term investments, net (13,860) 76,755 (34,504)
Acquisition of Westwood Studios, Inc. - (122,688) -
Acquisition of Kesmai (22,500) - -
Acquisition of other subsidiaries, net of cash acquired (22,096) (11,805) (3,225)
----------------------------------------------
Net cash used in investing activities (179,555) (151,631) (49,519)
----------------------------------------------
FINANCING ACTIVITIES:
Proceeds from sales of Class A shares through employee
stock plans and other plans 85,589 30,577 37,748
Proceeds from sales of Class B shares and stock warrants to AOL 20,000 - -
Purchase of treasury shares - (9,001) -
Repayment of notes receivable - - 87
Tax benefit from exercise of stock options 32,563 5,614 7,931
Proceeds from minority interest investment in consolidated joint venture - 2,109 -
----------------------------------------------
Net cash provided by financing activities 138,152 29,299 45,766
----------------------------------------------
Translation adjustment 124 (2,191) (1,273)
----------------------------------------------
Increase in cash and cash equivalents 4,057 26,245 73,967
Beginning cash and cash equivalents 242,208 215,963 141,996
----------------------------------------------
Ending cash and cash equivalents 246,265 242,208 215,963
Short-term investments 93,539 70,614 158,597
----------------------------------------------
Ending cash, cash equivalents and short-term investments $339,804 $312,822 $374,560
==============================================
Supplemental cash flow information:
Cash paid during the year for income taxes $ 15,525 $ 43,050 $ 32,888
==============================================
Non-cash investing activities:
Class B common stock issued in connection with the Kesmai acquisition $ 9,353 $ - $ -
Change in unrealized appreciation of investments and marketable securities $ (5,008) $ 1,805 $ (1,411)
==============================================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
49
ELECTRONIC ARTS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2000, 1999 and 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The accompanying consolidated financial statements include the accounts of
Electronic Arts Inc. and its wholly-owned and majority-owned subsidiaries (the
"Company"). All significant intercompany balances and transactions have been
eliminated in consolidation.
A summary of the significant accounting policies applied in the preparation
of the accompanying consolidated financial statements of the Company follows:
(a) Fiscal Year
The Company's fiscal year is reported on a 52/53-week period that ends on the
Saturday nearest to March 31 in each year. The results of operations for fiscal
2000, 1999 and 1998 contain 52 weeks. For clarity of presentation herein, all
fiscal periods are treated as ending on a calendar month end.
(b) Revenue Recognition
The Company's revenue recognition policies are in compliance with American
Institute of Certified Public Accountants Statement of Position ("SOP") 97-2,
"Software Revenue Recognition", and SOP 98-4, "Deferral of the Effective Date of
a Provision of SOP 97-2", which provide guidance on generally accepted
accounting principles for recognizing revenue on software transactions. SOP 97-2
requires that revenue recognized from software arrangements be allocated to each
element of the arrangement based on the relative fair values of the elements.
The Company has adopted the provisions of these SOPs as of April 1, 1998. The
adoption has, in certain circumstances, resulted in the deferral of certain
revenues associated with the Company's sales promotions and products with
multiple deliverable elements. Neither the changes in certain business practices
nor the deferral of certain revenues have resulted in a material impact on the
Company's operating results, financial position or cash flows for the fiscal
year ended March 31, 2000. Total deferred revenue at March 31, 2000 and 1999 was
$1,847,000, and $8,206,000, respectively.
In December 1998, the Accounting Standards Executive Committee of the AICPA
issued SOP 98-9, "Software Revenue Recognition, with Respect to Certain
Arrangements," which required recognition of revenue using the "residual method"
in a multiple element arrangement when fair value does not exist for one or more
of the undelivered elements in the arrangement. SOP 98-9 is effective for
transactions entered into after March 15, 1999. Under the "residual method", the
total fair value of the undelivered elements is deferred and subsequently
recognized in accordance with SOP 97-2. The adoption of SOP 98-9 in fiscal year
2000 did not have a material change in the accounting for revenues for the
Company.
Product Sales: The Company recognizes revenue upon shipment of its packaged
goods products based on "FOB Shipping" terms. Under FOB Shipping terms, title
and risk of loss are transferred when the products are delivered to the
customer. In order to recognize revenue, the Company must not have any
continuing obligations and it must also be probable that the Company will
collect the accounts receivable. Subject to certain limitations, the Company
permits customers to obtain exchanges within certain specified periods and
provides price protection on certain unsold merchandise. Revenue is recognized
net of an allowance for returns and price protection.
Online Subscription Revenues: Online subscription revenues are derived
principally from subscription revenues collected from customers for online play,
who are only contractually obligated for pay on a month-to-month basis. Prepaid
monthly subscription revenues, including revenues collected from credit card
sales as well as sales of Gametime subscription cards, are deferred and
subsequently recognized ratably over the period for which the hosting services
are provided.
Software Licenses: For those agreements which provide the customers the right to
multiple copies in exchange for guaranteed minimum royalty amounts, revenue is
recognized at delivery of the product master or the first copy. Per copy
royalties on sales that exceed the guarantee are recognized as earned.
Revenue from the licensing of software was $21,704,000, $17,788,000, and
$15,431,000 for the fiscal years ended March 31, 2000, 1999 and 1998,
respectively.
(c) Cash and Investments
Cash equivalents consist of highly liquid investments with insignificant rate
risk and with maturities of three months or less at the date of purchase.
Short-term investments include securities with maturities greater than three
months and less than one year, except for certain investments with stated
maturities greater than one year. Long-term investments consist of securities
with maturities greater than one year.
The Company accounts for investments under Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," ("SFAS 115"). The Company's policy is to protect the value of its
investment portfolio and to minimize principal risk by earning returns based on
current interest rates. Management determines the appropriate classification of
its debt and equity
50
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. Debt securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold the securities to maturity.
Securities classified as held-to-maturity are carried at amortized cost, which
is adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. Debt securities, not
classified as held-to-maturity, are classified as available-for-sale and are
stated at fair value. Securities sold is based on the specific identification
method.
(d) Prepaid Royalties
Prepaid royalties consist primarily of prepayments for manufacturing royalties,
original equipment manufacturer (OEM) fees and license fees paid to celebrities
and professional sports organizations for use of their trade name. Also included
in prepaid royalties are prepayments made to independent software developers
under development arrangements that have alternative future uses. Prepaid
royalties are expensed at the contractual royalty rate as cost of goods sold
based on actual net product sales. Management evaluates the future realization
of prepaid royalties quarterly and charges to income any amounts that management
deems unlikely to be realized through product sales. Royalty advances are
classified as current and non-current assets based upon estimated net product
sales for the following year. The current portion of prepaid royalties, included
in other current assets, was $54,970,000 and $35,057,000 at March 31, 2000 and
1999, respectively. The long-term portion of prepaid royalties, included in
other assets, was $11,373,000 and $7,602,000 at March 31, 2000 and 1999,
respectively.
(e) Software Development Costs
Research and development costs, which consist primarily of software development
costs, are expensed as incurred. Statement of Financial Accounting Standards No.
86, "Accounting for the Cost of Computer Software to be Sold, Leased, or
Otherwise Marketed" ("SFAS 86"), provides for the capitalization of certain
software development costs incurred after technological feasibility of the
software is established or for development costs that have alternative future
uses. Under the Company's current practice of developing new products, the
technological feasibility of the underlying software is not established until
substantially all product development is complete, which generally includes the
development of a working model. The software development costs that have been
capitalized to date have been insignificant.
(f) Inventories
Inventories are stated at the lower of cost or market. Inventories at March 31,
2000 and 1999 consisted of:
======================================= =========== ============
2000 1999
- --------------------------------------- ----------- ------------
(in thousands)
Raw materials and work in process $ 920 $ 2,983
Finished goods 22,066 19,393
- --------------------------------------- ----------- ------------
$22,986 $22,376
- --------------------------------------- ----------- ------------
(g) Advertising Costs
The Company generally expenses advertising costs as incurred, except for
production costs associated with media campaigns which are deferred and charged
to expense at the first run of the ad. Cooperative advertising with distributors
and retailers is accrued when revenue is recognized. Cooperative advertising
credits are reimbursed when qualifying claims are submitted. For the fiscal
years ended March 31, 2000, 1999 and 1998, advertising expenses totaled
approximately $87,377,000, $72,437,000 and $55,090,000, respectively.
(h) Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the
accelerated and straight-line methods over the following useful lives:
- ----------------------------- ------------------------------------
Buildings 20 to 25 years
- ----------------------------- ------------------------------------
Computer equipment and
software 3 to 7 years
- ----------------------------- ------------------------------------
Furniture and equipment 3 to 7 years
- ----------------------------- ------------------------------------
Leasehold improvements Lesser of the lease terms or the
estimated useful lives of the
improvements
- ----------------------------- ------------------------------------
(i) Intangible Assets
Intangible assets net of amortization at March 31, 2000 and 1999, of
$117,236,000, and $90,682,000, respectively, include goodwill, costs of
obtaining product technology and noncompete covenants which are amortized using
the straight-line method over the lesser of their estimated useful lives or the
agreement terms, typically from two to twelve years. Amortization expense for
fiscal years ended March 31, 2000, 1999 and 1998 was $11,989,000, $5,880,000,
and $692,000, respectively. The Company assesses the recoverability of goodwill
by determining whether the carried value of the assets may be recovered through
estimated future cash flows.
(j) Income Taxes
Income tax expense is based on reported earnings before income taxes. Deferred
income taxes reflect the impact of temporary differences between assets and
liabilities recognized for financial reporting purposes and such amounts
recognized for tax purposes.
51
(k) Foreign Currency Translation
For each of the Company's foreign subsidiaries the functional currency is its
local currency. Assets and liabilities of foreign operations are translated into
U.S. dollars using current exchange rates, and revenues and expenses are
translated into U.S. dollars using average exchange rates. The effects of
foreign currency translation adjustments are deferred and included as a
component of accumulated other comprehensive income (loss) in stockholders'
equity.
