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 September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ______ to_____
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1450 Fashion Island Boulevard
San Mateo, California 94404
(Address of principal executive offices) (Zip Code)
(415) 571-7171
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO _____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock October 26, 1996
--------------------- ----------------
$0.01 par value per share 53,609,191
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
September 30, 1996 and March 31, 1996 3
Consolidated Statements of Income for
the Three Months Ended September 30, 1996 and 1995
and the Six Months Ended September 30, 1996 and 1995 4
Consolidated Statements of Cash Flows for
the Six Months Ended September 30, 1996 and 1995 5
Notes to Consolidated Financial Statements 6 - 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9 - 24
Part II - Other Information
Item 1. Legal Proceedings 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
2
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
September 30, March 31,
1996 1996
------------- ---------
(unaudited)
Current assets:
Cash and short-term investments $135,251 $147,983
Marketable securities 16,312 37,869
Receivables, less allowances of $31,584 and $27,569, respectively 102,241 73,075
Inventories 24,425 14,704
Prepaid royalties 16,416 14,519
Other current assets 12,761 12,188
-------- --------
Total current assets 307,406 300,338
Property and equipment, net 78,030 70,062
Prepaid royalties 10,029 11,030
Long-term investments 24,200 24,200
Investments in affiliates 18,463 15,952
Other assets 3,614 2,637
-------- --------
$441,742 $424,219
======== ========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $39,038 $37,019
Accrued liabilities 66,093 63,606
-------- --------
Total current liabilities 105,131 100,625
Minority interest in consolidated joint venture - 1,277
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares - -
Common stock, $0.01 par value. Authorized 70,000,000 shares;
issued and outstanding 53,552,778 and 52,741,572, respectively 536 527
Paid-in capital 122,655 108,078
Retained earnings 205,442 199,523
Unrealized appreciation of investments 9,664 16,266
Translation adjustment (1,686) (2,077)
-------- --------
Total stockholders' equity 336,611 322,317
-------- --------
$441,742 $424,219
======== ========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
3
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
1996 1995 1996 1995
------------- ----------- ---------- ----------
Net revenues $129,267 $94,035 $209,894 $174,558
Cost of goods sold 64,477 47,922 103,944 90,723
-------- ------- -------- --------
Gross profit 64,790 46,113 105,950 83,835
-------- ------- -------- --------
Operating expenses:
Marketing and sales 19,319 14,873 33,284 26,563
General and administrative 11,591 7,332 19,757 13,513
Research and development 28,720 21,113 54,049 40,996
-------- ------- -------- --------
Total operating expenses 59,630 43,318 107,090 81,072
-------- ------- -------- --------
Operating income (loss) 5,160 2,795 (1,140) 2,763
Interest and other income, net 1,880 1,138 7,996 2,281
-------- ------- -------- --------
Income before provision for income taxes
and minority interest 7,040 3,933 6,856 5,044
Provision for income taxes 2,287 1,259 2,228 1,615
-------- ------- -------- --------
Income before minority interest 4,753 2,674 4,628 3,429
Minority interest in consolidated
joint venture 1,131 319 1,291 364
-------- ------- -------- --------
Net income $ 5,884 $ 2,993 $ 5,919 $ 3,793
======== ======= ======== ========
Net income per share $ 0.11 $ 0.06 $ 0.11 $ 0.07
======== ======= ======== ========
Number of shares used in computation 55,324 54,402 55,126 53,876
======== ======= ======== ========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Six Months
Ended September 30,
-----------------------
1996 1995
---------- ----------
Operating activities:
Net income $ 5,919 $ 3,793
Adjustments to reconcile net income to net cash used in
operating activities:
Minority interest in consolidated joint venture (1,291) (364)
Depreciation and amortization 9,677 6,878
Loss on sale of fixed assets 41 100
Gain on sale of marketable securities (5,456) -
Change in assets and liabilities:
Receivables (29,166) (17,277)
Inventories (9,721) (6,566)
Prepaid royalties (896) (12,137)
Other assets (2,090) (14,430)
Accounts payable 2,019 2,629
Accrued liabilities 5,461 (24,136)
Deferred income taxes (41) (590)
-------- --------
Net cash used in operating activities (25,544) (62,100)
-------- --------
Investing activities:
Proceeds from sales of furniture and equipment 152 83
Proceeds from sales of marketable securities 17,674 -
Capital expenditures (17,494) (39,222)
Investment in affiliates (2,511) (10,497)
Change in short-term investments, net (5,045) 16,100
Adjustment for effects of poolings in prior period - (89)
-------- --------
Net cash used in investing activities (7,224) (33,625)
-------- --------
Financing activities:
Proceeds from issuance of common stock 12,149 17,003
Tax benefit from exercise of stock options 2,437 1,276
-------- --------
Net cash provided by financing activities 14,586 18,279
-------- --------
Translation adjustment 391 103
Minority interest on translation adjustment 14 (99)
-------- --------
Decrease in cash and cash equivalents (17,777) (77,442)
Beginning cash and cash equivalents 105,628 143,421
-------- --------
Ending cash and cash equivalents 87,851 65,979
Short-term investments 47,400 14,600
-------- --------
Ending cash and short-term investments $135,251 $ 80,579
======== ========
Supplemental cash flow information:
Cash paid during the year for income taxes $ 660 $ 6,604
======== ========
Non-cash investing activities:
Increase (decline) on unrealized appreciation of investments $(9,535) $ 317
======== ========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
5
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The consolidated financial statements are unaudited and reflect all adjustments
(consisting only of normal recurring accruals) that, in the opinion of
management, are necessary for a fair presentation of the results for the interim
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.
These consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended March 31, 1996 as filed with the
Securities and Exchange Commission on July 1, 1996.
Note 2. Cash and Investments
Cash equivalents consist of highly liquid investments with maturities of three
months or less at the date of purchase. Short-term investments include
securities with maturities greater than three months and less than one year,
except for certain investments with stated maturities greater than one year.
The Company accounts for investments under Statement of Financial Accounting
Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities, ("SFAS 115"). SFAS 115 requires that investments in equity and debt
securities be classified and accounted for in one of three categories. The
Company has classified short-term investments as "available-for-sale" and has
stated applicable investments at fair value which approximates cost. The cost of
securities sold is based upon the specific identification method.
Cash and short-term investments at September 30, 1996 and March 31, 1996
consisted of (in thousands):
September 30, 1996 March 31, 1996
------------------ --------------
Cash and cash equivalents $ 87,851 $105,628
Short-term investments 47,400 42,355
-------- --------
$135,251 $147,983
======== ========
6
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 3. Marketable Securities
Marketable securities consist of equity securities. The Company has accounted
for investments in equity securities as "available-for-sale" and has stated
applicable investments at fair value with net unrealized gains (losses) reported
as a separate component of stockholders' equity.
At September 30, 1996, marketable securities included the Company's approximate
10.1% ownership interest (2,813,668 shares) in The 3DO Company ("3DO"). For the
three months ended September 30, 1996 there were no sales of 3DO stock. For the
six months ended September 30, 1996, the Company sold 422,000 shares of 3DO
stock and realized a gain before taxes of $4,702,000. See The 3DO Company,
below.
Note 4. Software Development Costs
To date, the Company has not capitalized any software development costs in
accordance with Statement of Financial Accounting Standard (SFAS) No. 86 since
the impact to the financial statements for all periods presented has been
immaterial.
Note 5. Inventories
Inventories are stated at the lower of average cost or market. Inventories at
September 30, 1996 and March 31, 1996 consisted of (in thousands):
September 30, 1996 March 31, 1996
------------------ --------------
Raw materials and work in process $14,253 $ 2,160
Finished goods 10,172 12,544
------- --------
$24,425 $ 14,704
======= ========
Note 6. Accrued Liabilities
Accrued liabilities at September 30, 1996 and March 31, 1996 consisted of (in
thousands):
September 30, 1996 March 31, 1996
------------------ --------------
Accrued expenses $26,341 $18,203
Accrued royalties 15,482 16,889
Accrued compensation and benefits 10,747 11,480
Accrued income taxes 9,716 10,477
Deferred income taxes 2,904 5,878
Deferred revenue 903 679
------- -------
$66,093 $63,606
======= =======
7
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 7: Operations by Geographic Areas
The Company operates in one industry segment. Information about the Company's
operations in North America, Europe, South Asia Pacific and Japan for the three
and six months ended September 30, 1996 and 1995 is presented below (in
thousands).
North South Asia
America Europe Pacific Japan Eliminations Total
------- ------ ------- ----- ------------ -----
Three months ended September 30, 1996
- -------------------------------------
Net revenues from unaffiliated
customers $ 86,087 $33,405 $ 6,111 $ 3,664 $ - $129,267
Intersegment net revenues 7,719 1,510 - - (9,229) -
-------- ------- ------- -------- --------- --------
Total net revenues $ 93,806 $34,915 $ 6,111 $ 3,664 $ (9,229) $129,267
======== ======= ======= ======== ========= ========
Operating income (loss) $ 4,742 $2,368 $ 1,280 $(3,230) $ - $ 5,160
Identifiable assets $337,260 $82,005 $10,031 $ 12,446 $ - $441,742
Six months ended September 30, 1996
- -----------------------------------
Net revenues from unaffiliated
customers $124,241 $63,727 $10,973 $ 10,953 $ - $209,894
Intersegment net revenues 14,765 2,249 - 11 (17,025) -
-------- ------- ------- -------- --------- --------
Total net revenues $139,006 $65,976 $10,973 $ 10,964 $(17,025) $209,894
======== ======= ======= ======== ========= ========
Operating income (loss) $(4,391) $ 4,737 $ 2,204 $(3,690) $ - $(1,140)
Three months ended September 30, 1995
- -------------------------------------
Net revenues from unaffiliated
customers $ 62,948 $19,763 $ 4,629 $ 6,695 $ - $ 94,035
Intersegment net revenues 6,372 2,186 19 65 (8,642) -
-------- ------- ------- -------- --------- --------
Total net revenues $ 69,320 $21,949 4,648 $ 6,760 $ (8,642) $ 94,035
======== ======= ======= ======== ========= ========
Operating income (loss) $ (390) $ 2,903 $ 1,139 $ (857) $ - $ 2,795
Identifiable assets $269,501 $55,380 $ 6,477 $ 10,314 $ - $341,672
Six months ended September 30, 1995
- -----------------------------------
Net revenues from unaffiliated
customers $110,151 $42,075 $ 7,916 $ 14,416 $ - $174,558
Intersegment net revenues 13,293 3,584 19 65 (16,961) -
-------- ------- ------- -------- --------- --------
Total net revenues $123,444 $45,659 $ 7,935 $ 14,481 $(16,961) $174,558
======== ======= ======= ======== ========= ========
Operating income (loss) $(5,697) $ 7,832 $ 1,749 $(1,121) $ - $ 2,763
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q, and in particular Management's Discussion
and Analysis of Financial Condition and Results of Operations, contains forward
looking statements regarding future events or the future performance of the
Company that involve certain risks and uncertainties including those discussed
in "Factors Affecting Future Performance" below at pages 19 to 24, as well as
under the same heading in the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 1996 as filed with the Securities and Exchange
Commission on July 1, 1996. Actual events or the actual future results of the
Company may differ materially from any forward looking statement due to such
risks and uncertainties.
