FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from ______ to_____
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
209 Redwood Shores Parkway
Redwood City, California 94065
(Address of principal executive offices) (Zip Code)
(650) 628-1500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock February 8, 2001
--------------------- ----------------
$0.01 par value per share 133,003,609
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Page
----
Part I - Financial Information
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
December 31, 2000 and March 31, 2000 3
Consolidated Statements of Operations for the
Three Months Ended December 31, 2000 and
1999 and the Nine Months Ended December 31, 2000
and 1999 4
Consolidated Statements of Cash Flows for
the Nine Months Ended December 31, 2000 and 1999 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 45
Part II - Other Information
Item 1. Legal Proceedings 47
Item 4. Submission of Matters to a Vote of Security Holders 47
Item 6. Exhibits and Reports on Form 8-K 47
Signatures 48
Exhibit Index 49
2
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(unaudited)
December 31, March 31,
2000 2000
----------- -----------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 295,377 $ 339,804
Marketable securities 17,249 236
Receivables, less allowances of $82,660 and $65,067, respectively 356,484 234,087
Inventories, net 19,852 22,986
Deferred income taxes 27,143 26,963
Other current assets 93,305 81,247
----------- -----------
Total current assets 809,410 705,323
Property and equipment, net 340,187 285,466
Long-term investments 8,400 8,400
Investments in affiliates 18,780 22,601
Goodwill and other intangibles, net 103,889 117,236
Other assets 56,610 53,286
----------- -----------
$ 1,337,276 $ 1,192,312
=========== ===========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 68,192 $ 97,703
Accrued and other liabilities 251,861 167,599
----------- -----------
Total current liabilities 320,053 265,302
Minority interest in consolidated joint venture 4,307 3,617
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 10,000,000 shares -- --
Common Stock
Class A common stock, $0.01 par value. Authorized 400,000,000 shares;
issued and outstanding 132,733,250 and 128,869,088 shares, respectively 1,327 1,288
Class B common stock, $0.01 par value. Authorized 100,000,000
shares; issued and outstanding 6,250,000 and 6,000,000, respectively 63 60
Paid-in capital 488,190 412,038
Retained earnings 523,166 516,368
Accumulated other comprehensive income (loss) 170 (6,361)
----------- -----------
Total stockholders' equity 1,012,916 923,393
----------- -----------
$ 1,337,276 $ 1,192,312
=========== ===========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
3
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
December 31, December 31,
-------------------------- --------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
Net revenues $ 640,319 $ 600,691 $ 1,015,018 $ 1,125,698
Cost of goods sold 306,146 299,423 502,828 562,821
----------- ----------- ----------- -----------
Gross profit 334,173 301,268 512,190 562,877
----------- ----------- ----------- -----------
Operating expenses:
Marketing and sales 65,394 67,475 138,850 147,422
General and administrative 28,480 28,237 76,981 68,246
Research and development 110,250 73,424 281,471 187,025
Amortization of intangibles 4,681 2,596 14,051 7,800
----------- ----------- ----------- -----------
Total operating expenses 208,805 171,732 511,353 410,493
----------- ----------- ----------- -----------
Operating income 125,368 129,536 837 152,384
Interest and other income, net 2,690 4,382 10,628 11,653
----------- ----------- ----------- -----------
Income before provision for income taxes
and minority interest 128,058 133,918 11,465 164,037
Provision for income taxes 39,698 41,214 3,554 50,852
----------- ----------- ----------- -----------
Income before minority interest 88,360 92,704 7,911 113,185
Minority interest in consolidated
joint venture (382) 157 (1,113) 134
----------- ----------- ----------- -----------
Net income $ 87,978 $ 92,861 $ 6,798 $ 113,319
=========== =========== =========== ===========
Net income per share:
Basic N/A $ 0.73 N/A $ 0.91
Diluted N/A $ 0.69 N/A $ 0.86
Number of shares used in computation:
Basic N/A 126,651 N/A 124,780
Diluted N/A 134,955 N/A 131,670
Class A common stock:
Net income:
Basic $ 95,416 N/A $ 21,942 N/A
=========== ===========
Diluted $ 87,978 N/A $ 6,798 N/A
=========== ===========
Net income per share:
Basic $ 0.72 N/A $ 0.17 N/A
Diluted $ 0.63 N/A $ 0.05 N/A
Number of shares used in computation:
Basic 132,339 N/A 130,716 N/A
Diluted 138,904 N/A 137,372 N/A
Class B common stock:
Net loss, net of retained interest in EA.com $ (7,438) N/A $ (15,144) N/A
=========== ===========
Net loss per share:
Basic $ (1.24) N/A $ (2.52) N/A
Diluted $ (1.24) N/A $ (2.52) N/A
Number of shares used in computation:
Basic 6,000 N/A 6,000 N/A
Diluted 6,000 N/A 6,000 N/A
See accompanying notes to consolidated financial statements.
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Nine Months
Ended December 31,
----------------------
2000 1999
--------- ---------
Operating activities:
Net income $ 6,798 $ 113,319
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Minority interest in consolidated joint venture 1,113 (134)
Equity in net (income) loss of affiliates 452 (625)
Gain on sale of affiliate (214) (842)
Depreciation and amortization 50,272 31,430
Loss on sale of fixed assets 1,542 402
Gain on sale of marketable securities -- (6,063)
Provision for doubtful accounts 6,091 6,427
Tax benefit from exercise of stock options 15,332 24,797
Change in assets and liabilities, net of acquisitions:
Receivables (128,488) (234,879)
Inventories 3,134 (462)
Other assets (9,814) (71,249)
Accounts payable (29,511) 26,092
Accrued liabilities 83,652 53,016
Deferred income taxes 966 (535)
--------- ---------
Net cash provided by (used in) operating activities 1,325 (59,306)
--------- ---------
Investing activities:
Proceeds from sale of property and equipment 3,958 56
Proceeds from sales of marketable securities, net -- 7,037
Purchase of marketable securities, net (2,479) --
Proceeds from sale of affiliate -- 8,842
Capital expenditures (104,860) (85,023)
Investment in affiliates, net 662 (2,949)
Change in short-term investments, net 22,443 (20,630)
Acquisition of subsidiaries, net of cash acquired -- (582)
--------- ---------
Net cash used in investing activities (80,276) (93,249)
--------- ---------
Financing activities:
Proceeds from sales of shares through employee stock
plans and other plans 60,862 68,477
--------- ---------
Net cash provided by financing activities 60,862 68,477
--------- ---------
Translation adjustment (3,886) (718)
--------- ---------
Decrease in cash and cash equivalents (21,975) (84,796)
Beginning cash and cash equivalents 246,265 242,208
--------- ---------
Ending cash and cash equivalents 224,290 157,412
Short-term investments 71,087 89,758
--------- ---------
Ending cash, cash equivalents and short-term investments $ 295,377 $ 247,170
========= =========
5
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
(unaudited)
Nine Months
Ended December 31,
--------------------
2000 1999
------- -------
Supplemental cash flow information:
Cash paid during the year for income taxes $10,706 $ 9,711
======= =======
Non-cash investing activities:
Change in unrealized appreciation of investments
and marketable securities $ 9,458 $(4,441)
======= =======
See accompanying notes to consolidated financial statements.
6
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The condensed consolidated financial statements are unaudited and reflect all
adjustments (consisting only of normal recurring accruals) that, in the opinion
of management, are necessary for a fair presentation of the results for the
interim period. The results of operations for the current interim period are not
necessarily indicative of results to be expected for the current year or any
other period. Certain amounts have been reclassified to conform to the fiscal
2001 presentation.
These condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto included in
Electronic Arts Inc. (the "Company") Annual Report on Form 10-K for the fiscal
year ended March 31, 2000 as filed with the Securities and Exchange Commission
("Commission") on June 29, 2000.
Note 2. 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
2001 will contain 53 weeks. Accordingly, the results of operations for the first
three quarters of fiscal 2001 and the first three quarters of fiscal 2000
contain 40 weeks and 39 weeks, respectively. The results of operations for the
fiscal quarter ended June 30, 2000 and the fiscal quarter ended June 30, 1999
contain 14 weeks and 13 weeks, respectively. Since the results of an additional
week are not material, and for clarity of presentation, all fiscal periods are
treated as ending on a calendar month.
Note 3. Approval of the Tracking Stock Proposal
On March 22, 2000, the shareholders of Electronic Arts approved the "Tracking
Stock Proposal" which authorized the issuance of a new series of common stock,
designated as Class B common stock ("Tracking Stock"). The Tracking Stock is
intended to reflect the performance of Electronic Arts' online and e-Commerce
division ("EA.com"). As a result of the approval of the Tracking Stock Proposal,
Electronic Arts' existing common stock has been re-classified as Class A common
stock ("Class A Stock") and that stock reflects the performance of Electronic
Arts' other businesses ("EA Core").
Note 4. Stock Split
On August 14, 2000, the Company's Board of Directors authorized a two-for-one
stock split of its Class A common stock which was distributed on September 8,
2000 in the form of a stock dividend for shareholders of record at the close of
business on August 25, 2000. All authorized and outstanding share and per share
amounts of Class A common stock in the accompanying consolidated financial
statements for all periods have been restated to reflect the stock split.
7
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 5. 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 or effective royalty rate as cost of
goods sold based on actual net product sales. Management evaluates the future
realization of prepaid royalties quarterly and charges to 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 $51,501,000 and $54,970,000 at
December 31, 2000 and March 31, 2000, respectively. The long-term portion of
prepaid royalties, included in other assets, was $9,326,000 and $11,373,000 at
December 31, 2000 and March 31, 2000, respectively.