Foreign currency transaction gains and losses are a result of the effect of
exchange rate changes on transactions denominated in currencies other than the
functional currency. Included in interest and other income in the statements of
income are foreign currency transaction losses of $1,781,000, $1,168,000 and
$517,000, for the fiscal years ended March 31, 2000, 1999 and 1998,
respectively.
(l) Net Income Per Share
The following summarizes the computations of Basic Earnings Per Share ("EPS")
and Diluted EPS. Basic EPS is computed as net earnings divided by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock-based compensation plans including stock options, restricted stock
awards, warrants and other convertible securities using the treasury stock
method.
(In thousands, except for per share amounts):
=========================== ====================================
Years Ended March 31,
2000 1999 1998
- --------------------------- ------------ ----------- -----------
Net income $116,751 $72,872 $72,562
- --------------------------- ------------ ----------- -----------
Shares used to compute
net income per share:
Weighted-average
common shares 62,830 60,748 58,867
Dilutive stock options 3,541 2,524 2,091
- --------------------------- ------------ ----------- -----------
Dilutive potential common
shares 66,371 63,272 60,958
- --------------------------- ------------ ----------- -----------
Net income per share:
Basic $ 1.86 $ 1.20 $ 1.23
Diluted $ 1.76 $ 1.15 $ 1.19
Excluded from the above computation of weighted-average shares for diluted EPS
for the fiscal years ended March 31, 2000, 1999 and 1998 were options to
purchase 229,000, 645,000 and 137,000 shares of common stock, respectively, as
the options' exercise price was greater than the average market price of the
common shares. For the fiscal year ended March 31, 2000, the weighted-average
exercise price of the respective options was $81.88. Class B common stock,
authorized on March 22, 2000 was excluded from the Company's calculations of
basic and diluted EPS because its impact on the calculations is immaterial.
(m) Employee Benefits
The Company has a 401(k) Plan covering substantially all of its U.S. employees.
The 401(k) Plan permits the Company to make discretionary contributions to
employees' accounts based on the Company's financial performance. The Company
contributed $1,799,000, $2,092,000 and $902,000 to the Plan in fiscal 2000,
fiscal 1999 and fiscal 1998, respectively.
(n) Stock-based Compensation
The Company accounts for stock-based awards to employees using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25").
(o) Impact of Recently Issued Accounting Standards
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101("SAB 101"), "Revenue Recognition," which outlines
the basic criteria that must be met to recognize revenue and provides guidance
for presentation of revenue and for disclosure related to revenue recognition
policies in financial statements filed with the SEC. SAB 101 is effective for
fiscal years beginning after December 15, 1999, except, as amended by SAB 101A,
registrants with fiscal years that begin between December 16, 1999 and March 15,
2000 may report a change in accounting principle no later than the second
quarter of fiscal years beginning after December 15, 1999. The Company believes
the adoption of SAB 101 will not have a material impact on the Company's
financial position and results of operations.
In March 2000, the Emerging Issues Task Force issued No. 00-02 ("EITF 00-02"),
"Accounting for Web Site Development Costs". EITF 00-02 states that all costs
relating to software used to operate a web site and relating to development of
initial graphics and web page design should be accounted for using Statement of
Position ("SOP") 98-1. Under this SOP, costs incurred in the preliminary project
stage should be expensed as incurred, as should most training and data
conversion costs. External direct costs of materials and services and internal
direct payroll-related costs should be capitalized once certain criteria are
met. EITF 00-02 is effective for all fiscal quarters beginning after June 30,
2000. The Company does not expect a significant impact on the consolidated
results of operations, financial position or cash flows on the EITF's effective
date.
In March 2000, the Emerging Issues Task Force issued No. 00-03 ("EITF 00-03"),
"Application of AICPA SOP 97-2, "Software Revenue Recognition," to Arrangements
That Include the Right to Use Software Stored on Another Entity's Hardware",
which discusses the effect on revenue recognition of a software vendor's
obligation to host its software that previously was licensed to a customer. The
EITF has reached the conclusion that, if the customer is unable to utilize the
52
software on the customer's hardware or contract with another party unrelated to
the vendor to host the software, then the arrangement with the customer is
outside the scope of SOP 97-2 and should be treated as a service contract. The
Company may be required to change the timing of its revenue recognition related
to product revenues. The Company believes the adoption of EITF 00-03 will not
have a material impact on the Company's financial position and results of
operations.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities", which establishes accounting and
reporting standards for derivative instruments and hedging activities. SFAS 133
is effective as of the beginning of the first quarter of the fiscal year
beginning after June 15, 2000. The Company is determining the effect of SFAS 133
on its financial statements.
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". SOP 98-1 requires that consulting, hardware,
software and direct payroll-related costs associated with the implementation of
customized internal-use software be capitalized and amortized over the estimated
useful life of the software. These costs relate to game site application and
infrastructure design and development, as well as costs related to providing
customer account management and building in e-Commerce functionality and
interfaces. SOP 98-1 is effective for financial statements issued for fiscal
years beginning after December 15, 1998. As of March 31, 2000, the Company has
capitalized $26,318,000 of these costs associated with the effort to build and
support the EA.com game sites at launch.
(p) Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. Such
estimates include provisions for doubtful accounts, sales returns and
allowances, warranty provisions, and estimates regarding the recoverability of
prepaid royalty advances and inventories. Actual results could differ from those
estimates.
(q) Reclassifications
Certain amounts have been reclassified to conform to fiscal 2000 presentation.
(r) Long-Lived Assets
The Company evaluates long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets is
measured by a comparison of the carrying amount of an asset to future net cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the asset exceeds its fair value.
(2) APPROVAL OF THE TRACKING STOCK PROPOSAL
On March 22, 2000, the stockholders of Electronic Arts voted on and approved a
proposal (the "Tracking Stock Proposal") to authorize the issuance of a new
series of common stock to be designated as Class B common stock ("Tracking
Stock"), intended to reflect the performance of Electronic Arts' online and
e-Commerce division ("EA.com"). As a result of the approval of the Tracking
Stock Proposal, Electronic Arts' existing common stock has been re-classified as
Class A common stock ("Class A Stock") and that stock will reflect the
performance of Electronic Arts' other businesses ("EA Core").
(3) FINANCIAL INSTRUMENTS
(a) Cash and Investments
===================================== ===========================
March 31,
2000 1999
- ------------------------------------- ------------- -------------
(in thousands)
Cash and cash equivalents:
Cash $153,436 $106,641
Municipal securities 81,326 -
Money market funds 11,503 135,567
- ------------------------------------- ------------- -------------
Cash and cash equivalents 246,265 242,208
- ------------------------------------- ------------- -------------
Short-term investments:
Available-for-sale
Municipal securities 76,513 21,700
Corporate bonds 3,013 -
U.S. Agency bonds 4,013 -
Money market preferreds - 43,114
Held-to-maturity
U.S. Treasury securities 10,000 5,800
- ------------------------------------- ------------- -------------
Short-term investments 93,539 70,614
- ------------------------------------- ------------- -------------
Cash, cash equivalents and short-
term investments $339,804 $312,822
- ------------------------------------- ------------- -------------
- ------------------------------------- ------------- -------------
Long-term investments:
U.S. Treasury securities $ 8,400 $ 18,400
- ------------------------------------- ------------- -------------
Long-term and short-term held-to-maturity investments include commercial notes
with original maturities of five to eight years secured by U.S. Treasury Notes
which enable the Company to take advantage of certain tax incentives from its
Puerto Rico operation. These investments are treated as held-to-maturity for
financial reporting purposes.
53
The fair value of held-to-maturity securities at March 31, 2000 was $18,162,000
which included gross unrealized losses of $238,000. The fair value of
held-to-maturity securities at March 31, 1999 was $24,353,000 which included
gross unrealized gains of $153,000.
(b) Marketable Securities
Marketable securities are comprised 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 net unrealized appreciation
reported as a separate component of accumulated other comprehensive income
(loss) in stockholders' equity. Marketable securities had an aggregate cost of
$15,000 and $585,000 at March 31, 2000 and 1999, respectively. At March 31,
2000, marketable securities included gross unrealized gains of $221,000. At
March 31, 1999 marketable securities included gross unrealized gains of
$4,299,000.
For the fiscal years ended March 31, 2000 and 1999, the fair value of marketable
securities sold was $8,604,000 and $1,818,000, respectively. The gross realized
gains from these sales totaled $7,528,000 and $1,454,000 for fiscal 2000 and
1999, respectively. The gain on sale of investments is based on the specific
identification method.
(c) Foreign Currency Forward Exchange Contracts
The Company utilizes 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.. The Company does not use forward exchange contracts for speculative or
trading purposes. The Company's accounting policies for these instruments are
based on the Company's designation of such instruments as hedging transactions.
The criteria the Company uses for designating an instrument as a hedge include
the instrument's effectiveness in risk reduction and one-to-one matching of
forward exchange contracts to underlying transactions. Gains and losses on
currency forward contracts that are designated and effective as hedges of firm
commitments are deferred and recognized in income in the same period that the
underlying transactions are settled. Gains and losses on currency forward
contracts that are designated and effective as hedges of existing transactions
are recognized in income in the same period as losses and gains on the
underlying transactions are recognized and generally offset. Gains and losses on
any instruments not meeting the above criteria would be recognized in income in
the current period. The Company transacts business in various foreign
currencies. At March 31, 2000, the Company had foreign exchange contracts, all
with maturities of less than nine months, to purchase and sell approximately
$242,143,000 in foreign currencies, primarily in British Pounds, Euro, Canadian
Dollars, Japanese Yen and other European currencies.
Fair value represents the difference in value of the contracts at the spot rate
and the forward rate, plus the unamortized premium or discount. At March 31,
2000, fair value of these contracts is not significant. 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 risk, there can be no assurances that our hedging activities will
adequately protect us against the risks associated with foreign currency
fluctuations.