Net Revenues
September 30, September 30,
1996 1995 % change
------------- -------------- ---------
Consolidated Net Revenues
Three Months Ended $129,267,000 $ 94,035,000 37.5%
Six Months Ended $209,894,000 $174,558,000 20.2%
North America Net Revenues
Three Months Ended $ 86,087,000 $ 62,948,000 36.8%
as a percentage of net revenues 66.6% 66.9%
Six Months Ended $124,241,000 $110,151,000 12.8%
as a percentage of net revenues 59.2% 63.1%
International Net Revenues
Three Months Ended $ 43,180,000 $ 31,087,000 38.9%
as a percentage of net revenues 33.4% 33.1%
Six Months Ended $ 85,653,000 $ 64,407,000 33.0%
as a percentage of net revenues 40.8% 36.9%
The Company derives revenues from shipments of EA Studio Compact Disk ("CD")
personal computer products ("PC CD") and floppy-disk personal computer products
(primarily entertainment software), EA Studio CD products for dedicated
entertainment systems ("CD-Videogame"), EA Studio cartridge products, licensing
of EA Studio products, distribution of EA Studio products through hardware
companies ("OEMs") and shipments of Affiliated Label ("AL") CD and floppy-disk
products that are created by third parties.
Overall, North American net revenues increased 36.8% for the three months ended
September 30, 1996 compared to the same period last year. The mix of North
American sales reflected the transition from the mature 16-bit cartridge market
to products for 32-bit CD-Videogames, including the Sony PlayStation
("PlayStation") and Sega Saturn, and the continued growth of the PC CD market.
Total North American PC CD and CD-Videogame revenue increased $43,217,000 to
$64,103,000 for the three months ended September 30, 1996 in comparison to the
same period in the prior year, while 16-bit net revenues decreased $16,965,000,
or 55.8%, to $13,443,000.
9
For the six months ended September 30, 1996, North America net revenue increased
$14,090,000 compared to the same period in the prior year due to the transition
of sales mix to products for 32-bit PC-CD and CD-Videogames noted above. Net
revenues from the sale of 32-bit products increased $56,079,000 while sales of
16-bit products decreased $29,360,000 in comparison to the prior year. This net
increase was offset by decreased Affiliated Label sales which include
arrangements for the exclusive distribution of certain PC and 3DO products to
two key accounts on of third party publishers. As this program was initiated
during the quarter ended June 30, 1995 Affilated Label sales during the six
months ended September 30, 1995 include this initial sell in.
International net revenues increased 38.9% for the three months ended September
30, 1996 compared to the same period last year. The increase was primarily due
to a 69.0% increase in European net revenues consisting of higher sales of
PlayStation, PC CD and AL products. Total net revenues in Europe were
$33,405,000 for the three months ended September 30, 1996 compared to
$19,763,000 in the same period last year.
The increase in European net revenues was offset by a decrease in net revenue of
$3,031,000 or 45.3% in Japan. Net revenues in Japan for the quarter ended
September 30, 1996 were $3,664,000 compared to $6,695,000 for the corresponding
period in the prior year. The decrease was primarily due to the delay in getting
localized product onto the market. Revenues in the current fiscal quarter were
comprised primarily of sales from PlayStation products compared to sales of 3DO
and PC CD products in the same period of the prior year.
For the three months ended September 30, 1996, sales in the South Asia Pacific
region increased by 32.0% to $6,111,000 compared to $4,629,000 in the prior year
due to increased sales of PlayStation and PC CD titles offset by lower revenues
on Sega Genesis ("Genesis") products.
International net revenues for the six months ended September 30, 1996 increased
$21,246,000, or 33%, in comparison to prior year. The increase resulted from the
worldwide transition from the 16-bit cartridge market to 32-bit videogame
consoles and the continued growth of the PC CD market. For the six months ended
September 30, 1996 net revenues from the sales of 32-bit PC-CD and CD-Videogame
products increased $29,119,000 over all regions while sales of 16-bit products
decreased $8,625,000 or 56.4% in comparison to the same period in the prior
year. Though international revenues are expected to grow in fiscal 1997, they
may not grow at as high a rate as in prior periods.
EA Studio Net Revenues:
32-bit Videogame Product Net Revenues
September 30, September 30,
1996 1995 % change
------------- --------------- ---------
Three Months Ended $54,145,000 $ 6,462,000 737.9%
as a percentage of net revenues 41.9% 6.9%
Six Months Ended $81,318,000 $12,336,000 559.2%
as a percentage of net revenues 38.7% 7.1%
10
The Company released five 32-bit CD-Videogame products during the quarter ended
September 30, 1996 comprised of three for the Sony PlayStation (Madden NFL 97,
PGA Tour 97 and Andretti Racing) and two for the Sega Saturn (Madden NFL 97 and
Space Hulk) compared to one PlayStation and one 3DO title released in the same
period last year. All 32-bit CD-Videogame revenues for the quarter ended
September 30, 1996 were from sales of PlayStation and Sega Saturn products. In
the prior year, 75% of 32-bit CD-Videogame revenues for the quarter ended
September 30, 1995 were derived from sales of products for the 3DO Interactive
Multiplayer. The Company has no planned releases of 3DO games in fiscal 1997.
The increase in sales is attributable to the increased number of titles released
and the greater installed base of 32-bit consoles.