Note 6. Inventories
Inventories are stated at the lower of cost or market. Inventories at December
31, 2000 and March 31, 2000 consisted of (in thousands):
December 31, March 31,
2000 2000
-------- --------
Raw materials and work in process $ 1,141 $ 920
Finished goods 18,711 22,066
-------- --------
$ 19,852 $ 22,986
======== ========
Note 7. Accrued and Other Liabilities
Accrued liabilities at December 31, 2000 and March 31, 2000 consisted of (in
thousands):
December 31, March 31,
2000 2000
-------- --------
Accrued expenses $ 77,650 $ 37,840
Accrued compensation and benefits 67,469 59,580
Accrued royalties 54,430 36,566
Accrued income taxes 26,543 22,682
Deferred revenue 17,098 1,847
Warranty reserve 7,863 8,886
Deferred income taxes 808 198
-------- --------
$251,861 $167,599
======== ========
8
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 8. 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 issuance of Class B common stock, which is intended to
reflect the performance of EA.com, management considers EA.com to be a separate
reportable segment. Accordingly, prior period information has been restated to
disclose separate segments. The Company operates in two principal business
segments globally:
* Electronic Arts core ("EA Core") business segment: creation, marketing
and distribution of entertainment software.
* EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online, ongoing
management of subscriptions of online games and related advertising.
Please see the discussion regarding segment reporting in the MD&A.
9
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about Electronic Arts business segments is presented below for the
three and nine months ended December 31, 2000 and 1999 (in thousands):
Three Months Ended December 31, 2000
-----------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
----------- ----------- ----------- -----------
Net revenues from unaffiliated customers $ 629,145 $ 11,174 $ -- $ 640,319
Group sales 752 -- (752)(a) --
----------- ----------- ----------- -----------
Total net revenues 629,897 11,174 (752) 640,319
----------- ----------- ----------- -----------
Cost of goods sold from unaffiliated customers 304,036 2,110 -- 306,146
Group cost of goods sold -- 752 (752)(a) --
----------- ----------- ----------- -----------
Total cost of goods sold 304,036 2,862 (752) 306,146
----------- ----------- ----------- -----------
Gross profit 325,861 8,312 -- 334,173
Operating expenses:
Marketing and sales 56,690 4,233 4,471 (c) 65,394
General and administrative 25,722 2,758 -- 28,480
Research and development 65,081 25,544 19,625 (b) 110,250
Network development and support -- 19,625 (19,625)(b) --
Carriage fee -- 4,471 (4,471)(c) --
Amortization of intangibles 3,184 1,497 -- 4,681
----------- ----------- ----------- -----------
Total operating expenses 150,677 58,128 -- 208,805
----------- ----------- ----------- -----------
Operating income (loss) 175,184 (49,816) -- 125,368
Interest and other income, net 2,456 234 -- 2,690
----------- ----------- ----------- -----------
Income (loss) before provision for income
taxes and minority interest 177,640 (49,582) -- 128,058
Provision for income taxes 39,698 -- -- 39,698
----------- ----------- ----------- -----------
Income (loss) before minority interest 137,942 (49,582) -- 88,360
Minority interest in consolidated joint venture (382) -- -- (382)
----------- ----------- ----------- -----------
Net income (loss) before retained interest in EA.com $ 137,560 $ (49,582) $ -- $ 87,978
=========== =========== =========== ===========
Interest income $ 3,147 $ 22 $ -- $ 3,169
Depreciation and amortization 7,539 11,150 -- 18,689
Identifiable assets 1,172,112 165,164 -- 1,337,276
Capital expenditures 10,192 7,807 -- 17,999
10
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Three Months Ended December 31, 1999
-----------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
----------- ----------- ----------- -----------
Net revenues from unaffiliated customers $ 595,761 $ 4,930 $ -- $ 600,691
Group sales 557 -- (557)(a) --
----------- ----------- ----------- -----------
Total net revenues 596,318 4,930 (557) 600,691
----------- ----------- ----------- -----------
Cost of goods sold from unaffiliated customers 297,883 1,540 -- 299,423
Group cost of goods sold -- 557 (557)(a) --
----------- ----------- ----------- -----------
Total cost of goods sold 297,883 2,097 (557) 299,423
----------- ----------- ----------- -----------
Gross profit 298,435 2,833 -- 301,268
Operating expenses:
Marketing and sales 66,192 1,283 -- 67,475
General and administrative 26,545 1,692 -- 28,237
Research and development 55,318 12,240 5,866 (b) 73,424
Network development and support -- 5,866 (5,866)(b) --
Carriage fee -- -- -- --
Amortization of intangibles 2,567 29 -- 2,596
----------- ----------- ----------- -----------
Total operating expenses 150,622 21,110 -- 171,732
----------- ----------- ----------- -----------
Operating income (loss) 147,813 (18,277) -- 129,536
Interest and other income, net 4,382 -- -- 4,382
----------- ----------- ----------- -----------
Income (loss) before provision for income
taxes and minority interest 152,195 (18,277) -- 133,918
Provision for income taxes 41,214 -- -- 41,214
----------- ----------- ----------- -----------
Income (loss) before minority interest 110,981 (18,277) -- 92,704
Minority interest in consolidated joint venture 157 -- -- 157
----------- ----------- ----------- -----------
Net income (loss) $ 111,138 $ (18,277) $ -- $ 92,861
=========== =========== =========== ===========
Interest income $ 3,301 $ -- $ -- $ 3,301
Depreciation and amortization 10,186 589 -- 10,775
Identifiable assets 1,127,445 53,324 -- 1,180,769
Capital expenditures 33,303 4,382 -- 37,685
11
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Nine Months Ended December 31, 2000
-----------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
----------- ----------- ----------- -----------
Net revenues from unaffiliated customers $ 985,754 $ 29,264 $ -- $ 1,015,018
Group sales 1,795 -- (1,795)(a) --
----------- ----------- ----------- -----------
Total net revenues 987,549 29,264 (1,795) 1,015,018
----------- ----------- ----------- -----------
Cost of goods sold from unaffiliated customers 496,620 6,208 -- 502,828
Group cost of goods sold -- 1,795 (1,795)(a) --
----------- ----------- ----------- -----------
Total cost of goods sold 496,620 8,003 (1,795) 502,828
----------- ----------- ----------- -----------
Gross profit 490,929 21,261 -- 512,190
Operating expenses:
Marketing and sales 126,702 7,677 4,471 (c) 138,850
General and administrative 69,611 7,370 -- 76,981
Research and development 182,935 59,712 38,824 (b) 281,471
Network development and support -- 38,824 (38,824)(b) --
Carriage fee -- 4,471 (4,471)(c) --
Amortization of intangibles 9,645 4,406 -- 14,051
----------- ----------- ----------- -----------
Total operating expenses 388,893 122,460 -- 511,353
----------- ----------- ----------- -----------
Operating income (loss) 102,036 (101,199) -- 837
Interest and other income, net 10,387 241 -- 10,628
----------- ----------- ----------- -----------
Income (loss) before provision for income
taxes and minority interest 112,423 (100,958) -- 11,465
Provision for income taxes 3,554 -- -- 3,554
----------- ----------- ----------- -----------
Income (loss) before minority interest 108,869 (100,958) -- 7,911
Minority interest in consolidated joint venture (1,113) -- -- (1,113)
----------- ----------- ----------- -----------
Net income (loss) before retained interest in EA.com $ 107,756 $ (100,958) $ -- $ 6,798
=========== =========== =========== ===========
Interest income $ 11,546 $ 71 $ -- $ 11,617
Depreciation and amortization 29,449 20,823 -- 50,272
Capital expenditures 39,442 65,418 -- 104,860
12
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Nine Months Ended December 31, 1999
-----------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
----------- ----------- ----------- -----------
Net revenues from unaffiliated customers $ 1,111,598 $ 14,100 $ -- $ 1,125,698
Group sales 1,465 -- (1,465)(a) --
----------- ----------- ----------- -----------
Total net revenues 1,113,063 14,100 (1,465) 1,125,698
----------- ----------- ----------- -----------
Cost of goods sold from unaffiliated customers 558,845 3,976 -- 562,821
Group cost of goods sold -- 1,465 (1,465)(a) --
----------- ----------- ----------- -----------
Total cost of goods sold 558,845 5,441 (1,465) 562,821
----------- ----------- ----------- -----------
Gross profit 554,218 8,659 -- 562,877
Operating expenses:
Marketing and sales 145,417 2,005 -- 147,422
General and administrative 65,924 2,322 -- 68,246
Research and development 152,077 22,877 12,071 (b) 187,025
Network development and support -- 12,071 (12,071)(b) --
Carriage fee -- -- -- --
Amortization of intangibles 7,742 58 -- 7,800
----------- ----------- ----------- -----------
Total operating expenses 371,160 39,333 -- 410,493
----------- ----------- ----------- -----------
Operating income (loss) 183,058 (30,674) -- 152,384
Interest and other income, net 11,653 -- -- 11,653
----------- ----------- ----------- -----------
Income (loss) before provision for income
taxes and minority interest 194,711 (30,674) -- 164,037
Provision for income taxes 50,852 -- -- 50,852
----------- ----------- ----------- -----------
Income (loss) before minority interest 143,859 (30,674) -- 113,185
Minority interest in consolidated joint venture 134 -- -- 134
----------- ----------- ----------- -----------
Net income (loss) $ 143,993 $ (30,674) $ -- $ 113,319
=========== =========== =========== ===========
Interest income $ 9,903 $ -- $ -- $ 9,903
Depreciation and amortization 30,680 750 -- 31,430
Capital expenditures 71,716 13,307 -- 85,023
<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.