(4) COMMITMENTS
Lease Obligations
The Company leases certain of its current facilities and certain equipment under
non-cancelable operating lease agreements. The Company is required to pay
property taxes, insurance and normal maintenance costs for certain of its
facilities and will be required to pay any increases over the base year of these
expenses on the remainder of the Company's facilities.
In February 1995, the Company entered into a master operating lease, as
subsequently amended, for land and a building to be constructed in Redwood City,
California. The initial term of the lease is for a period of three years from
November 30, 1998. Monthly lease payments are based upon the London InterBank
Offered Rate. The Company has the option to purchase the property for the
unamortized financed balance at any time after the non-cancelable lease term, or
it may terminate the lease at any time after the non-cancelable term by
arranging a third party sale or by making a termination payment. Should the
Company elect to terminate the lease, it will guarantee a residual value of up
to 85% of the unamortized value of the property. As part of the agreement, the
Company must also comply with certain financial covenants.
Total future minimum lease commitments as of March 31, 2000 are:
======================================= ========================
Year Ended March 31: (in thousands)
2001 $22,760
2002 16,477
2003 7,266
2004 5,681
2005 3,745
Thereafter 7,719
- --------------------------------------- ------------------------
$63,648
- --------------------------------------- ------------------------
Total rent expense for all operating leases was $23,591,000, $19,480,000 and
$13,842,000, for the fiscal years ended March 31, 2000, 1999 and 1998,
respectively.
54
(5) AMERICA ONLINE, INC. ("AOL") AGREEMENT
In November 1999, Electronic Arts Inc., EA.com and AOL entered into a five year
agreement which establishes the basis for EA.com's production of a games site on
the world wide web that will be available to AOL subscribers and to users of
other branded AOL properties. Under this agreement, EA.com is required to launch
its site no later than June 1, 2000, although, under certain circumstances
described in the agreement, this date can be extended to September 1, 2000. If
the site is not launched within the specified time frame, and if prescribed
additions to the site are not achieved within a specified time frame or the site
does not contain content as required under the agreement, then, under certain
circumstances, AOL would have the ability to terminate the agreement.
The Company is required to pay $50,000,000 to AOL as a carriage fee (including
certain advertising fees of which $604,000 was expensed for the fiscal year
ended March 31, 2000) under the AOL agreement. Of this amount, $25,000,000 was
paid upon signing the agreement and the remainder is due in four equal
installments on the first four anniversaries of the initial payment. Payment of
the first annual installment of $6,250,000 will be accelerated to June 1, 2000
since certain launch requirements will not be met by that date. The Company is
also required to pay to AOL $31,000,000 as an advance of a minimum guaranteed
revenue share for revenues generated by subscriptions and other certain
commercial transactions on the EA.com site. Of this amount $11,000,000 was paid
upon signing of the agreement and the remainder is due in four equal annual
installments on the first anniversary of the initial payment. The fair value of
the payments made under the AOL agreement was determined by an independent
valuation and the resulting amounts will be amortized (beginning with the site
launch) over the remaining term of the five year agreement. Advances of
$35,395,000 are included in other long-term assets as of March 31, 2000.
The Company also committed to spend $15,000,000 in offline media advertisments
promoting its games on AOL during the term of the agreement.
Sale of Class B Common Stock and Warrant to AOL
In connection with the agreement with AOL, the Company sold shares of Class B
common stock to AOL (the "AOL Shares") representing 10 percent of the initial
equity value attributable to EA.com valued at $18,700,000.
In addition to the AOL Shares, the Company sold AOL a warrant (the "AOL
Warrant") to purchase shares of Class B common stock representing an additional
5 percent of the initial equity value attributable to EA.com for $1,300,000. The
aggregate exercise price of the AOL Warrant will be $40,000,000. The AOL Warrant
expires at the latest at the fifth anniversary of its date of issuance, and
under certain conditions may expire at an earlier date.
AOL Exchange Rights
If a Qualified Public Offering (as defined in the AOL Agreement) does not occur
within 12 months following the initial sale of the AOL Shares to AOL, then AOL
may exchange their Class B common stock shares for a number of Class A common
stock based on the ratio of per share price paid by AOL for the Class B stock
relative to $83.7958.
(6) CONCENTRATION OF CREDIT RISK
The Company extends credit to various companies in the retail and mass
merchandising industry. Collection of trade receivables may be affected by
changes in economic or other industry conditions and may, accordingly, impact
the Company's overall credit risk. Although the Company generally does not
require collateral, the Company performs ongoing credit evaluations of its
customers and reserves for potential credit losses are maintained.
Short-term investments are placed with high credit-quality financial
institutions or in short-duration high quality securities. The Company limits
the amount of credit exposure in any one institution or type of investment
instrument.
(7) LITIGATION
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 would not have a material adverse effect upon the
consolidated financial condition of the Company.
(8) PREFERRED STOCK
At March 31, 2000 and 1999, the Company had 10,000,000 and 1,000,000 shares,
respectively, of Preferred Stock authorized but unissued. The rights,
preferences, and restrictions of the Preferred Stock may be designated by the
Board of Directors without further action by the Company's stockholders.
(9) TREASURY STOCK
In February 1999, the Board of Directors approved a plan to purchase up to two
million shares of the Company's common stock. For the year ended March 31, 2000,
the Company did not repurchase shares. For the year ended March 31, 1999, the
Company repurchased 222,500 shares for approximately $9,001,000 under this
program. For the fiscal years ended March 31, 2000 and 1999, 122,563 and 99,937
shares were reissued under the Company's Stock Plans, respectively.
55
When treasury shares were reissued, any excess of the average acquisition cost
of the shares over the proceeds from reissuance was charged to retained
earnings.
(10) STOCK PLANS
(a) Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan program whereby eligible
employees may authorize payroll deductions of up to 10% of their compensation to
purchase shares at 85% of the lower of the fair market value of the Common Stock
on the date of commencement of the offering or on the last day of the six-month
purchase period. The program commenced in September 1991. In fiscal 2000,
245,523 shares were purchased by the Company and distributed to employees at
prices ranging from $32.41 to $58.28. In fiscal 1999, 241,514 shares were
purchased by the Company and distributed to employees at prices ranging from
$26.19 to $36.60. In fiscal 1998, 199,680 shares were purchased by the Company
and distributed to employees at prices ranging from $26.14 to $26.19 per share.
The weighted average fair value of the fiscal 2000, fiscal 1999 and fiscal 1998
awards was $20.00, $18.27 and $9.43, respectively. Under the Employee Stock
Purchase Plan 30,928 shares were distributed from reissued treasury stock in
fiscal 1999. No shares were distributed from reissued treasury stock in fiscal
2000 or fiscal 1998. At March 2000, the Company had 366,921 shares of its Common
Stock reserved for future issuance under the Plan.
Prior to the Maxis merger in July 1997, Maxis employees were eligible to
participate in an employee stock purchase plan. In fiscal 1998, Maxis purchased
7,684 shares under this plan which were distributed to participating employees.
Shares were purchased at prices ranging from $27.70 to $27.99 in fiscal 1998.
(b) Stock Option Plans
The Company's 1991 Stock Option Plan, 1993 Stock Option Plan, 1995 Stock Option
Plan, and Directors' Plan ("Option Plans") provide stock options for employees,
officers and directors. Pursuant to these Option Plans, the Board of Directors
may grant non-qualified and incentive stock options to employees and officers
and non-qualified options to directors, at not less than the fair market value
on the date of grant.
Together with the Tracking Stock Proposal, the stockholders approved the
Electronic Arts Inc. 2000 Class B Equity Incentive Plan and the Electronic Arts
Inc. 2000 Class A Equity Incentive Plan. The Class B equity plan allows the
award of stock options or restricted stock for up to an aggregate of 6,000,000
shares of Class B common stock and the Class A equity plan allows the award of
stock options and restricted stock for up to an aggregate of 3,100,000 shares of
Class A common stock. Each includes a provision for automatic option grants to
the Company's outside directors. As of March 31, 2000 there were no shares
granted under either plan.
Under the Company's stock option plans, 122,563 and 69,009 shares were reissued
from treasury stock in fiscal 2000 and 1999, respectively. No shares were
distributed from reissued treasury stock in fiscal 1998.
The options generally expire ten years from the date of grant and are generally
exercisable in monthly increments over 50 months. Certain options assumed in
connection with the Maxis merger in fiscal 1998 expire ten years from the date
of grant, and vest and become exercisable at a rate of 25% on the first
anniversary of the date of grant and 25% of the shares each year thereafter.
Class B common stock grants will generally vest over 50 months with 2% vesting
per month.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS
123"). Accordingly, no compensation expense has been recognized for options
granted under the Company's employee-based stock option plans. Had compensation
expense been determined based on the fair value at the grant dates for awards
under those plans in accordance with the provisions of SFAS 123, the Company's
pro forma net income and net income per share for fiscal 2000, 1999 and 1998
would have been:
(In thousands, except per share data)
=================================================================
2000 1999 1998
- -----------------------------------------------------------------
Net income
As reported $116,751 $72,872 $72,562
Pro forma $ 78,380 $45,886 $52,892
Earnings per share
As reported - basic $1.86 $1.20 $1.23
Pro forma - basic $1.26 $0.77 $0.91
As reported - diluted $1.76 $1.15 $1.19
Pro forma - diluted $1.19 $0.74 $0.88
- -----------------------------------------------------------------
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model. The following weighted-average assumptions
are used for grants made in 2000, 1999 and 1998 under the stock plans: risk-free
interest rates of 4.93% to 6.54% in 2000; 4.39% to 5.55% in 1999; and 5.31% to
6.42% in 1998; expected volatility of 65% in fiscal 2000, 59% in fiscal 1999 and
58% in fiscal 1998; expected lives of 2.29 years in fiscal 2000, 2.27 years in
fiscal 1999 and 2.25 years in fiscal 1998 under the Option Plans and one year
for the Employee Stock Purchase Plan. No dividends are assumed in the expected
term. The Company's calculations are based on a multiple option valuation
approach and forfeitures are recognized when they occur. The above disclosures
include options granted under the former Maxis option plans as if they were
initially granted by the Company.