For the six months ended September 30,1996, total 32-bit Videogame revenue
increased $68,982,000 compared to the same period in the prior year. The bulk of
this increase was attributable to PlayStation sales which were $68,852,000,
compared to $1,633,000 for the six months ended September 30, 1995. Net revenues
from the sales of other 32-bit products were $12,466,000 from Sega Saturn in the
current year compared to $10,703,000 from 3DO Interactive Multiplayer in the
prior year.
As mentioned above and elsewhere in this report, the increase in both absolute
dollars and as a percentage of total net revenues attributable to CD-Videogame
products reflects the market transition from 16-bit cartridge systems to 32-bit
CD-Videogame platforms. Though 32-bit CD-Videogame revenues are expected to grow
in fiscal 1997, they are not expected to grow at as high a rate as in prior
periods.
Under the terms of a licensing agreement entered into with Sony Computer
Entertainment of America in July 1994 (the "Sony Agreement"), the Company is
authorized to develop and distribute CD based software products compatible with
the PlayStation. Pursuant to the Sony Agreement, the Company engages Sony to
supply PlayStation CDs for distribution by the Company. Accordingly, the Company
has limited ability to control its supply of PlayStation CD products or the
timing of their delivery. See Hardware Companies, below.
Under the terms of a licensing agreement entered into with Sega Enterprises,
Ltd. in January 1995 (the "Sega Saturn Agreement"), the Company is authorized to
develop and distribute CD based software products compatible with the Sega
Saturn. Pursuant to the Sega Saturn Agreement, the Company engages various third
party manufacturers approved by Sega to supply its Saturn CDs for distribution.
Accordingly, the Company has limited ability to control its supply of Saturn CD
products or the timing of their delivery. See Hardware Companies, below.
11
Personal Computer-based CD Product Net Revenues
September 30, September 30,
1996 1995 % change
-------------- -------------- ----------
Three Months Ended $39,173,000 $28,938,000 35.4%
as a percentage of net revenues 30.3% 30.8%
Six Months Ended $66,237,000 $50,020,000 32.4%
as a percentage of net revenues 31.6% 28.7%
The Company released nine new PC CD titles in the quarter ended September 30,
1996, all for MS-DOS and Windows based personal computers including Madden NFL
97, NHL 97, and Triple Play 97 compared to six PC titles and one title for the
Macintosh released in the same period last year.
16-bit Videogame Product Net Revenues
September 30, September 30,
1996 1995 % change
-------------- -------------- ----------
Three Months Ended $16,780,000 $36,203,000 (53.7%)
as a percentage of net revenues 13.0% 38.5%
Six Months Ended $24,934,000 $62,919,000 (60.4%)
as a percentage of net revenues 11.9% 36.0%
The Company released two new 16-bit videogames, College Football 97 and NHL 97
for the Genesis, during the quarter ended September 30, 1996. Genesis cartridge
sales were $16,225,000 for the three months ended September 30, 1996 compared to
$28,480,000 for the same period in the prior year when two titles were released.
Super Nintendo Entertainment System ("SNES") sales were $555,000 for the three
months ended September 30, 1996 compared to $7,723,000 for the same period last
year. One SNES title was released in the second quarter of fiscal 1996.
Genesis cartridge sales were $23,199,000 for the six months ended September 30,
1996 compared to $48,704,000 for the same period in the prior year. SNES sales
were $1,735,000 for the six months ended September 30, 1996 compared to
$14,215,000 for the same period in the prior year.
The Company's net revenues derived from 16-bit videogames declined 53.7% during
the second quarter of fiscal 1997 and 60.4% for the six months ended September
30, 1996 compared to the same periods in the prior year. As the installed base
of 32-bit videogame consoles has increased, sales of 16-bit videogame hardware
and related software have significantly declined and are expected to continue to
do so in fiscal 1997. The Company will ship fewer cartridge products in fiscal
1997 than in fiscal 1996 and expects to release the majority of these products
in the December quarter.
12
Under the terms of a licensing agreement entered into with Sega Enterprises,
Ltd., ("Sega") in July 1992, as amended ("the 16-bit Sega Agreement"), the
Company is authorized to develop ROM-cartridge software products compatible with
the Genesis system through December 1997 and to distribute those cartridges
through June 1998. Genesis cartridges are manufactured by the Company in Puerto
Rico under terms of the 16-bit Sega Agreement. A shortage of components or other
factors outside the control of the Company could impair the Company's ability to
manufacture an adequate supply of its products.
Under the terms of its licensing agreements with Nintendo, the Company is
authorized to publish cartridge products for the SNES. SNES cartridges
distributed in North America and Europe are manufactured by the Company in
Puerto Rico. The Company is required to purchase from Nintendo certain key
components for production of these cartridges. A shortage of these components or
other factors outside the control of the Company could impair the Company's
ability to manufacture an adequate supply of cartridges. The Company's SNES
cartridges distributed in the remainder of the world are manufactured by
Nintendo. Nintendo requires the Company to provide it irrevocable letters of
credit prior to Nintendo's acceptance of purchase orders from the Company for
these cartridges. For purchases of cartridges from Nintendo for distribution in
Japan, Nintendo also requires the Company to make cash deposits. Furthermore,
Nintendo maintains a policy of not accepting returns. Because of these and other
factors, the carrying of an inventory of cartridges entails significant
investment and risk. See Hardware Companies, below.
License/OEM Net Revenues
September 30, September 30,
1996 1995 % change
-------------- -------------- ---------
Three Months Ended $3,469,000 $5,931,000 (41.5%)
as a percentage of net revenues 2.7% 6.3%
Six Months Ended $8,449,000 $12,023,000 (29.7%)
as a percentage of net revenues 4.0% 6.9%
The decrease in license/OEM net revenues for the three months ended September
30, 1996 compared to the same period last year was primarily a result of a
decrease in licensing revenues related to the transition to developing strategic
partnerships with certain hardware companies in the United States. The decrease
in License/OEM net revenues for the six months ended September 30, 1996 compared
to the same period last year was primarily a result of a decrease in the
distribution of its products through OEM's in the United States and Europe.