(c) Represents reclassification of amortization of the AOL Carriage Fee to
Marketing.
</FN>
13
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about the Company's operations in North America and foreign areas
for the three and nine months ended December 31, 2000 and 1999 is presented
below:
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
---------- ---------- ---------- ---------- ---------- ----------
Three months ended December 31, 2000
Net revenues from unaffiliated
customers $ 416,904 $ 189,943 $ 19,887 $ 13,585 $ -- $ 640,319
Intercompany revenues 3,692 11,161 3,569 2,071 (20,493) --
---------- ---------- ---------- ---------- ---------- ----------
Total net revenues 420,596 201,104 23,456 15,656 (20,493) 640,319
========== ========== ========== ========== ========== ==========
Operating income 82,257 39,588 2,941 1,411 (829) 125,368
Interest income 2,598 494 77 -- -- 3,169
Depreciation and amortization 15,393 2,932 218 146 -- 18,689
Identifiable assets 876,560 406,952 29,083 24,681 -- 1,337,276
Capital expenditures 15,361 2,202 328 108 -- 17,999
Long-lived assets 323,825 160,420 4,146 3,967 -- 492,358
Nine months ended December 31, 2000
Net revenues from unaffiliated
customers $ 641,502 $ 291,786 $ 41,526 $ 40,204 $ -- $1,015,018
Intercompany revenues 8,971 19,979 10,126 2,071 (41,147) --
---------- ---------- ---------- ---------- ---------- ----------
Total net revenues 650,473 311,765 51,652 42,275 (41,147) 1,015,018
========== ========== ========== ========== ========== ==========
Operating income (loss) 2,547 (11,624) 4,812 4,800 302 837
Interest income 8,847 2,430 340 -- -- 11,617
Depreciation and amortization 41,053 8,202 591 426 -- 50,272
Capital expenditures 88,796 14,683 999 382 -- 104,860
Three months ended December 31, 1999
Net revenues from unaffiliated
customers $ 366,467 $ 210,855 $ 16,976 $ 6,393 $ -- $ 600,691
Intercompany revenues 16,031 11,499 1,755 -- (29,285) --
---------- ---------- ---------- ---------- ---------- ----------
Total net revenues 382,498 222,354 18,731 6,393 (29,285) 600,691
========== ========== ========== ========== ========== ==========
Operating income (loss) 86,896 41,670 1,723 (437) (316) 129,536
Interest income 2,693 542 66 -- -- 3,301
Depreciation and amortization 7,748 2,652 154 221 -- 10,775
Identifiable assets 751,490 383,204 32,257 13,818 -- 1,180,769
Capital expenditures 16,238 20,731 432 284 -- 37,685
Long-lived assets 211,827 137,151 3,518 3,821 -- 356,317
Nine months ended December 31, 1999
Net revenues from unaffiliated
customers $ 694,125 $ 367,649 $ 42,430 $ 21,494 $ -- $1,125,698
Intercompany revenues 23,751 24,145 4,660 -- (52,556) --
---------- ---------- ---------- ---------- ---------- ----------
Total net revenues 717,876 391,794 47,090 21,494 (52,556) 1,125,698
========== ========== ========== ========== ========== ==========
Operating income (loss) 114,520 35,535 3,907 (222) (1,356) 152,384
Interest income 8,676 1,071 156 -- -- 9,903
Depreciation and amortization 22,216 8,099 396 719 -- 31,430
Capital expenditures 36,700 46,883 1,024 416 -- 85,023
14
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information about the Company's net revenues by product line for the three and
nine months ended December 31, 2000 and 1999 is presented below:
Three Months Ended Nine Months Ended
(In thousands) December 31, December 31,
----------------------- -----------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
PC $ 153,246 $ 123,771 $ 305,396 $ 289,154
PlayStation 183,309 291,002 277,967 471,690
PlayStation 2 144,611 -- 157,629 --
N64 49,241 57,066 60,008 114,873
Online Subscription 6,753 3,941 22,209 10,915
License, OEM and Other 5,218 8,488 14,953 16,532
Advertising 2,591 -- 2,591 --
Affiliated label 95,350 116,423 174,265 222,534
---------- ---------- ---------- ----------
$ 640,319 $ 600,691 $1,015,018 $1,125,698
========== ========== ========== ==========
Note 9. Comprehensive Income
The components of comprehensive income, net of tax, for the three and nine
months ended December 31, 2000 and 1999 were as follows:
(In thousands) Three Months Ended Nine Months Ended
December 31, December 31,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- ---------
Net income $ 87,978 $ 92,861 $ 6,798 $ 113,319
--------- --------- --------- ---------
Other comprehensive income (loss):
Change in unrealized appreciation
(depreciation) of investments, net
of a tax provision (benefit) of
$(112), $117, $(536) and $519 (100) 248 9,994 1,103
Reclassification adjustment for
gains realized in net income for 1999,
net of a tax benefit of $(1,528) and $(1,940) -- (3,249) -- (4,123)
Foreign currency translation adjustments 2,280 (4,666) (3,463) (1,171)
--------- --------- --------- ---------
Total other comprehensive income (loss) 2,180 (7,667) 6,531 (4,191)
--------- --------- --------- ---------
Total comprehensive income $ 90,158 $ 85,194 $ 13,329 $ 109,128
========= ========= ========= =========
The currency translation adjustments are not adjusted for income taxes as they
relate to indefinite investments in non-U.S. subsidiaries.
Note 10. Earnings (Loss) Per Share
The following summarizes the computations of Basic Earnings Per Share ("EPS")
and Diluted EPS. Basic EPS is computed as net earnings divided by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur from common shares issuable
through stock-based compensation plans including stock options, restricted stock
awards, warrants and other convertible securities using the treasury stock
method.
15
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Net income (loss) per share was calculated on a consolidated basis until Class A
common stock and Class B common stock were created as a result of the approval
of the Tracking Stock Proposal, see Note 3. Subsequent to the approval of the
Tracking Stock Proposal, net income (loss) per share is computed individually
for Class A common stock and Class B common stock.
(in thousands, except per share amounts):
Three months ended December 31,
-------------------------------------------------------
2000 2000 2000 1999
Class A common Class A common Class B Electronic
stock-EA Core stock-EA Core common Arts common
Basic Diluted stock-EA.com stock
-------- -------- -------- --------
Net income (loss) $ 95,416 $ 87,978 $ (7,438) $ 92,861
-------- -------- -------- --------
Shares used to compute net income
(loss) per share:
Weighted-average common shares 132,339 132,339 6,000 126,651
Dilutive stock equivalents -- 6,565 -- 8,304
-------- -------- -------- --------
Dilutive potential common shares 132,339 138,904 6,000 134,955
======== ======== ======== ========
Net income (loss) per share:
Basic $ 0.72 N/A $ (1.24) $ 0.73
Diluted N/A $ 0.63 $ (1.24) $ 0.69
Nine months ended December 31,
-------------------------------------------------------
2000 2000 2000 1999
Class A common Class A common Class B Electronic
stock-EA Core stock-EA Core common Arts common
Basic Diluted stock-EA.com stock
-------- -------- -------- --------
Net income (loss) $ 21,942 $ 6,798 $(15,144) $113,319
-------- -------- -------- --------
Shares used to compute net income
(loss) per share:
Weighted-average common shares 130,716 130,716 6,000 124,780
Dilutive stock equivalents -- 6,656 -- 6,890
-------- -------- -------- --------
Dilutive potential common shares 130,716 137,372 6,000 131,670
======== ======== ======== ========
Net income (loss) per share:
Basic $ 0.17 N/A $ (2.52) $ 0.91
Diluted N/A $ 0.05 $ (2.52) $ 0.86
16
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
The Diluted EPS calculation for Class A common stock, presented above, includes
the potential dilution from the conversion of Class B common stock to Class A
common stock in the event that the initial public offering for Class B common
stock does not occur. Net income used for the calculation of Diluted EPS for
Class A common stock is $87,978,000 and $6,798,000 for the three and nine months
ended December 31, 2000, respectively. This net income includes the remaining
15% interest in EA.com, which is directly attributable to outstanding Class B
shares, which would be included in the Class A common stock EPS calculation in
the event that the initial public offering for Class B common stock does not
occur.
Excluded from the above computation of weighted-average shares for diluted EPS
were options to purchase 4,142,646 and 2,617,667 shares of common stock for the
three and nine months ended December 31, 2000, respectively, as the options'
exercise price was greater than the average market price of the common shares.
For the three and nine months ended December 31, 2000, the weighted-average
exercise price of the respective options was $49.55 and $46.99, respectively.
Excluded from the above computation of weighted-average shares for diluted EPS
were options to purchase 151,256 and 293,456 shares of common stock for the
three and nine months ended December 31, 1999, respectively, as the options'
exercise price was greater than the average market price of the common shares.
For the three and nine months ended December 31, 1999, the weighted-average
exercise price of the respective options was $45.97 and $37.57, respectively.
Note 11. New Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25)". FIN 44 clarifies the
application of APB Opinion No. 25 for certain issues: (a) the definition of
employee for purposes of applying Opinion 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. Generally, FIN 44 is effective July 1, 2000.
The adoption of FIN 44 did not have a material impact on the Company's
consolidated financial position or results of operations.
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. The
adoption of
17
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
EITF 00-03 did 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's accounting policy for internal-use software, as required by
SOP 98-1, incorporated the requirements of EITF 00-02.