56
Because SFAS 123 is applicable only to options granted subsequent to March 31,
1995, the impact of non-vested stock options granted prior to this date has been
excluded from the pro forma calculation. Accordingly, pro forma adjustments are
not indicative of future period pro forma adjustments as the pro forma effect
will not be fully reflected until subsequent years.
57
Additional information regarding options outstanding as of March 31, 2000 is as
follows:
==================================================================
------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Number of Contractual Exercise Number of Exercise
Range of Exercise Prices Shares Life Price Shares Price
- ------------------------------------------------------------------------------------------------
$ 1.990 - $23.500 1,684,898 4.21 $16.48 1,444,433 $15.34
23.750 - 29.875 1,544,350 6.52 27.37 1,144,030 27.66
30.000 - 35.000 1,524,245 6.97 34.15 653,137 33.49
35.063 - 43.125 1,263,602 8.08 39.64 365,063 40.01
43.625 - 46.875 1,467,705 8.62 44.61 404,804 44.12
47.125 - 57.938 1,025,608 8.77 50.62 208,722 49.82
59.750 1,826,819 9.39 59.75 205,977 59.75
66.375 - 83.875 761,102 9.68 74.38 20,293 72.67
87.813 185,600 9.93 87.81 56 87.81
91.938 183,025 9.65 91.94 7,147 91.94
- ------------------------------------------------------------------------------------------------
$ 1.990 - $91.938 11,466,954 7.65 $42.60 4,453,662 $29.86
================================================================================================
The following summarizes the activity under the Company's stock option plans
during the fiscal years ended March 31, 2000, 1999 and 1998:
=========================================
Options Outstanding
-----------------------------------------
Weighted-Average
Shares Exercise Price
-----------------------------------------
Balance at March 31, 1997 8,323,568 $21.97
Granted 3,833,539 32.92
Canceled (616,275) 37.96
Exercised (1,688,702) 18.92
-----------------------------------------
Balance at March 31, 1998 (3,961,559 shares were
exercisable at a weighted average price of $18.83) 9,852,130 25.76
Granted 3,147,216 44.18
Canceled (568,983) 34.74
Exercised (991,104) 22.73
-----------------------------------------
Balance at March 31, 1999 (5,094,075 shares were
exercisable at a weighted average price of $22.79) 11,439,259 30.65
Granted 3,907,976 63.84
Canceled (860,586) 43.36
Exercised (3,019,695) 24.83
-----------------------------------------
Balance at March 31, 2000 11,466,954 $42.60
-----------------------------------------
Options available for grant at March 31, 2000 3,582,266
58
(11) PROPERTY AND EQUIPMENT
Property and equipment at March 31, 2000 and 1999 consisted of:
================================================================================
2000 1999
- --------------------------------------------------------------------------------
(in thousands)
Computer equipment and software $213,815 $127,330
Buildings 99,819 62,413
Land 51,686 50,570
Office equipment, furniture and
fixtures 25,210 21,296
Leasehold improvements 12,157 5,749
Warehouse equipment and other 3,914 3,813
- --------------------------------------------------------------------------------
406,601 271,171
Less accumulated depreciation and
amortization (121,135) (89,905)
- --------------------------------------------------------------------------------
$285,466 $181,266
- --------------------------------------------------------------------------------
Depreciation and amortization expenses associated with property and equipment
amounted to $34,736,000, $34,581,000 and $26,215,000, for the fiscal years ended
March 31, 2000, 1999 and 1998, respectively.
(12) ACCRUED AND OTHER LIABILITIES
Accrued and other liabilities at March 31, 2000 and 1999 consisted of:
================================================================================
2000 1999
- --------------------------------------------------------------------------------
(in thousands)
Accrued compensation and benefits $ 59,580 $ 46,541
Accrued expenses 37,840 46,595
Accrued royalties 36,566 36,429
Accrued income taxes 22,682 23,724
Warranty reserve 8,886 7,900
Deferred revenue 1,847 8,206
Deferred income taxes 198 2,933
- --------------------------------------------------------------------------------
$167,599 $172,328
- --------------------------------------------------------------------------------
(13) BUSINESS COMBINATIONS AND DIVESTITURE
(a) Kesmai
On February 7, 2000, the Company acquired Kesmai Corporation (now referred to as
"Kesmai") from News America Corporation ("News Corp") in exchange for
$22,500,000 in cash and approximately 103,000 shares of the Company's existing
common stock valued at $8,650,000. Kesmai(TM) specializes in the design and
development of multiplayer games delivered directly to consumers over the
Internet and is a major provider of game content to the Games Channel on the AOL
service. The issuance of these shares was temporary, pending the authorization
of Class B common stock. Subsequently, on March 22, 2000, Class B shares were
authorized. The Company granted 5 percent of the initial equity attributable to
EA.com to News Corp, adjusting the total common stock consideration relating to
the acquisition by $703,000 to $9,353,000. The Company has contributed Kesmai to
the EA.com division.
The Company is also committed to spend $5 million in advertising with News Corp.
or any of its affiliates.
If a qualified public offering of Class B common stock does not occur within
twenty-four months of News Corp's purchase of such shares, then News Corp has
the right to (1) exchange Class B common stock for approximately 103,000 shares
of Class A common stock, and (2) receive cash from Electronic Arts in the amount
of $9,650,000.
The acquisition has been accounted for under the purchase method. The results of
operations of Kesmai and the estimated fair market values of the acquired assets
and liabilities have been included in the consolidated financial statements from
the date of acquisition. The adjusted allocation of the excess purchase price
over the net tangible liabilities assumed was $32,815,000, of which, based on
management's estimates prepared in conjunction with a third party valuation
consultant, $3,869,000 was allocated to purchased in-process research and
development and $28,946,000 was allocated to other intangible assets. Amounts
allocated to other intangibles include goodwill of $18,932,000, existing
technology of $3,992,000, amounts attributed to a prior AOL agreement of
$3,131,000 and other intangibles of $2,891,000. The allocation of intangible
assets is being amortized over lives ranging from two to seven years.
Purchased in-process research and development includes the value of products in
the development stage that are not considered to have reached technological
feasibility or to have alternative future use. Accordingly, this non-recurring
item was expensed in the Consolidated Statement of Income upon consummation of
the acquisition. The non-recurring charge for in-process research and
development reduced diluted earnings per share by approximately $0.04 in the
fiscal year 2000.
In connection with the acquisition of Kesmai, the Company allocated and expensed
$3,869,000 of the purchase price to acquired in-process technology. Kesmai had
various projects in progress at the time of the acquisition. As of the
acquisition date, costs to complete Kesmai projects acquired were expected to be
approximately $10,550,000 in future periods. The Company believes there have
been no significant changes
59
to these estimates as of March 31, 2000. The Company currently expects to
complete the development of these projects at various dates through fiscal 2002
and to publish the projects upon completion. In conjunction with the merger of
Kesmai, the Company accrued approximately $200,000 related to direct transaction
costs and other related costs. At March 31, 2000 there were $133,000 in accruals
remaining related to these items.
The purchase price for the Kesmai transaction was allocated to assets acquired
and liabilities assumed as set forth below (in thousands):
================================================================================
Current assets (net of cash acquired) $ 605
Fixed assets (net of depreciation) 759
In-process technology 3,869
Goodwill and other intangibles 28,946
Liabilities (2,326)
- --------------------------------------------------------------------------------
Total cash and stock paid $31,853
- --------------------------------------------------------------------------------
The following table reflects unaudited pro forma combined results of operations
of the Company and Kesmai on the basis that the acquisition had taken place on
April 1, 1998 (in thousands, except per share data):
================================================================================
Year Ended March 31,
2000 1999
- --------------------------------------------------------------------------------
Net revenues $1,421,313 $1,223,444
Net income $ 113,996 $ 64,237
Net income per share - basic $1.81 $1.06
Net income per share - diluted $1.72 $1.02
Number of shares used in
computation - basic 62,830 60,748
Number of shares used in
computation - diluted 66,371 63,272
- --------------------------------------------------------------------------------
In management's opinion, the unaudited pro forma combined results of operations
are not indicative of the actual results that would have occurred had the
acquisition been consummated at the beginning of fiscal 1999 or of future
operations of the combined companies under the ownership and management of the
Company.
(b) Westwood Studios
In September 1998, the Company completed the acquisition of Westwood Studios,
Inc. and certain assets of the Irvine, California - based Virgin Studio
(collectively "Westwood") for approximately $122,688,000 in cash, including
transaction expenses. The adjusted allocation of the excess purchase price over
the net tangible liabilities assumed was $128,573,000 of which, based on
management's estimates prepared in conjunction with a third party valuation
consultant, $41,836,000 was allocated to purchased in-process research and
development and $86,737,000 was allocated to other intangible assets. Amounts
allocated to other intangibles include franchise trade names of $32,357,000,
existing technology of $6,510,000, workforces of $1,680,000 and other goodwill
of $46,190,000 and are being amortized over lives ranging from two to twelve
years. Purchased in-process research and development includes the value of
products in the development stage that are not considered to have reached
technological feasibility or to have alternative future use. Accordingly, this
non-recurring item was expensed in the Consolidated Statement of Income upon
consummation of the acquisition. The non-recurring charge for in-process
research and development reduced diluted earnings per share by approximately
$0.59 in the fiscal year 1999. The results of the operations of Westwood and the
estimated fair value of assets acquired and liabilities assumed are included in
the Company's financial statements from the date of acquisition.
In conjunction with the merger of Westwood, the Company accrued approximately
$1,500,000 related to direct transaction costs and other related accruals. At
March 31, 2000, there were $500,000 in accruals remaining related to these
items.