13
Other Revenues
September 30, September 30,
1996 1995 % change
-------------- -------------- ---------
Three Months Ended $108,000 $1,351,000 (92.0%)
as a percentage of net revenues 0.0% 1.4%
Six Month Ended $257,000 $4,330,000 (94.1%)
as a percentage of net revenues 0.1% 2.5%
Other revenues for the three and six months ended September 30, 1996 consisted
primarily of sales of floppy-disk based PC titles. For the comparable periods in
the prior year, other revenues included sales of products for Sega 32X, Nintendo
Gameboy, Sega GameGear, and floppy-disk PC titles. The Company does not plan to
release any new titles for currently-existing hand-held equipment, the Sega 32X
or on floppy-disks and accordingly, revenues for these platforms are not
expected to be significant.
Affiliated Label Net Revenues
September 30, September 30,
1996 1995 % change
-------------- -------------- ---------
Three Months Ended $15,592,000 $15,150,000 2.9%
as a percentage of net revenues 12.1% 16.1%
Six Months Ended $28,699,000 $32,930,000 (12.8%)
as a percentage of net revenues 13.7% 18.8%
The increase in Affiliated Label net revenues for the three months ended
September 30, 1996 compared to the prior year period reflects higher sales of AL
products in Europe offset by decreases in North America and Japan. The decrease
in Affiliated Label net revenues for the six months ended September 30, 1996
compared to the prior year reflects the decrease in revenues associated with two
exclusive distribution arrangements for certain PC and 3DO products to key
accounts on behalf of other third party publishers in North America, partially
offset by the expansion of the distribution business in Europe in the current
year.
Cost of Goods Sold
September 30, September 30,
1996 1995 % change
-------------- -------------- ---------
Three Months Ended $64,477,000 $47,922,000 34.5%
as a percentage of net revenues 49.9% 51.0%
Six Months Ended $103,944,000 $90,723,000 14.6%
as a percentage of net revenues 49.5% 52.0%
The decrease in costs of goods sold as a percentage of net revenues, for the
three and six months ended September 30, 1996, compared to the same periods last
year was primarily due to the increase in sales of higher margin PC CD and
CD-Videogame titles compared to lower margin 16-bit cartridge products. The
higher margins were partially offset by higher professional, celebrity and
manufacturing royalties.
14
Marketing and Sales
September 30, September 30,
1996 1995 % change
-------------- ------------- ---------
Three Months Ended $19,319,000 $14,873,000 29.9%
as a percentage of net revenues 14.9% 15.8%
Six Months Ended $33,284,000 $26,563,000 25.3%
as a percentage of net revenues 15.9% 15.2%
The increase in marketing and sales expenses was primarily attributable to
increased TV advertising for titles released in the current quarter, increased
co-op advertising as well as the continued expansion of the Company's worldwide
distribution business. The increase reflected new sales and distribution offices
in the international market, including New Zealand, Singapore, Sweden and South
Africa.
General and Administrative
September 30, September 30,
1996 1995 % change
-------------- ------------- ---------
Three Months Ended $11,591,000 $7,332,000 58.1%
as a percentage of net revenues 9.0% 7.8%
Six Months Ended $19,757,000 $13,513,000 46.2%
as a percentage of net revenues 9.4% 7.7%
The increase in general and administrative expenses resulted primarily from
$2,300,000 in additional bad debt expense related to potentially uncollectable
receivables from a customer who filed for bankruptcy during the quarter ended
September 30, 1996. In addition, general and administrative costs increased due
to the opening of additional international offices.
Research and Development
September 30, September 30,
1996 1995 % change
-------------- ------------- ---------
Three Months Ended $28,720,000 $21,113,000 36.0%
as a percentage of net revenues 22.2% 22.5%
Six Months Ended $54,049,000 $40,996,000 31.8%
as a percentage of net revenues 25.8% 23.5%
The increase in research and development expenses was primarily due to
additional headcount relating to increased in-house development capacity, and
higher average development costs for CD-based products than for cartridge
products. Additionally, for the three and six months ended September 30, 1996,
reserves against artists advances and depreciation expense increased compared to
the prior year.
15
Operating Income (Loss)
September 30, September 30,
1996 1995 % change
-------------- ------------- ----------
Three Months Ended $5,160,000 $2,795,000 84.6%
as a percentage of net revenues 4.0% 3.0%
Six Months Ended $(1,140,000) $2,763,000 (141.3%)
as a percentage of net revenues (0.5%) 1.6%
Operating income increased for the three months ended September 30, 1996
compared to the same period last year due to higher revenues and increased gross
profit margins, partially offset by higher operating expenses. The operating
loss for the six months ended September 30, 1996 was attributable to higher
average product development costs associated with CD-based products and the
timing of revenues which are associated with product releases in the quarters
ended September and December.
Interest and Other Income, Net
September 30 September 30,
1996 1995 % change
------------- ------------- ---------
Three Months Ended $1,880,000 $1,138,000 65.2%
as a percentage of net revenues 1.5% 1.2%
Six Months Ended $7,996,000 $2,281,000 250.5%
as a percentage of net revenues 3.8% 1.3%
Interest and other income, net, increased for the three and six months ended
September 30, 1996 compared to the same period last year primarily due to gains
on sales of marketable securities of $754,000 and $5,456,000, respectively.
There were no sales of securities in the six months ended September 30, 1995.