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 the
fourth fiscal quarter of fiscal years beginning after December 15, 1999 as
amended by SAB 101B. 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 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", as amended by SFAS 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No.
133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB Statement No. 133" which establish
accounting and reporting standards for derivative instruments and hedging
activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning
of the first quarter of the fiscal year beginning after June 15, 2000. The
Company is determining the effect of SFAS 133, 137 and 138 on its financial
statements.
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q and, in particular, the following
"Management's 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 our future results
and performance include, but are not limited to, those discussed under the
heading "Risk Factors" below at pages 35 to 44, as well as in our Annual Report
on Form 10-K for the fiscal year ended March 31, 2000 as filed with the
Securities and Exchange Commission on June 29, 2000 and other documents filed
with the Commission.
We derive revenues primarily from shipments of entertainment software, which
includes EA Studio products for dedicated entertainment systems (that we call
video game systems or consoles such as PlayStation, PlayStation 2 and Nintendo
64), EA Studio personal computer products (or PC), Co- Publishing products that
are co-published and distributed by us, and Affiliated Label (or AL) products
that are published by third parties and distributed by us. We also derive
revenues from licensing of EA Studio products and AL products through hardware
companies (or OEM), online subscription, advertising and e-Commerce revenues.
Information about our net revenues for North America and foreign areas for the
three and nine months ended December 31, 2000 and 1999 is summarized below (in
thousands):
December 31, December 31, Increase/
2000 1999 (Decrease) % change
----------- ----------- ---------- --------
Net Revenues for the
Three Months Ended:
North America $ 416,904 $ 366,467 $ 50,437 13.8%
----------- ----------- ---------- ------
Europe 189,943 210,855 (20,912) (9.9%)
Asia Pacific 19,887 16,976 2,911 17.1%
Japan 13,585 6,393 7,192 112.5%
----------- ----------- ---------- ------
International 223,415 234,224 (10,809) (4.6%)
----------- ----------- ---------- ------
Consolidated Net Revenues $ 640,319 $ 600,691 $ 39,628 6.6%
=========== =========== ========== ======
19
December 31, December 31, Increase/
2000 1999 (Decrease) % change
----------- ----------- ---------- --------
Net Revenues for the
Nine Months Ended:
North America $ 641,502 $ 694,125 $ (52,623) (7.6%)
----------- ----------- ---------- ------
Europe 291,786 367,649 (75,863) (20.6%)
Asia Pacific 41,526 42,430 (904) (2.1%)
Japan 40,204 21,494 18,710 87.0%
----------- ----------- ---------- ------
International 373,516 431,573 (58,057) (13.5%)
----------- ----------- ---------- ------
Consolidated Net Revenues
$ 1,015,018 $ 1,125,698 $ (110,680) (9.8%)
=========== =========== ========== ======
North America Net Revenues
The increase in North America net revenues for the three months ended December
31, 2000, compared to the same period last year was primarily due to:
* The launch of PlayStation 2 platform in North America generated $97,800,000
in revenue for the quarter from titles such as Madden NFL 2001, SSX and NHL
2001.
* A 32% increase in PC revenues due to the shipment of key releases including
Command & Conquer Red Alert 2 and American McGee's Alice and continued
strong sales of The Sims and The Sims: Livin' Large.
* These increases were offset by a 34% decrease in PlayStation revenues
related to the console transition. With the exception of Madden NFL 2001,
which was released in the second quarter of the current fiscal year, all
franchise titles are showing a significant decrease from prior year
releases.
* These increases were also partially offset by a decrease in N64 revenues
due to the console transition. We released two titles in the current
quarter compared to three in the comparable prior year period.
The decrease in North America net revenues for the nine months ended December
31, 2000, compared to the same period last year was primarily due to:
* A 43% decrease in PlayStation revenues due to the console transition to
PlayStation 2. We released 16 titles in the nine months ended December 31,
2000 compared to 20 in the comparable prior year period.
* A 48% decrease in N64 revenues also related to the console transition. We
released three titles in the nine months ended December 31, 2000 compared
to seven in the comparable prior year period.
* These decreases were partially offset by a 23% increase in PC revenues due
to the strong sales of The Sims, Command & Conquer Red Alert 2 and The
Sims: Livin' Large.
International Net Revenues
The decrease in international net revenues for the three months ended December
31, 2000, compared to the same period last year was primarily attributable to:
* Europe's net revenues decreased 10% primarily due to market weakness, the
PlayStation 2 console transition as well as weakness in the Euro currency.
PlayStation revenues
20
decreased 41% compared to the same period last year but were partially
offset by revenues generated from PlayStation 2 titles, such as FIFA 2001
and SSX.
* European AL sales decreased 33% due to a weaker market, fewer hit titles
and product release slips from large ALs as compared to the prior year.
* Offset by Asia Pacific's net revenues, which increased 17% mainly in PC
revenues, due to the release of Command & Conquer Red Alert 2 in the
current period, and revenues generated from PlayStation 2 titles.
* Offset by Japan's net revenues, which increased 113% due to revenues
generated from PlayStation 2 titles, such as FIFA Soccer World Championship
and SSX.
The decrease in international net revenues for the nine months ended December
31, 2000, compared to the same period last year was primarily attributable to:
* Europe's net revenues decreased 21% primarily due to market weakness, lower
AL sales due to product release slips and fewer hit titles released in the
current year, lower PC sales with fewer titles shipping in the period, the
strong sales of Command & Conquer Tiberian Sun for the PC in the comparable
prior year period, and weakness in the Euro currency. In addition,
PlayStation revenue decreased 37% due to fewer titles shipping during the
console transition period with most franchise titles showing significant
decreases from the prior year releases.
* Asia Pacific's net revenues decreased 2%, mainly due to the decrease in
PlayStation revenues as there were no significant new titles released in
the current year. This was offset by sales of PlayStation 2 titles such as
SSX and FIFA 2001.
* Offset by Japan's net revenues which increased 87% compared to the prior
year primarily due to the shipment of PlayStation 2 titles such as FIFA
Soccer World Championship, FIFA 2001 and SSX.
Information about our net revenues by product line for the three and nine months
ended December 31, 2000 and 1999 is presented below (in thousands):
December 31, December 31, Increase/
2000 1999 (Decrease) % change
----------- ----------- ----------- --------
Net Revenues for the
Three Months Ended:
EA Studio:
PC $ 153,246 $ 123,771 $ 29,475 23.8%
PlayStation 183,309 291,002 (107,693) (37.0%)
PlayStation 2 144,611 -- 144,611 N/A
N64 49,241 57,066 (7,825) (13.7%)
Online Subscriptions 6,753 3,941 2,812 71.4%
License, OEM and Other 5,218 8,488 (3,270) (38.5%)
Advertising 2,591 -- 2,591 N/A
----------- ----------- ----------- -----
544,969 484,268 60,701 12.5%
Affiliated Label: 95,350 116,423 (21,073) (18.1%)
----------- ----------- ----------- -----
Consolidated Net Revenues $ 640,319 $ 600,691 $ 39,628 6.6%
=========== =========== =========== =====
21
December 31, December 31, Increase/
2000 1999 (Decrease) % change
----------- ----------- ----------- --------
Net Revenues for the
Nine Months Ended:
EA Studio:
PC $ 305,396 $ 289,154 $ 16,242 5.6%
PlayStation 277,967 471,690 (193,723) (41.1%)
PlayStation 2 157,629 -- 157,629 N/A
N64 60,008 114,873 (54,865) (47.8%)
Online Subscriptions 22,209 10,915 11,294 103.5%
License, OEM and Other 14,953 16,532 (1,579) (9.6%)
Advertising 2,591 -- 2,591 N/A
----------- ----------- ----------- -----
840,753 903,164 (62,411) (6.9%)
Affiliated Label: 174,265 222,534 (48,269) (21.7%)
----------- ----------- ----------- -----
Consolidated Net Revenues $ 1,015,018 $ 1,125,698 $ (110,680) (9.8%)
=========== =========== =========== =====
Personal Computer Product Net Revenues
The increase in sales of PC products for the three and nine months ended
December 31, 2000 was primarily attributable to the continued strong sales of
The Sims, which shipped in the prior year. Key current year releases were
Command and Conquer Red Alert 2 and The Sims: Livin' Large. We released five PC
titles in the third quarter of the current fiscal year compared to ten for the
same period last year. We released 13 PC titles in the nine months ended
December 31, 2000 compared to 21 in the same period last year.
PlayStation Product Net Revenues
We released ten PlayStation titles in the third quarter of the current fiscal
year and the same period last year. We released 16 PlayStation titles in the
nine months ended December 31, 2000 compared to 20 in the same period last year.
As expected, PlayStation sales decreased for the three months and nine months
ended December 31, 2000 compared to the prior year primarily attributable to the
PlayStation 2 platform transition. With the exception of Madden NFL, all of our
franchises experienced significant decreases from the prior year release.
Although our PlayStation products are playable on the PlayStation 2 console, we
expect sales of current PlayStation products to continue to decline in fiscal
2001.
Under the terms of a licensing agreement with Sony Computer Entertainment of
America in July 1994 (the "Sony Agreement"), as amended, we are authorized to
develop and distribute CD-based software products compatible with the
PlayStation. Pursuant to the Sony Agreement, we engage Sony to supply
PlayStation CDs for distribution by us. Accordingly, we have limited ability to
control our supply of PlayStation CD products or the timing of their delivery.
See Risk Factors - "Our platform licensors are our chief competitors and
frequently control the manufacturing of our video game products", below.