In connection with the Westwood acquisition, the purchase price has been
allocated to the assets and liabilities assumed based upon the fair values on
the date of acquisition, as follows (in thousands):
================================================================================
Current assets $ 4,500
Property and equipment 3,257
In-process technology 41,836
Other intangible assets 86,737
Current liabilities (13,642)
- --------------------------------------------------------------------------------
Total purchase price $122,688
- --------------------------------------------------------------------------------
The following table reflects unaudited pro forma combined results of operations
of the Company and Westwood on the basis that the acquisition had taken place on
April 1, 1997 (in thousands, except per share data):
================================================================================
1999 1998
- --------------------------------------------------------------------------------
Revenues $1,229,055 $1,011,234
Net income $ 111,308 $ 64,604
Net income per share - basic $1.83 $1.10
Net income per share - diluted $1.76 $1.06
Number of shares used in
computation - basic 60,748 58,867
Number of shares used in
computation - diluted 63,272 60,958
- --------------------------------------------------------------------------------
In management's opinion, the unaudited pro forma combined results of operations
are not indicative of the actual results that would have occurred had the
acquisition been consummated at the beginning of fiscal 1998 or at the beginning
of fiscal 1999 or of future operations of the combined companies under the
ownership and management of the Company.
60
(c) ABC Software
In July 1998, the Company acquired ABC Software AG and ABC Software GmbH
(collectively "ABC"), independent distributors of entertainment, edutainment and
application software in Switzerland and Austria, respectively, for approximately
$9,466,000 in cash (net of cash acquired of $5,099,000) and $570,000 in other
consideration. The transaction has been accounted for under the purchase method.
The excess purchase price over the fair value of the net tangible assets
acquired of approximately $7,377,000 was allocated to goodwill and is being
amortized over 7 years.
(d) Square Co., Ltd.
In May 1998, the Company and Square Co., Ltd. ("Square"), a leading developer
and publisher of entertainment software in Japan, completed the formation of two
new joint ventures in North America and 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, the Company has the exclusive right to distribute in North
America products published by this joint venture. The Company contributed
$3,000,000 and owns a 30% minority interest in this joint venture while Square
owns 70%. This joint venture is accounted for under the equity method.
In Japan, the companies established Electronic Arts Square KK ("EA Square KK"),
which will localize and publish in Japan the Company's properties originally
created in North America and Europe, as well as develop and publish original
video games in Japan. The Company contributed cash and has a 70% majority
ownership interest, while Square contributed cash and owns 30%. Accordingly, the
assets, liabilities and results of operations for EA Square KK are included in
the Company's Consolidated Balance Sheets and Results of Operations since June
1, 1998, the date of formation. Square's 30% interest in EA Square KK has been
reflected as "Minority interest in consolidated joint venture" on the Company's
Consolidated Financial Statements.
(e) Maxis, Inc.
On July 25, 1997, the Company completed a merger with Maxis, Inc. ("Maxis"), a
California-based interactive software developer. Under the transaction,
approximately 4.1 million shares of Electronic Arts' stock were exchanged for
all outstanding Maxis common stock. The transaction was accounted for as a
pooling of interests. The accompanying financial statements, notes and analyses
have been restated for all periods presented to reflect this transaction.
In conjunction with the merger of Maxis, the Company recorded costs of
$10,792,000. This charge included direct transaction fees for investment
bankers, attorneys, accountants, and other related costs of approximately
$2,781,000 and costs associated with integrating the operations of the two
companies of approximately $8,011,000. Included in the integration costs were
redundant facility costs, severance payments, equipment abandonment costs and
other asset write downs, contract termination charges and other related
expenses. Of the total merger costs, approximately $5,185,000 related to cash
expenditures while approximately $5,607,000 related to noncash charges. At March
31, 2000, there were no accruals remaining related to these merger related
costs.
(f) Creative Wonders, LLC
In December 1997, the Company completed the sale of its 50% ownership interest
in Creative Wonders, LLC, a joint venture company formed with the Walt Disney
Company for $16,750,000 in cash. The Company recognized a gain of $12,625,000,
which is included in interest and other income. Prior to the sale, the Company
distributed children's interactive titles published and sold by the joint
venture into the retail channel. The investment was accounted for under the
equity method prior to sale.
(g) Other Business Combinations
Additionally, during the year ended March 31, 2000, the Company acquired two
software development companies. In connection with these acquisitions, the
Company incurred a charge of $2,670,000 for acquired in-process technology. The
charge was made after the Company concluded that the in-process technology had
not reached technological feasibility and had no alternative future use after
taking into consideration the potential for usage of the software in different
products and resale of the software.
During the quarter ended June 30, 1998, the Company acquired two software
development companies. In connection with these acquisitions, the Company
incurred a charge of $2,279,000 for acquired in-process technology. The charge
was made after the Company concluded that the in-process technology had not
reached technological feasibility and had no alternative future use after taking
into consideration the potential for usage of the software in different products
and resale of the software.
61
(14) INCOME TAXES
The Company's pretax income from operations for the fiscal years ended March
31, 2000, 1999 and 1998 consisted of the following components:
===============================================================================
(in thousands) 2000 1999 1998
- -------------------------------------------------------------------------------
Domestic $104,096 $ 79,789 $51,620
Foreign 65,718 38,669 56,640
- -------------------------------------------------------------------------------
Total pretax income $169,814 $118,458 $108,260
- -------------------------------------------------------------------------------
Income tax expense (benefit) for the fiscal years ended March 31, 2000, 1999 and
1998 consisted of:
================================================================================
(in thousands) Current Deferred Total
- --------------------------------------------------------------------------------
2000:
Federal $2,766 $3,231 $5,997
State 299 859 1,158
Foreign 15,573 (2,649) 12,924
Charge in lieu of taxes
from employee stock plans 32,563 - 32,563
- --------------------------------------------------------------------------------
$51,201 $1,441 $52,642
- --------------------------------------------------------------------------------
1999:
Federal $31,204 $(10,340) $20,864
State 4,401 (2,590) 1,811
Foreign 15,715 1,410 17,125
Charge in lieu of taxes
from employee stock plans 5,614 - 5,614
- --------------------------------------------------------------------------------
$56,934 $(11,520) $45,414
- --------------------------------------------------------------------------------
1998:
Federal $14,751 $(7,585) $7,166
State 1,361 (727) 634
Foreign 18,561 1,434 19,995
Charge in lieu of taxes
from employee stock plans 7,931 - 7,931
- --------------------------------------------------------------------------------
$42,604 $(6,878) $35,726
- --------------------------------------------------------------------------------
The components of the net deferred tax assets as of March 31, 2000 and 1999
consist of:
================================================================================
(in thousands) 2000 1999
- --------------------------------------------------------------------------------
Deferred tax assets:
Accruals, reserves and other expenses $70,131 $76,015
- --------------------------------------------------------------------------------
Total gross deferred tax assets 70,131 76,015
Less: valuation allowance - -
- --------------------------------------------------------------------------------
Net deferred tax assets $70,131 $76,015
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Undistributed earnings of DISC (1,487) (1,784)
Prepaid royalty expenses (38,562) (43,681)
Fixed assets (3,249) -
Unrealized gains on marketable
securities (68) (1,395)
Other - (949)
- --------------------------------------------------------------------------------
Total gross deferred tax $(43,366) $(47,809)
liabilities
- --------------------------------------------------------------------------------
Net deferred tax asset $26,765 $28,206
- --------------------------------------------------------------------------------
At March 31, 2000, deferred tax assets of $26,963,000 were included in other
current assets.
The differences between the statutory income tax rate and the Company's
effective tax rate, expressed as a percentage of income before provision for
income taxes, for the years ended March 31, 2000, 1999 and 1998 were as follows:
================================================================================
2000 1999 1998
- --------------------------------------------------------------------------------
Statutory Federal tax rate 35.0% 35.0% 35.0%
State taxes, net of Federal benefit 1.5 1.5 1.0
Differences between statutory rate
and foreign effective tax rate (2.8) (2.5) (2.2)
Research and development credits (1.7) (2.1) (0.6)
Nondeductible acquisition costs - 7.4 -
Other (1.0) (1.0) (0.2)
- --------------------------------------------------------------------------------
31.0% 38.3% 33.0%
- --------------------------------------------------------------------------------
The Company provides for U.S. taxes on an insignificant portion of the
undistributed earnings of its foreign subsidiaries and does not provide taxes on
the remainder. We have not provided for Federal income tax on approximately
$165,000,000 of undistributed earnings of our foreign subsidiaries, since we
intend to reinvest this amount in foreign subsidiary operations indefinitely.
The Company's U.S. income tax returns for the years 1992 through 1995 have been
examined by the Internal Revenue Service (IRS). In 1998, the Company received a
notice of deficiencies from the IRS. These deficiencies relate primarily to
operations in Puerto Rico, which the Company is contesting in Tax Court. The
Company believes that any additional liabilities, if any, that arise from the
outcome of this examination will not be material to the Company's consolidated
financial statements.
62
(15) INTEREST AND OTHER INCOME, NET
Interest and other income, net for the years ended March 31, 2000, 1999 and 1998
consisted of:
================================================================================
(in thousands) 2000 1999 1998
- --------------------------------------------------------------------------------
Interest income $13,744 $12,625 $13,649
Gain on disposition of assets,
net 8,339 725 14,910
Foreign currency losses (1,781) (1,168) (517)
Equity in net gain (loss) of
affiliates 1,138 (155) (1,162)
Other income (expense), net (5,412) 1,153 (2,069)
- --------------------------------------------------------------------------------
$16,028 $13,180 $24,811
- --------------------------------------------------------------------------------
(16) COMPREHENSIVE INCOME
In fiscal 1999, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains and losses) in financial
statements. SFAS 130 requires classification of other comprehensive income in a
financial statement and display of other comprehensive income separately from
retained earnings and additional paid-in capital. Other comprehensive income
includes primarily foreign currency translation adjustments and unrealized gains
(losses) on investments.