Income Taxes
September 30, September 30,
1996 1995 % change
-------------- ------------- ---------
Three Months Ended $2,287,000 $1,259,000 81.7%
effective tax rate 32.5% 32.0%
Six Months Ended $2,228,000 $1,615,000 38.0%
effective tax rate 32.5% 32.0%
The Company's effective tax rate increased for the three and six months ended
September 30, 1996 due to higher North American profits as a proportion of
worldwide profits and losses generated by Electronic Arts Victor ("EAV").
16
Minority Interest in Consolidated Joint Venture
September 30, September 30,
1996 1995 % change
-------------- -------------- ----------
Three Months Ended $1,131,000 $319,000 254.5%
as a percentage of net revenue 0.9% 0.3%
Six Months Ended $1,291,000 $364,000 254.7%
as a percentage of net revenue 0.6% 0.2%
EAV is sixty-five percent owned by the Company and thirty-five percent owned by
Victor Entertainment Industries, Inc. ("VEI"), (formerly Victor Musical
Industries, Inc.) a wholly owned subsidiary of Victor Company of Japan, Limited.
The minority interest represents VEI's 35% interest in EAV. Minority interest
for the three and six months ended September 30, 1996 reflects higher reported
losses for EAV compared to the same periods in the prior year.
Net Income
September 30, September 30,
1996 1995 % change
-------------- ------------- ---------
Three Months Ended $5,884,000 $2,993,000 96.6%
as a percentage of net revenue 4.6% 3.2%
Six Months Ended $5,919,000 $3,793,000 56.1%
as a percentage of net revenue 2.8% 2.2%
The increase in net income as compared to the prior year period was primarily
related to higher revenues, other income and gross profit margins partially
offset by higher operating expenses.
17
Liquidity and Capital Resources
As of September 30, 1996, the Company's working capital was $202,275,000
compared to $199,713,000 at March 31, 1996. Cash and short term investments
decreased by approximately $12,732,000 for the six months ended September 30,
1996 as the Company used $25,544,000 of cash in operations and $17,494,000 in
capital expenditures offset by proceeds from the sale of marketable securities
and the exercise of stock options.
Reserves for bad debts and sales returns increased from $27,569,000 at March 31,
1996 to $31,584,000 at September 30, 1996. Reserves have been charged for
returns of product and price protection credits issued for products sold in
prior periods. Management believes these reserves are adequate based on
historical experience and its current estimate of potential returns and
allowances.
Inventory levels at September 30, 1996 increased $9,721,000 compared to March
31, 1996 due to the build up of videogame cartridge components, including the
initial manufacturing of SNES cartridges, in anticipation of the upcoming
holiday season.
In connection with the Company's purchases of Sony products to be distributed in
Japan, Sony of Japan requires cash deposits totaling one-third of purchase
orders. In lieu of letters of credit, EAV utilizes a line of credit to fund
these deposits, purchases of Sony products and other operating requirements. At
September 30, 1996, EAV had approximately $5,300,000 outstanding on this line.
The Company's principal source of liquidity is $135,251,000 in cash and
short-term investments. Management believes the existing cash, cash equivalents,
short-term investments, marketable securities and cash generated from operations
will be sufficient to meet cash and investment requirements for the foreseeable
future.
18
Factors Affecting Future Performance
Future operating results of the Company depend upon many factors and are subject
to various risks and uncertainties. Some of those important risks and
uncertainties which may cause the Company's operating results to vary or which
may materially and adversely affect EA's operating results are as follows:
The Industry and Competition. The interactive software business has historically
been a volatile and highly dynamic industry affected by changing technology,
limited hardware platform life cycles, hit products, competition, component
supplies, seasonality, consumer spending and other economic trends. The business
is also intensely competitive. A variety of companies offer products that
compete directly with one or more of the Company's products. These direct
competitors vary in size from very small companies to companies with financial,
managerial and technical resources comparable to or greater than those of the
Company. Typically, the Company's chief competitor on dedicated game platforms
is the hardware manufacturer/ licensor itself, to which the Company must pay
royalties and, in the case of Sony, manufacturing charges. For example, Sony has
aggressively launched sports product lines that directly compete with the
Company's sports products on the PlayStation. Additionally, new entrants in the
interactive entertainment and multimedia industries, such as cable television,
telephone and diversified media and entertainment companies, and a proliferation
of new technologies, such as on-line networks and the Internet, are making
market forecasting and prediction of financial results increasingly difficult
for the Company. For example, as the Company increases its share of the PC CD
market, the potential for competition with companies such as Microsoft
increases.
Products. Interactive entertainment software products typically have life spans
of only 3 to 12 months. In addition, the market is crowded with a large number
of titles competing for limited shelf space at retail. The Company's future
success will depend in large part on its ability to develop and introduce new
competitive products on a timely basis and to get those products distributed
widely at retail. To compete successfully, new products must adapt to new
hardware platforms and emerging industry standards, provide additional
functionality and be successfully distributed in numerous changing worldwide
markets. If the Company were unable, due to resource constraints or
technological or other reasons, to successfully develop and distribute such
products in a timely manner, this inability would have a material adverse effect
on its operating results and financial condition.
Development. Product development schedules, particularly for new hardware
platforms and high-end multimedia PC's, are difficult to predict because they
involve creative processes, use of new development tools for new platforms and
the learning process associated with development for new technologies. CD
products frequently include more content and are more complex, time-consuming
and costly to develop than cartridge products and, accordingly, cause additional
development and scheduling risk. For example, in fiscal 1996, John Madden
Football 96 and NHL Hockey 96 for the Sony PlayStation did not ship at all due
to significant delays in development that made the delayed completion date
untimely for these products. In addition, Dungeon Keeper was originally
scheduled to ship in the quarter ending June 30, 1996 but it is now expected to
ship in the quarter ending March 31, 1997 due to development delays. Because of
the increased cost of CD product development, write-offs of advance payments
made to outside artists for discontinued or unsuccessful products have increased
and may continue to increase.