PlayStation 2 Product Net Revenues
We released ten titles worldwide for the three months and nine months ended
December 31, 2000 for the PlayStation 2. Key releases for the quarter included
Madden NFL 2001, SSX, FIFA 2001 and NHL 2001. Revenue was lower than expected
due to the shortage of
22
PlayStation 2 hardware in the quarter resulting from component shortages which
limited the number of units that could be manufactured, according to Sony. We
anticipate that the hardware shortage will continue to have an adverse impact on
our PlayStation 2 net revenues in the fourth quarter of the fiscal year 2001,
but expect Sony to correct these issues for the next fiscal year.
N64 Product Net Revenues
We released two N64 titles in the third quarter of fiscal 2001 compared to three
titles during the same period last year. We released three N64 titles in the
nine months ended December 31, 2000 compared to seven in the same period last
year. The expected decrease in N64 revenues for the three months and nine months
ended December 31, 2000, compared to the same period last year was primarily due
to fewer releases. The decrease is also due to the weaker market for Nintendo 64
products in the current year. We expect revenues for N64 products to continue to
decline significantly in fiscal 2001. The key release for the quarter was The
World Is Not Enough.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64
cartridges for distribution by us. Accordingly, we have little ability to
control our supply of N64 cartridges or the timing of their delivery. A shortage
of microchips or other factors outside our control could impair our ability to
obtain an adequate supply of cartridges.
In connection with our purchases of N64 cartridges for distribution in North
America, Nintendo requires us to provide irrevocable letters of credit prior to
Nintendo's acceptance of purchase orders from us for purchases of these
cartridges. For purchases of N64 cartridges for distribution in Japan and
Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo
maintains a policy of not accepting returns of N64 cartridges. Because of these
and other factors, the carrying of an inventory of cartridges entails
significant capital and risk. See Risk Factors - "Our platform licensors are our
chief competitors and frequently control the manufacturing of our video game
products", below.
Online Net Revenues
The increase in online revenues for the three and nine months ended December 31,
2000 as compared to the three and nine months ended December 31, 1999 was
attributable to the following:
* The average number of monthly customers for Ultima Online increased to over
200,000 for the three months ended December 31, 2000 as compared to over
130,000 for the same period last year and was over 196,000 for the nine
months ended December 31, 2000 as compared to over 121,000 for the same
period last year. This increase was due to continued strong sales of Ultima
Online, the addition of new events and parties within the Ultima worlds and
the release of Ultima Renaissance in April 2000. Ultima Renaissance added
features including new houses and land mass.
* We generated over $740,000 in revenues for Kesmai and Wordplay products in
the current quarter and over $4,600,000 for the nine months ended December
31, 2000. These products were not part of EA.com last year due to the
Kesmai acquisition in the fourth quarter of fiscal 2000. It is anticipated
that revenues associated with these services will continue to decrease
significantly as these products are either shut-down or converted into
23
our free, advertising supported offerings. Certain products will be
retained as part of our new subscription offerings.
License, OEM and Other Revenues
The decrease in license, OEM and other revenues for the three and nine months
ended December 31, 2000 was primarily a result of higher license revenue in the
prior year of certain titles on the Game Boy platform.
Advertising
We began selling advertising following the launch of the EA.com/AOL Games
Channel in October 2000.
Affiliated Label Product Net Revenues
The decrease in Affiliated Label net revenues for the three and nine months
ended December 31, 2000 compared to the same periods last year was primarily due
to the strong sales of Final Fantasy VIII in the prior year, our acquisition of
DreamWorks Interactive, formerly an AL, in the fourth quarter of the prior year,
fewer hit AL product releases and product release slips in Europe.
Operations by Segment
As a result of the approval of the 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 to be a separate reportable segment.
Accordingly, prior period information has been restated to disclose this
separate segment. We operate in two principal business segments globally:
* Electronic Arts core ("EA Core") business segment: creation, marketing
and distribution of entertainment software.
* EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online, ongoing
management of subscriptions of online games and related advertising.
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, related website advertising,
sales of packaged goods for Internet-only based games and sales of Electronic
Arts games sold through EA.com websites. The statement of operations includes
all revenues and costs directly attributable to EA.com, including charges for
shared facilities, functions and services used by EA.com and provided by
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.
24
Information about our operations by segment for fiscal 2001 and 2000 is
presented below (in thousands):
Three Months Ended December 31, 2000
------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Net revenues from unaffiliated customers $ 629,145 $ 11,174 $ -- $ 640,319
Group sales 752 -- (752)(a) --
--------- --------- --------- ---------
Total net revenues 629,897 11,174 (752) 640,319
--------- --------- --------- ---------
Cost of goods sold from unaffiliated customers 304,036 2,110 -- 306,146
Group cost of goods sold -- 752 (752)(a) --
--------- --------- --------- ---------
Total cost of goods sold 304,036 2,862 (752) 306,146
--------- --------- --------- ---------
Gross profit 325,861 8,312 -- 334,173
Operating expenses:
Marketing and sales 56,690 4,233 4,471 (c) 65,394
General and administrative 25,722 2,758 -- 28,480
Research and development 65,081 25,544 19,625 (b) 110,250
Network development and support -- 19,625 (19,625)(b) --
Carriage fee -- 4,471 (4,471)(c) --
Amortization of intangibles 3,184 1,497 -- 4,681
--------- --------- --------- ---------
Total operating expenses 150,677 58,128 -- 208,805
--------- --------- --------- ---------
Operating income (loss) 175,184 (49,816) -- 125,368
Interest and other income, net 2,456 234 -- 2,690
--------- --------- --------- ---------
Income (loss) before provision for income
taxes and minority interest 177,640 (49,582) -- 128,058
Provision for income taxes 39,698 -- -- 39,698
--------- --------- --------- ---------
Income (loss) before minority interest 137,942 (49,582) -- 88,360
Minority interest in consolidated joint venture (382) -- -- (382)
--------- --------- --------- ---------
Net income (loss) before retained interest in EA.com $ 137,560 $ (49,582) $ -- $ 87,978
========= ========= ========= =========
Allocation of retained interest (in thousands):
Three Months Ended December 31, 2000
------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Net income (loss) before retained interest in EA.com $ 137,560 $ (49,582) $ -- $ 87,978
Net loss related to retained interest in EA.com (42,144) 42,144 -- --
--------- --------- --------- ---------
Net income (loss) $ 95,416 $ (7,438) $ -- $ 87,978
========= ========= ========= =========
25
Three Months Ended December 31, 1999
------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Net revenues from unaffiliated customers $ 595,761 $ 4,930 $ -- $ 600,691
Group sales 557 -- (557)(a) --
--------- --------- --------- ---------
Total net revenues 596,318 4,930 (557) 600,691
--------- --------- --------- ---------
Cost of goods sold from unaffiliated customers 297,883 1,540 -- 299,423
Group cost of goods sold -- 557 (557)(a) --
--------- --------- --------- ---------
Total cost of goods sold 297,883 2,097 (557) 299,423
--------- --------- --------- ---------
Gross profit 298,435 2,833 -- 301,268
Operating expenses:
Marketing and sales 66,192 1,283 -- 67,475
General and administrative 26,545 1,692 -- 28,237
Research and development 55,318 12,240 5,866 (b) 73,424
Network development and support -- 5,866 (5,866)(b) --
Carriage fee -- -- -- --
Amortization of intangibles 2,567 29 -- 2,596
--------- --------- --------- ---------
Total operating expenses 150,622 21,110 -- 171,732
--------- --------- --------- ---------
Operating income (loss) 147,813 (18,277) -- 129,536
Interest and other income, net 4,382 -- -- 4,382
--------- --------- --------- ---------
Income (loss) before provision for income
taxes and minority interest 152,195 (18,277) -- 133,918
Provision for income taxes 41,214 -- -- 41,214
--------- --------- --------- ---------
Income (loss) before minority interest 110,981 (18,277) -- 92,704
Minority interest in consolidated joint venture 157 -- -- 157
--------- --------- --------- ---------
Net income (loss) $ 111,138 $ (18,277) $ -- $ 92,861
========= ========= ========= =========
26
Nine Months Ended December 31, 2000
------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ----------
Net revenues from unaffiliated customers $ 985,754 $ 29,264 $ -- $1,015,018
Group sales 1,795 -- (1,795)(a) --
--------- --------- --------- ----------
Total net revenues 987,549 29,264 (1,795) 1,015,018
--------- --------- --------- ----------
Cost of goods sold from unaffiliated customers 496,620 6,208 -- 502,828
Group cost of goods sold -- 1,795 (1,795)(a) --
--------- --------- --------- ----------
Total cost of goods sold 496,620 8,003 (1,795) 502,828
--------- --------- --------- ----------
Gross profit 490,929 21,261 -- 512,190
Operating expenses:
Marketing and sales 126,702 7,677 4,471 (c) 138,850
General and administrative 69,611 7,370 -- 76,981
Research and development 182,935 59,712 38,824 (b) 281,471
Network development and support -- 38,824 (38,824)(b) --
Carriage fee -- 4,471 (4,471)(c) --
Amortization of intangibles 9,645 4,406 -- 14,051
--------- --------- --------- ----------
Total operating expenses 388,893 122,460 -- 511,353
--------- --------- --------- ----------
Operating income (loss) 102,036 (101,199) -- 837
Interest and other income, net 10,387 241 -- 10,628
--------- --------- --------- ----------
Income (loss) before provision for income
taxes and minority interest 112,423 (100,958) -- 11,465
Provision for income taxes 3,554 -- -- 3,554
--------- --------- --------- ----------
Income (loss) before minority interest 108,869 (100,958) -- 7,911
Minority interest in consolidated joint venture (1,113) -- -- (1,113)
--------- --------- --------- ----------
Net income (loss) before retained interest in EA.com $ 107,756 $(100,958) $ -- $ 6,798
========= ========= ========= ==========
Allocation of retained interest (in thousands):
Nine Months Ended December 31, 2000
------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ----------
Net income (loss) before retained interest in EA.com $ 107,756 $(100,958) $ -- $ 6,798
Net loss related to retained interest in EA.com (85,814) 85,814 -- --
--------- --------- --------- ----------
Net income (loss) $ 21,942 $ (15,144) $ -- $ 6,798
========= ========= ========= ==========
27
Nine Months Ended December 31, 1999
------------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
---------- --------- --------- ----------
Net revenues from unaffiliated customers $1,111,598 $ 14,100 $ -- $1,125,698
Group sales 1,465 -- (1,465)(a) --
---------- --------- --------- ----------
Total net revenues 1,113,063 14,100 (1,465) 1,125,698
---------- --------- --------- ----------
Cost of goods sold from unaffiliated customers 558,845 3,976 -- 562,821
Group cost of goods sold -- 1,465 (1,465)(a) --
---------- --------- --------- ----------
Total cost of goods sold 558,845 5,441 (1,465) 562,821
---------- --------- --------- ----------
Gross profit 554,218 8,659 -- 562,877
Operating expenses:
Marketing and sales 145,417 2,005 -- 147,422
General and administrative 65,924 2,322 -- 68,246
Research and development 152,077 22,877 12,071 (b) 187,025
Network development and support -- 12,071 (12,071)(b) --
Carriage fee -- -- -- --
Amortization of intangibles 7,742 58 -- 7,800
---------- --------- --------- ----------
Total operating expenses 371,160 39,333 -- 410,493
---------- --------- --------- ----------
Operating income (loss) 183,058 (30,674) -- 152,384
Interest and other income, net 11,653 -- -- 11,653
---------- --------- --------- ----------
Income (loss) before provision for income
taxes and minority interest 194,711 (30,674) -- 164,037
Provision for income taxes 50,852 -- -- 50,852
---------- --------- --------- ----------
Income (loss) before minority interest 143,859 (30,674) -- 113,185
Minority interest in consolidated joint venture 134 -- -- 134
---------- --------- --------- ----------
Net income (loss) $ 143,993 $ (30,674) $ -- $ 113,319
========== ========= ========= ==========
<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.