The change in the components of accumulated other comprehensive income, net of
taxes, is summarized as follows (in thousands):
================================================================================
Foreign Unrealized Accumu-
currency gains lated other
translation (losses) on comprehen-
adjustments investments sive income
- --------------------------------------------------------------------------------
Balance at March
31, 1997 $(1,925) $2,593 $668
Other
comprehensive loss (1,273) (863) (2,136)
- --------------------------------------------------------------------------------
Balance at March
31, 1998 (3,198) 1,730 (1,468)
Other
comprehensive
income (loss) (2,643) 1,544 (1,099)
- --------------------------------------------------------------------------------
Balance at March
31, 1999 (5,841) 3,274 (2,567)
Other
comprehensive loss (339) (3,455) (3,794)
- --------------------------------------------------------------------------------
Balance at March
31, 2000 $(6,180) $(181) $(6,361)
- --------------------------------------------------------------------------------
Change in unrealized gains (losses) on investments, net are shown net of taxes
of $(1,553,000), $727,000 and $(426,000) in fiscal 2000, 1999 and 1998,
respectively.
The currency translation adjustments are not adjusted for income taxes as they
relate to indefinite investments in non-U.S. subsidiaries.
(17) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash, cash equivalents, short-term investments, receivables, accounts payable
and accrued liabilities - the carrying amount approximates fair value because of
the short maturity of these instruments.
Long-term investments, investments classified as held-to-maturity and marketable
securities - fair value is based on quoted market prices.
63
(18) SEGMENT INFORMATION
In 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", which supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise". SFAS No. 131 establishes
standards for the reporting by public business enterprises of information about
product lines, geographic areas and major customers. The method for determining
what information to report is based on the way that management organizes the
operating segments within the Company for making operational decisions and
assessments of financial performance. The Company's chief operating decision
maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO
reviews financial information presented on a consolidated basis accompanied by
disaggregated information about revenues by geographic region and by product
lines for purposes of making operating decisions and assessing financial
performance.
As a result of the approval of the Tracking Stock proposal to authorize issuance
of a new series of common stock designated as Class B common stock, intended to
reflect the performance of EA.com, management considers EA.com a separate
reportable segment. Accordingly, prior period information has been restated to
disclose separate segments. The Company operates in two principal business
segments globally:
o Electronic Arts core ("EA Core") business segment: creation, marketing
and distribution of entertainment software.
o EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online.
Please see the discussion regarding segment reporting in the MD&A.
64
Information about Electronic Arts business segments is presented below for the
fiscal years ended March 31, 2000, 1999, 1998 (in thousands):
Year Ended March 31, 2000
------------------------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $1,399,093 $ 20,918 $ - $1,420,011
Group sales 2,014 - (2,014) (a) -
------------------------------------------------------------------------
Total net revenues 1,401,107 20,918 (2,014) 1,420,011
------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 700,024 5,784 - 705,808
Group cost of goods sold - 2,014 (2,014) -
------------------------------------------------------------------------
Total cost of goods sold 700,024 7,798 (2,014) 705,808
------------------------------------------------------------------------
Gross profit 701,083 13,120 - 714,203
Operating expenses:
Marketing and sales 185,714 2,914 - 188,628
General and administrative 87,513 4,989 - 92,502
Research and development 205,933 34,775 20,051 (b) 260,759
Network development and support - 20,051 (20,051) -
Charge for acquired in-process technology 2,670 3,869 - 6,539
Amortization of intangibles 10,866 1,123 - 11,989
------------------------------------------------------------------------
Total operating expenses 492,696 67,721 - 560,417
------------------------------------------------------------------------
Operating income (loss) 208,387 (54,601) - 153,786
Interest and other income, net 16,017 11 - 16,028
------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 224,404 (54,590) - 169,814
Provision for income taxes 52,642 - - 52,642
------------------------------------------------------------------------
Income (loss) before minority interest 171,762 (54,590) - 117,172
Minority interest in consolidated joint venture (421) - - (421)
------------------------------------------------------------------------
Net income (loss) 171,341 (54,590) - 116,751
------------------------------------------------------------------------
Interest income 13,733 11 - 13,744
Depreciation and amortization 39,818 6,907 - 46,725
Identifiable assets 1,085,411 106,901 - 1,192,312
Capital expenditures 97,279 37,605 - 134,884
65
Year Ended March 31, 1999
------------------------------------------------------------------------
EA Core EA.com Adjustments and Electronic Arts
(excl. EA.com) Eliminations
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $1,204,689 $17,174 $ - $1,221,863
Group sales 985 - (985)(a) -
------------------------------------------------------------------------
Total net revenues 1,205,674 17,174 (985) 1,221,863
------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 624,252 3,571 - 627,823
Group cost of goods sold - 985 (985) -
------------------------------------------------------------------------
Total cost of goods sold 624,252 4,556 (985) 627,823
------------------------------------------------------------------------
Gross profit 581,422 12,618 - 594,040
Operating expenses:
Marketing and sales 161,029 2,378 - 163,407
General and administrative 74,995 1,224 - 76,219
Research and development 181,245 8,050 9,846 (b) 199,141
Network development and support - 9,846 (9,846) -
Charge for acquired in-process technology 44,115 - - 44,115
Amortization of intangibles 5,880 - - 5,880
------------------------------------------------------------------------
Total operating expenses 467,264 21,498 - 488,762
------------------------------------------------------------------------
Operating income (loss) 114,158 (8,880) - 105,278
Interest and other income, net 13,180 - - 13,180
------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 127,338 (8,880) - 118,458
Provision for income taxes 45,414 - - 45,414
------------------------------------------------------------------------
Income (loss) before minority interest 81,924 (8,880) - 73,044
Minority interest in consolidated joint venture (172) - - (172)
------------------------------------------------------------------------
Net income (loss) 81,752 (8,880) - 72,872
------------------------------------------------------------------------
Interest income 12,625 - - 12,625
Depreciation and amortization 40,271 190 - 40,461
Identifiable assets 898,905 2,968 - 901,873
Capital expenditures 113,939 1,881 - 115,820
66
Year Ended March 31, 1998
------------------------------------------------------------------------
EA Core EA.com Adjustments and Electronic Arts
(excl. EA.com) Eliminations
- ---------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $897,877 $10,975 $ - $908,852
Group sales 538 - (538)(a) -
------------------------------------------------------------------------
Total net revenues 898,415 10,975 (538) 908,852
------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 478,967 2,266 - 481,233
Group cost of goods sold - 538 (538) -
------------------------------------------------------------------------
Total cost of goods sold 478,967 2,804 (538) 481,233
------------------------------------------------------------------------
Gross profit 419,448 8,171 - 427,619
Operating expenses:
Marketing and sales 125,711 2,597 - 128,308
General and administrative 57,650 188 - 57,838
Research and development 137,360 5,352 3,020 (b) 145,732
Network development and support - 3,020 (3,020) -
Charge for acquired in-process technology 1,500 - - 1,500
Merger costs 10,792 - - 10,792
------------------------------------------------------------------------
Total operating expenses 333,013 11,157 - 344,170
------------------------------------------------------------------------
Operating income (loss) 86,435 (2,986) - 83,449
Interest and other income, net 24,811 - - 24,811
------------------------------------------------------------------------
Income (loss) before provision for income
taxes and minority interest 111,246 (2,986) - 108,260
Provision for income taxes 35,726 - - 35,726
------------------------------------------------------------------------
Income (loss) before minority interest 75,520 (2,986) - 72,534
Minority interest in consolidated joint venture 28 - - 28
------------------------------------------------------------------------
Net income (loss) 75,548 (2,986) - 72,562
------------------------------------------------------------------------
Interest income 13,649 - - 13,649
Depreciation and amortization 26,805 102 - 26,907
Identifiable assets 745,000 681 - 745,681
Capital expenditures 44,715 523 - 45,238
<FN>
(a) Represents elimination of intercompany sales of Electronic Arts packaged
goods products to EA.com; and represents elimination of royalties paid to
Electronic Arts by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support to Research
and Development.
</FN>
67
Information about Electronic Arts' operations in the North America and foreign
areas for the fiscal years ended March 31, 2000, 1999 and 1998 is presented
below:
Asia
(in thousands) Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
--------------- -------------- ------------- ------------ --------------- --------------
Fiscal 2000:
Net revenues from unaffiliated
customers $846,637 $492,430 $47,573 $33,371 $ - $ 1,420,011
Intercompany revenues 28,701 28,385 9,059 - (66,145) -
--------------- -------------- ------------- ------------ --------------- --------------
Total net revenues 875,338 520,815 56,632 33,371 (66,145) 1,420,011
=============== ============== ============= ============ =============== ==============
Operating income 101,919 48,712 3,623 1,921 (2,389) 153,786
Interest income 11,775 1,755 214 - - 13,744
Depreciation and amortization 35,114 9,968 473 1,170 - 46,725
Capital expenditures 78,298 54,379 1,447 760 - 134,884
Identifiable assets 734,626 418,034 18,019 21,633 - 1,192,312
Long-lived assets 244,845 154,475 3,306 3,975 - 406,601
Fiscal 1999:
Net revenues from unaffiliated
customers $704,998 $443,937 $39,560 $33,368 $ - $1,221,863
Intercompany revenues 32,216 15,062 2,800 12 (50,090) -
--------------- -------------- ------------- ------------ --------------- --------------
Total net revenues 737,214 458,999 42,360 33,380 (50,090) 1,221,863
=============== ============== ============= ============ =============== ==============
Operating income 78,826 21,052 3,208 2,192 - 105,278
Interest income 9,931 2,551 143 - - 12,625
Depreciation and amortization 29,272 9,399 506 1,284 - 40,461
Capital expenditures 54,029 58,383 418 2,990 - 115,820
Identifiable assets 596,357 268,152 20,938 16,426 - 901,873
Long-lived assets 174,582 91,546 2,051 2,992 - 271,171
Fiscal 1998:
Net revenues from unaffiliated
customers $519,423 $325,938 $41,494 $21,997 $ - $ 908,852
Intercompany revenues 45,913 21,613 513 133 (68,172) -
--------------- -------------- ------------- ------------ --------------- --------------
Total net revenues 565,336 347,551 42,007 22,130 (68,172) 908,852
=============== ============== ============= ============ =============== ==============
Operating income (loss) 31,852 51,807 6,995 (7,205) - 83,449
Interest income 10,931 2,471 247 - - 13,649
Depreciation and amortization 20,826 4,541 661 879 - 26,907
Capital expenditures 25,423 18,035 669 1,111 - 45,238
Identifiable assets 515,728 201,988 17,347 10,618 - 745,681
Long-lived assets 143,398 36,300 1,959 4,805 - 186,462
For the fiscal year ended March 31, 2000 and March 31, 1999, Electronic Arts had
sales to one customer which represented 12% of total net revenues in both years.