19
Manufacturing. 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.
Manufacturing lead times during the year for CD based products have been as
brief as one to three weeks; cartridge products more typically have had a six to
twelve week lead time for manufacture.
Platform Changes. A large portion of the Company's revenues are derived from the
sale of products designed to be played on proprietary videogame platforms such
as the PlayStation, Sega Saturn, SNES and Sega Genesis. The interdependent
nature of the Company's business and that of its hardware licensors brings
significant risks to the Company's business. The success of the Company's
products is significantly affected by market acceptance of the new videogame
hardware systems and the life span of older hardware platforms, and the
Company's ability to accurately predict these factors with respect to each
platform. In many cases, the Company will have expended a large amount of
development and marketing resources on products designed for new videogame
systems (such as the PlayStation and Sega Saturn) that have not yet achieved
large installed bases or continued product development for older hardware
platforms that may have shorter life cycles than the Company expected.
Conversely, if the Company does not choose to develop for a platform that
achieves significant market acceptance, or discontinues development for a
platform that has a longer life cycle than expected, the Company's revenue
growth may be adversely affected.
The Company believes that investment in products for the 32-bit market,
including both PC CD and CD-Videogame platforms, is strategically important and
the Company is therefore continuing its aggressive development activities for
32-bit platforms. Though Sony and Sega have announced price reductions of their
32-bit systems, the CD-Videogame market may grow at a slower than expected rate.
Also, the introduction of the Nintendo 64 may have a negative impact on the
market acceptance of CD-Videogames. In addition, the Company's revenues and
earnings are dependent on its ability to meet its product release schedule and
its failure to meet those schedules could result in revenues and earnings below
anticipated levels for the remainder of its current fiscal year.
Hardware Companies. The Company's contracts with hardware licensors, which are
also some of the Company's chief competitors, often grant significant control to
the licensor over the approval and manufacturing of, and in certain cases supply
of key components for, the manufacturing of the Company's videogame products on
both CD and cartridge formats. This fact could, in certain circumstances, leave
the Company unable to get its products manufactured and shipped to customers. In
most events, control of the approval, manufacturing and supply process by
hardware companies increases both the manufacturing lead times and the expense
to the Company over the lead times and costs that the Company could achieve
independently. For example, the Company has experienced delays in the approval
and manufacturing of Sony PlayStation products which caused delays in shipping
those products. The results of future periods may be affected by similar delays.
Finally, the Company's contracts with its hardware licensors often require the
Company to take significant risks in holding or prepaying for its inventory of
products.
20
Revenue and Expenses. A substantial majority of the revenue of the Company in
any quarter typically results from orders received in that quarter and products
introduced in that quarter. The Company's expenses are based, in part, on
development of products to be released in the future. Certain overhead and
product development expenses do not vary directly in relation to revenues. As a
result, the Company's quarterly results of operations are difficult to predict,
and small delays in product deliveries may cause quarterly revenues, operating
results and net income to fall significantly below anticipated levels. The
Company typically receives orders shortly before shipments, making backlog an
unreliable indicator of quarterly results. A shortfall in shipments at the end
of any particular quarter may cause the results of that quarter to fall
significantly short of anticipated levels. In addition, due in part to the
volume of products introduced into the market and the short shelf life of most
products, there is increasing pressure from retailers to offer price protection
and accept returns of retailers' excess inventory.
Film and Videotape. The Company produces film and videotape to include in
certain products pursuant to agreements between certain of the Company's
subsidiaries with the Screen Actors Guild (SAG), the American Federation of
Television and Radio Actors (AFTRA) and the British Actors Equity Association.
However, the costs of video production are significantly higher than for
software production, and for products which include a substantial amount of
video such as certain interactive movies, the costs of producing the video
component is significantly higher than the cost of developing the software
component. For example, the film component of Wing Commander IV cost
approximately $8.0 million. Accordingly, more units of such products must be
sold to recoup the development and production costs. While Wing Commander IV has
sold sufficient units to recoup the full costs of development, there can be no
assurances that other products including significant film or videotape
components will be commercially successful enough to recoup development costs.
The Company expects to release one product with significant video content during
the remainder of the current fiscal year. In addition, the Company's agreements
with SAG and AFTRA expire during the current calendar year, and there can be no
assurances that the Company will be able to renegotiate favorable terms.
Employees. Competition for employees in the interactive software business is
intense and increasing as competition in the industry increases. In the last
fiscal year, recruiting of the Company's employees generally and its executive
officers in particular has been severe. Large software and media companies
frequently offer significantly larger cash compensation than does the Company,
placing pressure on the Company's base salary and cash bonus compensation. Small
start-up companies such as those proliferating in the on-line business offer
significant potential equity gains which are difficult for more mature companies
like the Company to match without significant shareholder dilution. In the last
two years, three of the Company's executive officers have resigned to work with
small start-up ventures, and virtually all of the executives are under intense
recruiting pressure. There can be no assurances that the Company will be able to
continue to attract and retain enough qualified employees in the future.
21
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 the Company's common stock in
any given period. As a result of the factors discussed in this quarterly report
and other factors that may arise in the future, the market price of the
Company's common stock may be subject to significant fluctuations over a short
period of time. These fluctuations may be due to factors specific to the
Company, to changes in analysts' earnings estimates, or to factors affecting the
computer, software, entertainment, media or electronics industries or the
securities markets in general. For example, during the most recently completed
fiscal year, the price per share of the Company's common stock ranged from
$20.13 to $41.75 and in the first six months of the current fiscal year ranged
from $24.75 to $39.13.