(c) Represents reclassification of amortization of the AOL carriage fee to
marketing.
</FN>
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 benefit could not be recognized by EA.com on a
stand-alone basis. The sum of tax expense and tax benefit for EA Core and EA.com
is the same as consolidated tax expense and tax benefit. This presentation
represents how management analyzes each segment of the business (in thousands):
Three Months Ended December 31, 2000
-----------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Income (loss) before provision for (benefit from)
income taxes and minority interest $ 177,640 $ (49,582) $ -- $ 128,058
Provision for (benefit from) income taxes 55,068 (15,370) -- 39,698
--------- --------- --------- ---------
Income (loss) before minority interest 122,572 (34,212) -- 88,360
Minority interest in consolidated joint venture (382) -- -- (382)
--------- --------- --------- ---------
Net income (loss) $ 122,190 $ (34,212) $ -- $ 87,978
========= ========= ========= =========
Three Months Ended December 31, 1999
-----------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Income (loss) before provision for (benefit from)
income taxes and minority interest $ 152,195 $ (18,277) $ -- $ 133,918
Provision for (benefit from) income taxes 46,755 (5,541) -- 41,214
--------- --------- --------- ---------
Income (loss) before minority interest 105,440 (12,736) -- 92,704
Minority interest in consolidated joint venture 157 -- -- 157
--------- --------- --------- ---------
Net income (loss) $ 105,597 $ (12,736) $ -- $ 92,861
========= ========= ========= =========
Nine Months Ended December 31, 2000
-----------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Income (loss) before provision for (benefit from)
income taxes and minority interest $ 112,423 $(100,958) $ -- $ 11,465
Provision for (benefit from) income taxes 34,851 (31,297) -- 3,554
--------- --------- --------- ---------
Income (loss) before minority interest 77,572 (69,661) -- 7,911
Minority interest in consolidated joint venture (1,113) -- -- (1,113)
--------- --------- --------- ---------
Net income (loss) $ 76,459 $ (69,661) $ -- $ 6,798
========= ========= ========= =========
Nine Months Ended December 31, 1999
-----------------------------------------------------
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
--------- --------- --------- ---------
Income (loss) before provision for (benefit from)
income taxes and minority interest $ 194,711 $ (30,674) $ -- $ 164,037
Provision for (benefit from) income taxes 60,361 (9,509) -- 50,852
--------- --------- --------- ---------
Income (loss) before minority interest 134,350 (21,165) -- 113,185
Minority interest in consolidated joint venture 134 -- -- 134
--------- --------- --------- ---------
Net income (loss) $ 134,484 $ (21,165) $ -- $ 113,319
========= ========= ========= =========
29
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 the three and nine months ended December 31, 2000 and
1999 is presented below:
Percent of Net Percent of Net
Revenues Revenues
Three Months Nine Months
Ended Dec 31, Ended Dec 31,
-------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
Cost of goods sold 47.8% 49.8% 49.5% 50.0%
Marketing and sales 10.2 11.2 13.7 13.1
General and administrative 4.5 4.7 7.6 6.1
Research and development (includes Network
development and support) 17.2 12.2 27.7 16.6
Amortization of intangibles 0.7 0.5 1.4 0.7
Interest and other income, net 0.4 0.7 1.0 1.0
Income taxes - effective tax rate 31.0 30.8 31.0 31.0
Net income 13.7% 15.5% 0.7% 10.1%
Cost of Goods Sold. Cost of goods sold as a percentage of net revenues decreased
for the three months and nine months ended December 31, 2000 compared to the
same period last year primarily due to:
* An increase in sales of higher margin PC titles. The current year included
higher sales on higher margin internally developed titles such as The Sims,
Command & Conquer Red Alert 2, and The Sims: Livin' Large.
* The introduction of higher margin PlayStation 2 products in the current
year.
* A decrease in sales of lower margin AL and N64 titles.
* Offset by a decrease in sales of PlayStation titles combined with the
decrease in average margins on PlayStation products due to a decrease in
the average sales price on front line and catalogue products.
Marketing and Sales. Marketing and sales expenses for the three months ended
December 31, 2000 decreased as a percentage of revenue, primarily attributed to:
* Lower television and print advertising in North America and Europe.
* Offset by an increase in EA.com marketing and sales expense due to
increased staff required to support the live game site and advertising
campaigns run on the AOL service promoting the Games Channel. In future
periods, EA.com intends to further increase marketing and advertising
spending in order to promote our game site and the Games Channel on AOL.
* Offset by the amortization of the AOL carriage fee, which began with the
launch of EA.com in October of the current fiscal year. The Carriage Fee
will be amortized straight-line over the term of the AOL agreement.
30
Marketing and sales expenses for the nine months ended December 31, 2000
increased as a percentage of revenue, primarily attributed to:
* Higher EA.com marketing and sales expense due to increased staff required
to support the live game site and advertising campaigns run on the AOL
service promoting the Games Channel. In future periods, EA.com intends to
further increase marketing and advertising spending in order to promote our
game site and the Games Channel on AOL.
* The amortization of the AOL carriage fee, which began with the launch of
EA.com in October of the current fiscal year. The Carriage Fee will be
amortized straight-line over the term of the AOL agreement.
* Offset by lower television and print advertising in North America and
Europe due to fewer number of releases compared to the same period last
year.
* Offset by a decrease in cooperative advertising associated with lower
revenues in North America.
General and Administrative. General and administrative expenses increased for
the three months ended December 31, 2000 in absolute dollars by 0.9% and
increased 12.8% for the nine months ended December 31, 2000, primarily
attributed to:
* The expansion of the EA.com staff and additional administrative-related
costs required to support the growth of the EA.com business. We anticipate
a continued increase in the absolute dollars spent on general and
administrative related expenses.
* Increase in depreciation expense for Europe due to the implementation of a
new transaction processing system.
Research and Development (excluding Network Development and Support). Research
and development expenses increased for the three months ended December 31, 2000
in absolute dollars by 34.1% and 38.7% for the nine months ended December 31,
2000, primarily attributed to:
* Increase in research and development expenses by EA.com (including expenses
incurred by EA core on behalf of EA.com) due to an increase in the number
of online projects in development and increased development staff to
support these products. This includes headcount-related costs associated
with the acquisition of Kesmai in the fourth quarter of fiscal 2000. The
type of games that will be in development will most likely increase in
complexity and depth. To support this effort, EA.com may be required to
increase its development and production expenses.
* An increase in development spending for next generation console products
including development for the PlayStation 2 console.
* The increase is also due to research and development expenses related to
the acquisition of DreamWorks Interactive, a software development company,
in the fourth quarter of the prior fiscal year.
Network Development and Support. The increase in network development and support
expenses was primarily due to increased spending for the EA.com network
infrastructure, the formation of the support organization for the live game site
and the Games Channel on the AOL service and the amortization of capitalized
costs associated with the pre-launch network infrastructure build including
costs capitalized in accordance with SOP 98-1. The amortization cost for the
quarter associated with the launch of the website in October 2000 was
$1,900,000.
31
As a result, we expect network development and support expenses to increase in
absolute dollars in the future.
Amortization of Intangibles. The amortization of intangibles results primarily
from the acquisitions of Westwood, Kesmai, DreamWorks Interactive, ABC Software
and other acquisitions. Amortization of intangibles was $3,184,000 for EA Core
and $1,497,000 for EA.com for the three months ended December 31, 2000.