The Company had no sales to any one customer in excess of 10% of total net
revenues for fiscal years ended March 31, 1998.
68
Information about Electronic Arts' net revenues by product line for the fiscal
years ended March 31, 2000, 1999 and 1998 is presented below (in thousands):
================================================================================
2000 1999 1998
- --------------------------------------------------------------------------------
PlayStation $586,821 $519,830 $380,299
PC 397,777 270,793 231,034
Affiliated label 275,333 248,105 185,865
N64 120,415 152,349 56,677
License, OEM and Other 39,665 30,786 54,977
- --------------------------------------------------------------------------------
$1,420,011 $1,221,863 $908,852
- --------------------------------------------------------------------------------
69
QUARTERLY FINANCIAL AND MARKET INFORMATION (UNAUDITED)
(In thousands, except per share data)
Quarter Ended
----------------------------------------------------------- Year
June 30 Sept. 30 Dec. 31 March 31 Ended
-----------------------------------------------------------------------------
Fiscal 2000:
Net revenues $186,120 $ 338,887 $600,691 $294,313 $1,420,011
Operating income (loss) (849) 23,697 129,536 1,402 153,786
Net income 2,326 (a) 18,132 (a) 92,861 (a) 3,432 (b) 116,751
Net income per share - basic $ 0.04 (a) $ 0.29 (a) $ 1.47 (a) $ 0.05 (b) $ 1.86
Net income per share - diluted $ 0.04 (a) $ 0.28 (a) $ 1.38 (a) $ 0.05 (b) $ 1.76
Common stock price per share
High $ 54.81 $ 76.19 $ 120.94 $ 102.19 $ 120.94
Low $ 45.63 $ 52.88 $ 66.44 $ 69.00 $ 45.63
Fiscal 1999:
Net revenues $178,221 $ 245,763 $520,155 $277,724 $1,221,863
Operating income (loss) 3,050 (29,545) 102,439 29,334 105,278
Net income (loss) 3,700 (c) (25,273)(d) 72,531 (e) 21,914 (e) 72,872
Net income (loss) per share - basic $ 0.06 (c) $ (0.42)(d) $ 1.19 (e) $ 0.36 (e) $ 1.20
Net income (loss) per share - diluted $ 0.06 (c) $ (0.42)(d) $ 1.15 (e) $ 0.35 (e) $ 1.15
Common stock price per share
High $ 54.81 $ 55.56 $ 56.00 $ 52.19 $ 56.00
Low $ 41.63 $ 38.13 $ 33.88 $ 38.25 $ 33.88
Fiscal 1998:
Net revenues $123,712 $ 189,828 $391,245 $204,067 $ 908,852
Operating income (loss) (4,807) (3,080) 70,983 20,353 83,449
Net income (loss) (1,451) 41 (f) 58,620 (g) 15,352 72,562
Net income (loss) per share - basic $ (0.02) $ - (f) $ 0.99 (g) $ 0.26 $ 1.23
Net income (loss) per share - diluted $ (0.02) $ - (f) $ 0.96 (g) $ 0.25 $ 1.19
Common stock price per share
High $ 35.38 $ 37.50 $ 39.56 $ 46.94 $ 46.94
Low $ 20.13 $ 30.75 $ 29.94 $ 34.94 $ 20.13
<FN>
(a) Net income and net income per share include goodwill amortization of $1.8
million, net of taxes.
(b) Net income and net income per share include one-time acquisition related
charges of $4.5 million, net of taxes, incurred in connection with the
acquisition of Kesmai and other business combinations made during the quarter as
well as goodwill amortization of $2.9 million, net of taxes.
(c) Net income and net income per share include one-time acquisition related
charges of $1.6 million, net of taxes, incurred in connection with the
acquisition of two software development companies made during the quarter.
(d) Net income and net income per share include one-time acquisition related
charges of $35.9 million, net of taxes, incurred in connection with the
acquisition of Westwood Studios as well as goodwill amortization of $0.6
million, net of taxes.
(e) Net income and net income per share include goodwill amortization of $1.7
million, net of taxes.
(f) Net income and net income per share include one-time merger related charges
of $7.2 million, net of taxes, incurred in connection with the merger of Maxis,
Inc.
(g) Net income and net income per share include one-time acquisition related
charges of $1.0 million, net of taxes, incurred in connection with the remaining
minority ownership interest in Electronic Arts Victor, Inc. Net income and net
income per share include a one-time gain on sale of Creative Wonders. LLC in the
amount of $8.5 million, net of taxes.
</FN>
The Company's common stock is traded in the over-the-counter market under the
Nasdaq Stock Market symbol ERTS. The closing prices for the common stock in the
table above represent the high and low closing prices as reported on the Nasdaq
National Market.
70
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable.
71
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors who are nominated for re-election required
by Item 10 is incorporated herein by reference to the information in our
definitive Proxy Statement for the 2000 Annual Meeting of Stockholders (the
"Proxy Statement") under the caption "Proposal No. 1 - Re-Election of
Directors." The information regarding executive officers required by Item 10 is
included in Item 4A hereof.
ITEM 11: EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the
information in the Proxy Statement under the caption "Compensation of Executive
Officers" specifically excluding the "Compensation Committee Report on Executive
Compensation".
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the
information in the Proxy Statement under the caption "Principal Stockholders"
and "Amount and Nature of Shares Beneficially Owned."
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to the
information in the Proxy Statement under the caption "Certain Transactions."
72
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Index to Financial Statements. Page(s) in Form 10-K
Independent Auditors' Report 44
Consolidated Balance Sheets as of March 31, 2000
and 1999 45
Consolidated Statements of Income for the Years Ended
March 31, 2000, 1999 and 1998 46
Consolidated Statements of Stockholders' Equity for the
Years Ended March 31, 2000, 1999 and 1998 47
Consolidated Statements of Cash Flows for the Years Ended
March 31, 2000, 1999 and 1998 49
Notes to Consolidated Financial Statements for the Years
Ended March 31, 2000, 1999 and 1998 50-70
2. Financial Statement Schedule.
The following financial statement schedule of Electronic Arts for the
years ended March 31, 2000, 1999 and 1998 is filed as part of this report
and should be read in conjunction with the Consolidated Financial
Statements of Electronic Arts.
Schedule II - Valuation and Qualifying Accounts
Other financial statement schedules are omitted because the information
called for is not required or is shown either in the Consolidated
Financial Statements or the notes thereto.
3. Exhibits.
The following exhibits are filed as part of, or incorporated by reference
into, this report:
Number Exhibit Title
------ -------------
3.01 Registrant's Certificate of Incorporation, as amended to December
1, 1992. (1)
3.02 Registrant's Certificate of Amendment of Certificate of
Incorporation. (2)
3.03 Registrant's By-Laws, as amended to date. (3)
3.04 Amended and Restated Certificate of Incorporation of Electronic
Arts Inc.
4.01 Specimen Certificate of Registrant's Common Stock. (4)
10.01 Registrant's 1982 Stock Option Plan, as amended to date, and
related documents. (5) (6)
10.02 Registrant's Directors Stock Option Plan and related documents.
(6) (7)
10.03 Description of Registrant's FY 2001 Executive Bonus Plan. (6)
10.04 Directors and Officers and Company Reimbursement Indemnity Policy
by and between Registrant and certain underwriters at Lloyd's,
London and Continental Insurance Company, dated June 20, 1992.
(8)
10.05 Lease by and between Registrant, Electronic Arts Limited and
Allied Dunbar Assurance PLC, dated June 24, 1987, for the
Registrant's U.K. facilities. (9)
73
Number Exhibit Title
------ -------------
10.06 Lease by and between Registrant and H.G.C. Associates, dated June
24, 1992, for the Registrant's warehouse and production
facilities. (10)
10.07 Lease Agreement by and between Registrant and 1450 Fashion Island
Boulevard Associates, L.P., dated March 22, 1991. (11)
10.08 Registrants' 1991 Stock Option Plan and related documents as
amended. (6) (12)
10.09 Form of Indemnity Agreement with Directors. (13)
10.10 Registrants' Employee Stock Purchase Plan and related documents
as amended. (6) (14)
10.11 Lease Agreement by and between Registrant and The Canada Life
Assurance Company, dated December 20, 1991, for the Registrant's
Canadian facilities. (15)
10.13 Amendment to Lease Agreement by and between Registrant and 1450
Fashion Island Boulevard Associates, L.P., dated March 22, 1991.
(17)
10.14 Agreement between Registrant and Sega Enterprises, Ltd., dated
July 14, 1992. (18) (19)
10.15 Lease Agreement by and between Registrant and Century Centre II
Associates, dated July 27, 1992. (19)
10.16 Amendment to Lease Agreement by and between Registrant and 1450
Fashion Island Boulevard Associates, L.P., dated October 1, 1992.
(19)
10.17 Amendment to Lease Agreement by and between Registrant and
Century Centre II Associates, dated February 2, 1993. (19)
10.18 Amendment to Lease Agreement by and between Registrant and
Century Centre II Associates, dated February 22, 1993. (19)
10.19 Directors and Officers and Company Reimbursement Indemnity Policy
by and between Registrant and certain underwriters at Lloyd's,
London and Continental Insurance Company, dated June 20, 1993.