Rapid Technological Change. The interactive software industry has recently
undergone another significant change due in part to the introduction or planned
introduction of new hardware platforms, as well as remote and electronic
delivery systems. The new generation of systems are based on 32-bit and 64-bit
microprocessors that incorporate dedicated graphics chipsets. Many of these
systems utilize CD-ROM drives. Sony and Sega each began distribution of their
next generation hardware systems (named the "PlayStation" and "Saturn",
respectively) in Japan during the quarter ended December 1994. Sega began
limited shipment of the Saturn in North America in May 1995 and Sony began
shipping the PlayStation in North America in September 1995. Nintendo shipped
the Nintendo 64 ("N64") in Japan in June 1996 and began shipping the N64 in
North America in September of 1996. In October 1995, 3DO Company announced an
agreement to license its next generation system, the M2, to Matsushita Electric
Industrial Co. Ltd.
As compact discs have emerged as the preferred medium for interactive
entertainment, education, and information software, the Company has continued
its investment in the development of CD-ROM tools and technologies and has more
than 40 titles in development for CD-ROM platforms, including MS-DOS and
Windows-based PC's, the PlayStation and the Sega Saturn. Most of these products
will be convertible for use on multiple advanced hardware systems. As a result,
the Company's new product releases in its current fiscal year will be primarily
for 32-bit platforms, and to a lesser degree 16-bit videogame systems. However,
the transition from 16-bit cartridge-based game machines to the advanced systems
described above may continue to adversely affect the near term financial results
of the Company.
The 3DO Company. The Company currently owns approximately 10.1% of the common
stock of 3DO. There can be no assurance that 3DO as a company will be
successful. Because of the Company's equity stake in and historical association
with 3DO, a material adverse effect on the business or prospects of 3DO or a
substantial adverse change in the stock price of 3DO could have a material
adverse effect on the Company's stock price. At September 30, 1996, the price of
3DO stock had declined to $5.75.
22
Marketing and Distribution. As discussed above, the 16-bit videogame business
has become increasingly "hits" driven, requiring significantly greater
expenditures for advertising, particularly for television advertising. There can
be no assurance that the Company will continue to produce hit products or that
advertising expenditures will increase sales sufficiently to recoup the
advertising expenditures.
The Company has stock-balancing programs for its PC products (whether
provided on floppy-disk or CD-ROM) that, under certain circumstances and up to a
specified amount, allow the exchange of PC products by resellers. The Company
also typically provides price protection for its PC and 16-bit and 32-bit
videogame system products that, under certain conditions, allows the reseller a
price reduction from the Company for unsold products. The Company maintains a
policy of exchanging products or giving credits, but does not give cash refunds.
The risk of price protection requirements is increasing as a result of the
maturing and the increasingly hit-based nature of the 16-bit video cartridge
market. Moreover, the risk of product returns may increase as new hardware
platforms become more popular or market factors force the Company to make
changes in its distribution system. The Company monitors and manages the volume
of its sales to retailers and distributors and their inventories as substantial
overstocking in the distribution channel can result in high returns or the
requirement for substantial price protection in subsequent periods. The Company
believes that it provides adequate reserves for returns and price protection
which are based on estimated future returns of products, taking into account
promotional activities, the timing of new product introductions, distributor and
retailer inventories of the Company's products and other factors, and that its
current reserves will be sufficient to meet return and price protection
requirements for the foreseeable future. However, there can be no assurance that
actual returns or price protection will not exceed the Company's reserves. See
Revenue and Expenses, above.
The distribution channels through which consumer software products are
sold have been characterized by change, including consolidations and financial
difficulties of certain distributors and retailers and the emergence of new
retailers such as general mass merchandisers. The development of remote and
electronic delivery systems will create further changes. The bankruptcy or other
business difficulties of a distributor or retailer could render Electronic Arts'
accounts receivable from such entity uncollectible, which could have an adverse
effect on the operating results and financial condition of the Company. For
example, the Company recorded $2,300,000 in bad debt expense related to
potentially uncollectable receivables from a customer which filed for bankruptcy
in the quarter ended September 30, 1996. In addition, an increasing number of
companies are competing for access to these channels. Electronic Arts'
arrangements with its distributors and retailers may be terminated by either
party at any time without cause. Distributors and retailers often carry products
that compete with those of the Company. Retailers of Electronic Arts' products
typically have a limited amount of shelf space and promotional resources for
which there is intense competition. There can be no assurance that distributors
and retailers will continue to purchase Electronic Arts' products or provide
Electronic Arts' products with adequate levels of shelf space and promotional
support.
23
Seasonality. The Company's business is highly seasonal. The Company typically
experiences its highest revenues and profits in the calendar year-end holiday
season and a seasonal low in revenues and profits in the quarter ending in June.
Because of the foregoing factors, as well as other factors affecting
the Company's operating results and financial condition, past financial
performance should not be considered a reliable indicator of future performance,
and investors should not use historical trends to anticipate results or trends
in future periods.
24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to pending claims. Management, after
review and consultation with counsel, considers that any
liability from the disposition of such lawsuits in the
aggregate would not have a material adverse effect upon the
consolidated financial position or results of operations of
the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - The following exhibits are filed as part of this report:
None
(b) No reports on Form 8-K were filed by the Registrant during the three
months ended September 30, 1996.
25
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
November 13, 1996 Senior Vice President and
Chief Financial and Administrative Officer
(Duly authorized officer)
26