Amortization of intangibles was $2,567,000 for EA Core and $29,000 for EA.com
for the three months ended December 31, 1999. Amortization of intangibles was
$9,645,000 for EA Core and $4,406,000 for EA.com for the nine months ended
December 31, 2000. Amortization of intangibles was $7,742,000 for EA Core and
$58,000 for EA.com for the nine months ended December 31, 1999.
Interest and Other Income, Net. Interest and other income, net, decreased in
absolute dollars for the three months and nine months ended December 31, 2000
primarily due to gains on the sale of marketable securities in the prior year.
Income Taxes. Our effective tax rate was 31% for the nine months ended December
31, 2000 and 1999. The effective tax rate was 31% and 30.8% for the three months
ended December 31, 2000 and 1999, respectively.
Net Income. In absolute dollars, reported net income decreased for the
three months ended December 31, 2000 primarily related to higher product
development expenses, as a percent of net revenues, compared to the same period
last year. The increase in development expense is due to an increase in the
number of products in development by EA Core and EA.com and higher network
development and support costs in preparation for new online products and the
launch of our game site on the worldwide web and the AOL service which occurred
in October 2000.
In absolute dollars, reported net income decreased for the nine months ended
December 31, 2000 primarily related to lower revenues as well as higher costs
and expenses compared to the same period last year. The decrease was also due to
an increase in the number of products in development by EA Core and EA.com and
higher network development and support costs in preparation for new online
products and the launch of our game site on the worldwide web and the AOL
service which occurred in October 2000.
Excluding goodwill and non-cash compensation charges in the amount of
$3,479,000, net of taxes, for the three months ended December 31, 2000, net
income would have been $91,457,000. Excluding goodwill and non-cash compensation
charges in the amount of $1,995,000, net of taxes, for the three months ended
December 31, 1999, net income would have been $94,856,000. Excluding goodwill
and non-cash compensation charges in the amount of $11,028,000, net of taxes,
for the nine months ended December 31, 2000, net income would have been
$17,826,000. Excluding goodwill and non-cash compensation charges in the amount
of $5,833,000, net of taxes, for the nine months ended December 31, 1999, net
income would have been $119,152,000.
32
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, our working capital was $489,357,000 compared to
$440,021,000 at March 31, 2000. Cash, cash equivalents and short-term
investments decreased by approximately $44,427,000 during the nine months ended
December 31, 2000 as we used $104,860,000 of cash in capital expenditures,
offset by $60,862,000 provided through the sale of equity securities under our
stock plans, $3,958,000 of proceeds from the sale of property and equipment and
$1,325,000 provided by operating activities.
Reserves for bad debts and sales returns increased from $65,067,000 at March 31,
2000 to $82,660,000 at December 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.
Our principal source of liquidity is $295,377,000 in cash, cash equivalents and
short-term investments. Management believes the existing cash, cash equivalents,
short-term investments, marketable securities and cash generated from operations
will be sufficient to meet cash and investment requirements on both a short-term
and long-term basis.
Included in the amounts above is the following for the EA.com business:
* To date, EA.com has been funded solely by Electronic Arts. No interest
charge has been reflected in the accompanying consolidated financial
statements. Excess cash generated from operations is transferred to
Electronic Arts. We anticipate these funding procedures will continue in
the near-term. Electronic Arts may, at its discretion, provide funds to
EA.com under a debt arrangement, instead of treating such funding as a
capital contribution.
* During the nine months ended December 31, 2000, EA.com used $93,934,000 of
cash in operations, $65,418,000 in capital expenditures for computer
equipment, network infrastructure and related software (including
$41,263,000 of consulting, hardware, software and direct payroll and
payroll-related costs associated with the implementation of customized
internal-use software), offset by $159,667,000 provided through the capital
contribution from Electronic Arts.
* As of December 31, 2000, the Company has $8,375,000 of capitalized costs
associated with the effort to build the EA.com website and infrastructure
that have been put into service related to SOP 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use".
As of October 2000, EA.com began to amortize $39,100,000 of costs
associated with this pronouncement.
Impact of Recently Issued Accounting Standards
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB Opinion No. 25)". FIN 44 clarifies the
application of APB Opinion No. 25 for certain
33
issues: (a) the definition of employee for purposes of applying Opinion 25, (b)
the criteria for determining whether a plan qualifies as a noncompensatory plan,
(c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. Generally, FIN 44 is
effective July 1, 2000. The adoption of FIN 44 did not have a material impact on
the Company's consolidated financial position or results of operations.
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. The
adoption of EITF 00-03 did 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's accounting policy for internal-use software, as required by
SOP 98-1, incorporated the requirements of EITF 00-02.
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 the
fourth fiscal quarter of fiscal years beginning after December 15, 1999 as
amended by SAB 101B. 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 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", as amended by SFAS 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No.
133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB Statement No. 133" which establishes
accounting and reporting standards for derivative instruments and hedging
activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning
of the first quarter of the fiscal year beginning after June 15, 2000. The
Company is determining the effect of SFAS 133, 137 and 138 on its financial
statements.
34
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 shipped its PlayStation 2 product in Japan, North
America and Europe in calendar year 2000. For the December quarter,
manufacturing shortages, resulting in the delay of a significant number of
shipments of PlayStation 2 units in North America and Europe, have adversely
affected our results of operations. Consequently, these manufacturing shortages
pose serious uncertainty for our current fourth quarter and fiscal year results.
In addition, Nintendo and Microsoft have 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. The
success of our products is significantly affected by acceptance of the new video
game hardware systems and the life span of older hardware platforms and our
ability to accurately predict which platforms will be most successful.
Sometimes we will spend development and marketing resources on products
designed for new video game systems that have not yet achieved large installed
bases or will continue product development for older hardware platforms that may
have shorter life cycles than we expected. Conversely, if we do not develop for
a platform that achieves significant market acceptance, or discontinue
development for a platform that has a longer life cycle than expected, our
revenue growth may be adversely affected.
For example, the Sega Dreamcast console launched in Japan in early 1999 and
in the United States in September of 1999. We have developed no products for
this platform. Had this platform achieved wide market acceptance, our revenue
growth would have been adversely affected. Similarly, we released a variety of
products for the new Sony platform, the PlayStation 2. The shortages of
PlayStation 2 units has adversely affected our results, and if
35
that platform does not achieve wide acceptance by consumers, we will have spent
a disproportionate amount of our resources for this platform. Additionally, we
have not negotiated a publishing agreement with Nintendo for their next
generation platform and we do not know whether the terms of this agreement 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, The World is Not Enough for the
PlayStation 2 and EMPEROR: Battle for Dune for the PC, which were expected to
ship in fiscal 2001 will not be released until fiscal 2002 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 highly seasonal with a significant percentage of our
revenues occurring in the December quarter. In our fourth quarter of fiscal
2001, we expect these seasonal trends to be magnified by general industry
factors, including the current platform transition, the manufacturing shortages
for the PlayStation 2 as noted above, and the economic slowdown in the United
States. In addition, we are continuing to invest significantly in our online
operation, EA.com. Our business is also cyclical; video game platforms have
historically had a life cycle of four to six years, and decline as more advanced
platforms are being introduced. As one group of platforms is reaching the end of
its cycle and new platforms are emerging, buying patterns may change. Purchases
of products for older platforms may slow at a faster rate than sales of new
platforms. We are currently in such a platform transition. Sega introduced its
latest platform in calendar year 1999, and Sony shipped its PlayStation 2
console in Japan, North America and Europe in calendar year 2000. Nintendo and
Microsoft have 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
36
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 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.
37
Risk Factors Relating to Our Online Business
Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate
its Business and Prospects
EA.com's business is still in the developing stages, so evaluating its
business and prospects will be more difficult than would be the case for a more
mature business. We will continue to encounter the risks and difficulties faced
in launching a new business, and we may not achieve our goals or may be
compelled to change the manner in which we seek to develop the business. These
uncertainties as to the future operations of EA.com will increase the difficulty
we face in completing and pursuing the essential plans for the development of
the business and will also make it more difficult for our stockholders and
securities analysts to predict the operating results of this business.
EA.com Has a History of Losses and Expects To Continue To Incur Losses and May
Never Achieve Profitability
EA.com has incurred substantial losses to date, including the current
fiscal year. We expect EA.com to continue to incur losses as it 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 a series of agreements with America Online ("AOL") for the offering
of our games for online play. These agreements require that we make substantial
guaranteed payments to AOL and that we commit our resources to the pursuit of
the online game opportunity. We cannot be assured that the substantial costs
associated with the AOL agreements will be justified by the revenues generated
from that relationship. In addition, restrictions included in the AOL agreements
limiting other channels we may develop for offering online games may limit our
ability to diversify our online distribution strategies. The success for us of
the AOL agreements will also be a result of AOL's performance under the
agreements, a factor over which we will have very little control.
We Have Very Limited Experience with Online Games and May Not Be Able To Operate
This Business Effectively
Offering games solely for online play is a substantial departure from our
traditional business of selling packaged software games. We have employed
various pricing models, including subscription fees, "pay to play fees" and
advertising. We have very little experience with developing optimal pricing
strategies for online games 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.