(19)
10.20 Lease by and between Registrant and 1450 Fashion Island Boulevard
Associates, L.P., dated August 27, 1992 for additional space at
corporate headquarters. (10)
10.22 Lease by and between Registrant, Electronic Arts Limited and
Heron Slough Limited, dated June 12, 1992, for the Registrant's
U.K. facilities. (20)
10.23 Lease by and between Registrant and the Travelers Insurance
Company, dated April 14, 1993, for the Registrant's production
facilities. (21)
10.24 Amendment to Lease Agreement by and between Registrant and 1450
Fashion Island Boulevard Associates, L.P., dated June 1, 1993.
(22)
10.25 Amendment to Lease Agreement by and between Registrant and the
Travelers Insurance Company, dated November 30, 1993. (23)
10.26 Amendment to Lease Agreement by and between Registrant and the
Travelers Insurance Company, dated November 30, 1993. (23)
10.27 Lease Agreement by and between Registrant and Arthur J. Rogers &
Co., dated January 14, 1994. (24)
10.28 Lease Agreement by and between Registrant and the Prudential
Insurance Company of America, dated January 10, 1994. (24)
10.29 Agreement for Lease between Flatirons Funding, LP and Electronic
Arts Redwood, Inc. dated February 14, 1995. (25)
10.30 Guarantee from Electronic Arts Inc. to Flatirons Funding, LP
dated February 14, 1995. (25)
74
Number Exhibit Title
------ -------------
10.31 Lease Agreement by and between Registrant and Dixie Warehouse &
Cartage Co., dated April 10, 1995. (25)
10.32 Commercial Earnest Money Contract between Novell, Inc. and ORIGIN
Systems, Inc. dated April 13, 1995. (26)
10.33 First Amendment to Commercial Earnest Money Contract between
Novell, Inc. and ORIGIN Systems, Inc. dated June 1, 1995. (27)
10.34 Amendment No. 1 to Agreement between Registrant and Sega
Enterprises, Inc. effective December 31, 1995. (28)
10.35 Lease Agreement by and between Registrant and Don Mattrick dated
October 16, 1996. (29)
10.36 Amended and Restated Guaranty from Electronic Arts Inc. to
Flatirons Funding, LP dated March 7, 1997. (30)
10.37 Amended and Restated Agreement for Lease between Flatirons
Funding, LP and Electronic Arts Redwood Inc. dated March 7, 1997.
(30)
10.38 Amendment No. 1 to Lease Agreement between Electronic Arts
Redwood Inc. and Flatirons Funding, LP dated March 7, 1997. (30)
10.39 Employment Agreement by and between the Registrant and John
Riccitiello dated August 29, 1997. (31)
10.40 Lease Agreement by and between Registrant and John Riccitiello
dated August 29, 1997. (31)
10.41 Employment Agreement by and between Registrant and James "Rusty"
Russell Rueff, Jr. dated September 9, 1998. (32)
10.42 Lease Agreement by and between Registrant and Louisville Commerce
Realty Corporation, dated April 1, 1999. (32)
10.43 Option agreement, agreement of purchase and sale, and escrow
instructions for Zones 2 and 4, Electronic Arts Business Park,
Redwood Shores California, dated April 5, 1999. (32)
10.44 Lease Agreement by and between Registrant and Spieker Properties,
L.P., dated September 3, 1999. (33)
21.01 Subsidiaries of the Registrant.
23.01 Report on Financial Statement Schedule and Consent of KPMG LLP,
Independent Auditors.
23.02 Consent of Ernst & Young LLP, Independent Auditors (32)
27 Financial Data Schedule
99.01 Report of Ernst & Young LLP, Independent Auditors (32)
- --------------------------------------------------------------------------------
(1) Incorporated by reference to Exhibit 3.01 to Registrant's Current
Report on Form 8-K filed on October 16, 1991.
(2) Incorporated by reference to Exhibit 4.01 to Registrant's
Registration Statement on Form S-8 filed on December 1, 1992 (File
No. 33-55212) (the "1992 Form S-8").
(3) Incorporated by reference to Exhibit 3.02 to Registrant's Current
Report on Form 8-K filed on October 16, 1991.
75
(4) Incorporated by reference to Exhibit 4.01 to Registrant's
Registration Statement on Form S-4 filed on March 3, 1994 (File No.
33-75892).
(5) Incorporated by reference to Exhibit 4.03 to Post-Effective
Amendment No. 2 to Registrant's Registration Statement on Form S-8
filed on November 6, 1991 (File No. 33-32616) ("S-8 Amendment No.
2").
(6) Management contract or compensatory plan or arrangement.
(7) Incorporated by reference to Exhibit 4.04 to S-8 Amendment No. 2.
(8) Incorporated by reference to Exhibit 10.08 to Registrant's Annual
Report on Form 10-K for the year ended March 31, 1992 (the "1992
Form 10-K").
(9) Incorporated by reference to Exhibit 10.07 to the Registrant's
Registration Statement on Form S-1 filed on September 20, 1989, and
all amendments thereto (File No. 33-30346) (the "Form S-1").
(10) Incorporated by reference to similarly numbered exhibits to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1992.
(11) Incorporated by reference to Exhibit 10.11 to Registrant's Annual
Report on Form 10-K for the year ended March 31, 1991.
(12) Incorporated by reference to Exhibit 4.01 to the Registrant's
Registration Statement on Form S-8 filed on July 29, 1993 (File No.
33-66836) (the "1993 Form S-8").
(13) Incorporated by reference to Exhibit 10.09 to the Form S-1.
(14) Incorporated by reference to Exhibit 4.02 to 1993 Form S-8.
(15) Incorporated by reference to Exhibit 10.16 to the 1992 Form 10-K.
(16) Not Used.
(17) Incorporated by reference to Exhibit 10.18 to the 1992 Form 10-K.
(18) Confidential treatment has been granted with respect to certain
portions of this document.
(19) Incorporated by reference to similarly numbered exhibits to
Registrants Annual Report on Form 10-K for the year ended March 31,
1993.
(20) Incorporated by reference to Exhibit 19.01 of Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1992.
(21) Incorporated by reference to Exhibit 10.23 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1993.
76
(22) Incorporated by reference to Exhibit 10.24 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1993.
(23) Incorporated by reference to similarly numbered exhibits to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
December 31, 1993.
(24) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March 31,
1994 (the "1994 Form 10-K").
(25) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March 31,
1995 (the "1995 Form 10-K").
(26) Incorporated by reference to Exhibit 10.01 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(27) Incorporated by reference to Exhibit 10.02 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995.
(28) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March 31,
1996 (the "1996 Form 10-K").
(29) Incorporated by reference to Exhibit 10.35 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended December 31, 1996.
(30) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March 31,
1997 (the "1997 Form 10-K").
(31) Incorporated by reference to similarly numbered exhibits to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
December 31, 1997.
(32) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March 31,
1999 (the "1999 Form 10-K").
(33) Incorporated by reference to similarly numbered exhibits to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended March 31,
2000.
(c) Exhibits:
The Registrant hereby files as part of this Form 10-K the exhibits
listed in Item 14(a)3, as set forth above.
(d) Financial Statement Schedule:
The Registrant hereby files as part of this Form 10-K the financial
statement schedule listed in Item 14(a)2, as set forth on page 79.
77
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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
By: /s/ Lawrence F. Probst III
---------------------------------
(Lawrence F. Probst III, Chairman
of the Board and Chief Executive
Officer)
Date: June 28, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons, on behalf of the
Registrant in the capacities indicated and on the 28th of June 2000.
Name Title
---- -----
/s/ Lawrence F. Probst III Chairman of the Board
- --------------------------------------- and Chief Executive Officer
(Lawrence F. Probst III)
/s/ E. Stanton McKee, Jr. Executive Vice President and Chief
- --------------------------------------- Financial and Administrative Officer
(E. Stanton McKee, Jr.)
/s/ David L. Carbone Vice President, Finance
- --------------------------------------- (Principal Accounting Officer)
(David L. Carbone)
Directors:
/s/ M. Richard Asher Director
- ---------------------------------------
(M. Richard Asher)
/s/ William J. Byron Director
- ---------------------------------------
(William J. Byron)
/s/ Daniel H. Case III Director
- ---------------------------------------
(Daniel H. Case III)
/s/ Gary M. Kusin Director
- ---------------------------------------
(Gary M. Kusin)
/s/ Timothy J. Mott Director
- ---------------------------------------
(Timothy J. Mott)
78
ELECTRONIC ARTS INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Years Ended March 31, 2000, 1999 and 1998
(in thousands)
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
Description of Period Expenses Accounts (1) Deductions of Period
- ----------- --------- -------- ------------ ---------- ---------
Year Ended March 31, 2000
Allowance for doubtful
accounts and returns $ 72,850 $179,952 $ 39 $187,774 $ 65,067
======== ======== ======== ======== ========
Year Ended March 31, 1999
Allowance for doubtful
accounts and returns $ 51,575 $161,297 $ (369) $139,653 $ 72,850
======== ======== ======== ======== ========
Year Ended March 31, 1998
Allowance for doubtful
accounts and returns $ 43,268 $ 82,706 $ (3,243) $ 71,156 $ 51,575
======== ======== ======== ======== ========
<FN>
(1) Primarily the translation effect of using the average exchange rate for
expense items and the year-ended exchange rate for the balance sheet item
(allowance account).
</FN>
79
ELECTRONIC ARTS INC.
2000 FORM 10-K ANNUAL REPORT
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -------------
3.04 Amended and Restated Certificate of Incorporation of Electronic Arts
Inc.
10.03 Description of Registrant's FY 2001 Executive Bonus Plan
21.01 Subsidiaries of the Registrant
23.01 Report on Financial Statement Schedule and Consent of KPMG LLP,
Independent Auditors
27 Financial Data Schedule
80