38
Online Games Have Risks That Are Not Associated with Our Traditional Business
Online games, particularly multiplayer games, pose risks to player
enjoyment that do not generally apply to packaged game sales. Players frequently
would not be acquainted with other players, which may adversely affect the
playing experience. Social issues raised by a player's conduct may impact the
experience for other players. We have not determined whether or how we might
monitor or proctor player behavior that impairs the game experience. In
addition, there are substantial technical challenges to be met both in the
introduction of our games online and in maintaining an effective game playing
environment over time. Also, hacking and spamming has become a serious problem
for online sites, and significant hacking and spamming could seriously interfere
with online game play. If these risks are not successfully controlled and
technical challenges resolved, potential customers for our games may be
unwilling to play in sufficient volume to allow us to attain or sustain
profitability.
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 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.
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
39
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. The use of the Internet for sophisticated games like ours is
relatively new. Our business would be seriously harmed if:
* use of the Internet does not continue to increase or increases more
slowly than expected,
* the infrastructure for the Internet does not effectively support
online game play,
* concerns over the secure transmission of confidential information over
public networks inhibit the growth of the Internet as a means of
conducting commercial transactions, or
* government regulations regarding Internet content, privacy or other
conditions impede the effectiveness of the Internet to users.
Capacity Restraints May Restrict the Use of the Internet as a Forum for Game
Play, Resulting in Decreased Demand for Our Products
The Internet infrastructure may not be able to support the demands placed
on it by increased usage or the limited capacity of networks to transmit large
amounts of data. Other risks associated with commercial use of the Internet
could slow its growth, including:
* outages and other delays resulting from the inadequate reliability of
the network infrastructure,
* slow development of enabling technologies and complementary products,
and
* limited availability of cost-effective, high speed access.
Delays in the development or adoption of new equipment standards or
protocols required to handle increased levels of Internet activity, or increased
governmental regulation, would cause the Internet to fail to gain, or lose,
viability as a means of game playing. If these or any other factors cause use of
the Internet for commerce to slow or decline, the Internet may not prove viable
as a commercial marketplace. This, in turn, would result in decreased demand for
EA.com's products and services.
40
To Become and Remain Competitive, EA.com Must Continually Develop and Expand New
Content. This Is Inherently Risky and Expensive.
EA.com's success depends on our ability to develop products and services
for the EA.com site and our ability to continually expand the content on that
site. Our agreement with AOL requires us to develop new games under our
relationship with AOL. We cannot assure you that products will be developed on
time, in a cost effective manner, or that they will be successful.
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, Our Ability To
Develop Our Online Business Will Be Impaired
Because approximately 16% of the staff creating, designing, and developing
the infrastructure for EA.com's website and network interface is being provided
by outside consultants, 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
In the near term, 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,
41
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 may impact the release ("go live") dates of products
during a particular quarter. Several online products currently under development
are experiencing development delays and will be released later than planned. Our
revenues and operating costs are dependent on our ability to meet our product
"go live" schedules, and our failure to meet those schedules could result in
revenues falling short of analysts' expectations, with no corresponding decrease
in expenses, resulting in increased operating losses for EA.com.
General Risk Factors
Because of the 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 continues to be extremely competitive, and we may not be able to
attract and retain the employees we need. In addition, the cost of real estate
in the San Francisco Bay area - the location of our headquarters and largest
studio has increased dramatically, and has made recruiting from other areas and
relocating employees to our headquarters more difficult. If we cannot
successfully
42
recruit and retain the employees we need, our ability to develop and manage our
businesses will be impaired.
Foreign Sales and Currency Fluctuations
For the nine months ended December 31, 2000 international net revenues
comprised 37% of total consolidated net revenues. For the fiscal year ended
March 31, 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. While we hedge
against foreign currency fluctuations, we cannot control translation issues. For
example, our European revenues in the nine months ended December 31, 2000 were
adversely impacted by a devaluation of the Euro and British Pound as compared to
the prior year. The devaluation will have an adverse effect for the year on our
sales and net income. Any of these factors may significantly harm our business.
Increased Difficulties in Forecasting Results
During platform transition periods, where the success of our products is
significantly impacted by the changing market for our products, forecasting our
revenues and earnings is more difficult than in more stable or rising product
markets. The demand for our products may decline during a transition faster than
we anticipate, negatively impacting both revenues and earnings. At launch, Sony
shipped only half of the number of PlayStation 2 units to retail in North
America than it had originally planned, and it shipped significantly fewer units
than planned at launch in Europe as well. Shortages were announced as being
caused by shortages of components for manufacturing. Due to these shortages, our
results of operations for the quarter ended December 31, 2000 have been
adversely affected. Consequently, depending on the number and the timing of
units actually available for the quarter ended March 31, 2001, these shortages
may adversely impact our sales of PlayStation 2 products for the fourth quarter
and fiscal year.
We cannot predict the impact of recent actions and comments by the SEC and FASB
Recent actions and comments from the SEC have focused on the integrity of
financial reporting. In addition, the FASB and other regulatory accounting
agencies have recently introduced several new or proposed accounting standards,
some of which represent a significant change from current industry practices.
For example, in December 1999, the SEC issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." SAB 101 provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements of
all public registrants. In response to numerous requests for interpretive
guidance of SAB 101, the effective date of the standard has been delayed twice.
SAB 101 became effective during the first quarter of fiscal 2001. SAB 101 did
not have a material effect on the underlying strength or weakness of our
consolidated business operations as measured by the dollar value of our product
shipments and cash flows.
43
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 ended March 31, 2000, the price per
share of our common stock ranged from $22.82 to $60.47 and $26.59 to $55.38
during the nine months ended December 31, 2000.
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.
44
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Market Risk
We are exposed to various market risks, including the changes in foreign
currency exchange rates and interest rates. Market risk is the potential loss
arising from changes in market rates and prices. Foreign exchange contracts used
to hedge foreign currency exposures and short-term investments are subject to
market risk. We do not consider our cash and cash equivalents to be subject to
interest rate risk due to their short maturities. We do not enter into
derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rate Risk
We utilize foreign exchange contracts to hedge foreign currency exposures of
underlying assets and liabilities, primarily certain intercompany receivables
that are denominated in foreign currencies thereby limiting our risk. Gains and
losses on foreign exchange contracts are reflected in the income statement. At
December 31, 2000, we had foreign exchange contracts, all with maturities of
less than six months to purchase and sell approximately $395,982,000 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 counter parties to these contracts are substantial and
creditworthy multinational commercial banks. The risks of counter party
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 table below provides information about our foreign currency forward exchange
contracts at December 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 Amount Contract Rate Fair Value
--------------- ------------- ----------
(in thousands) (in thousands)
Foreign currency to be sold
under contract:
British Pound $200,457 1.4675 $(3,850)
Euro 91,578 0.9022 (4,068)
Canadian Dollar 22,238 1.5064 (106)
Japanese Yen 12,820 110.76 409
Sweden Krone 9,518 9.5611 (149)
South African Rand 4,347 7.5914 (7)
Australian Dollar 3,744 0.5349 (167)
Norway Krone 3,131 8.9418 (48)
Denmark Krone 3,043 8.2166 (113)
Swiss Franc 2,367 1.6903 (115)
Brazilian Real 902 1.9950 (21)
-------- ------- -------
45
Total $354,145 $(8,235)
-------- ------- -------
Foreign currency to be purchased
under contract:
British Pound $ 41,837 1.4957 $(1,134)
-------- ------- -------
Total $ 41,837 $(1,134)
-------- -------
Grand Total $395,982 $(9,369)
======== =======
While the contract amounts provide one measurement of the volume of these
transactions, they do not represent the amount of our exposure to credit risk.
The amounts (arising from the possible inabilities of counterparties to meet the
terms of their contracts) are generally limited to the amounts, if any, by which
the counterparties' obligations exceed our obligations as these contracts can be
settled on a net basis at our option. We control credit risk through credit
approvals, limits and monitoring procedures.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. We manage our interest rate risk by maintaining an
investment portfolio primarily consisting of debt instruments of high credit
quality and relatively short average maturities. We also manage our interest
rate risk by maintaining sufficient cash and cash equivalent balances such that
we are typically able to hold our investments to maturity. At December 31, 2000,
our cash equivalents, short-term and long-term investments included debt
securities of $203,603,000. Notwithstanding our efforts to manage interest rate
risks, there can be no assurances that we will be adequately protected against
the risks associated with interest rate fluctuations.
The table below presents the amounts and related weighted-average interest rates
of our investment portfolio at December 31, 2000:
Average
Interest Rate Cost Fair Value
------------- -------- ----------
(Dollars in thousands)
Cash equivalents
Fixed rate 0.00% $ -- $ --
Variable rate 6.19% $124,116 $124,116
Short-term investments
Fixed rate 4.07% $ 60,798 $ 61,087
Variable rate 6.22% $ 10,000 $ 10,000
Long-term investments
Fixed rate 0.00% $ -- $ --
Variable rate 6.35% $ 8,400 $ 8,509
Maturity dates for short-term investments range from 6 months to 3 years.
46
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to pending claims. Management, after review and
consultation with counsel, considers that any liability from the
disposition of such lawsuits in the aggregate would not have a material
adverse effect upon the consolidated financial position or results of
operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - the following exhibit is filed as part of this report:
10.45 Master Lease and Deed of Trust by and between Registrant and
Selco Service Corporation, dated December 6, 2000.
(b) Reports on Form 8-K: None
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRONIC ARTS INC.
(Registrant)
/s/ E. STANTON MCKEE
------------------------------------------
DATED: E. STANTON MCKEE
February 13, 2001 Executive Vice President and
Chief Financial and Administrative Officer
48
ELECTRONIC ARTS INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2000
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE PAGE
- ------ ------------- ----
10.45 Master Lease and Deed of Trust by and between Registrant
and Selco Service Corporation, dated December 6, 2000 50
49