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, 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 January 25, 1997
--------------------- ----------------
$0.01 par value per share 53,910,366
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
- ------------------------------ ----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
December 31, 1996 and March 31, 1996 3
Consolidated Statements of Income for the Three Months Ended
December 31, 1996 and 1995 and the Nine Months Ended
December 31, 1996 and 1995 4
Consolidated Statements of Cash Flows for
the Nine Months Ended December 31, 1996 and 1995 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Part II - Other Information
- ---------------------------
Item 1. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
- ----------
Exhibit Index 28
- -------------
2
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
ASSETS
December 31, March 31,
1996 1996
----------- ---------
(unaudited)
Current assets:
Cash and short-term investments $ 177,327 $ 147,983
Marketable securities 12,925 37,869
Receivables, less allowances of $50,935 and $27,569, respectively 196,119 73,075
Inventories 18,677 14,704
Prepaid royalties 11,798 14,519
Other current assets 11,250 12,188
--------- ---------
Total current assets 428,096 300,338
Property and equipment, net 83,423 70,062
Prepaid royalties 5,873 11,030
Long-term investments 24,200 24,200
Investments in affiliates 19,573 15,952
Other assets 3,680 2,637
--------- ---------
$ 564,845 $ 424,219
========= =========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 56,448 $ 37,019
Accrued liabilities 128,788 63,606
--------- ---------
Total current liabilities 185,236 100,625
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 53,845,993 and 52,741,572, respectively 538 527
Paid-in capital 129,598 108,078
Retained earnings 242,120 199,523
Unrealized appreciation of investments 7,279 16,266
Translation adjustment 74 (2,077)
--------- ---------
Total stockholders' equity 379,609 322,317
--------- ---------
$ 564,845 $ 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 Nine Months Ended
December 31, December 31,
1996 1995 1996 1995
-------------- ------------------- -------------- ----------------
Net revenues $ 271,081 $ 240,075 $ 480,975 $ 414,633
Cost of goods sold 135,529 127,014 239,473 217,737
--------- --------- --------- ---------
Gross profit 135,552 113,061 241,502 196,896
--------- --------- --------- ---------
Operating expenses:
Marketing and sales 33,816 30,914 67,100 57,477
General and administrative 12,184 10,699 31,941 24,212
Research and development 33,769 30,379 87,818 71,375
--------- --------- --------- ---------
Total operating expenses 79,769 71,992 186,859 153,064
--------- --------- --------- ---------
Operating income 55,783 41,069 54,643 43,832
Interest and other income, net 908 2,522 8,904 4,803
--------- --------- --------- ---------
Income before provision for income taxes
and minority interest 56,691 43,591 63,547 48,635
Provision for income taxes 20,013 13,705 22,241 15,320
--------- --------- --------- ---------
Income before minority interest 36,678 29,886 41,306 33,315
Minority interest in consolidated
joint venture -- (620) 1,291 (256)
--------- --------- --------- ---------
Net income $ 36,678 $ 29,266 $ 42,597 $ 33,059
========= ========= ========= =========
Net income per share $ 0.66 $ 0.54 $ 0.77 $ 0.61
========= ========= ========= =========
Number of shares used in computation 55,896 54,698 55,378 54,121
========= ========= ========= =========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Nine Months
Ended December 31,
----------------------
1996 1995
--------- ---------
Operating activities:
Net income $ 42,597 $ 33,059
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Minority interest in consolidated joint venture (1,291) 256
Depreciation and amortization 15,140 10,799
Gain on sale of fixed assets (38) (1,935)
Gain on sale of marketable securities (6,700) --
Change in assets and liabilities:
Receivables (123,044) (106,332)
Inventories (3,973) (3,183)
Prepaid royalties 7,878 (9,254)
Other assets (820) (7,499)
Accounts payable 19,429 14,502
Accrued liabilities 69,083 18,868
Deferred income taxes (169) (588)
--------- ---------
Net cash provided by (used in) operating activities 18,092 (51,307)
--------- ---------
Investing activities:
Proceeds from sales of furniture and equipment 152 4,164
Proceeds from sales of marketable securities 19,121 --
Capital expenditures (28,096) (47,919)
Investment in affiliates (3,621) (10,118)
Change in short-term investments, net 335 13,475
Adjustment for effects of poolings in prior period -- (89)
--------- ---------
Net cash used in investing activities (12,109) (40,487)
--------- ---------
Financing activities:
Proceeds from issuance of common stock 15,535 18,268
Tax benefit from exercise of stock options 5,996 1,276
--------- ---------
Net cash provided by financing activities 21,531 19,544
--------- ---------
Translation adjustment 2,151 (322)
Minority interest on translation adjustment 14 (129)
--------- ---------
Increase (decrease) in cash and cash equivalents 29,679 (72,701)
Beginning cash and cash equivalents 105,628 143,421
--------- ---------
Ending cash and cash equivalents 135,307 70,720
Short-term investments 42,020 17,225
--------- ---------
Ending cash and short-term investments $ 177,327 $ 87,945
========= =========
Supplemental cash flow information:
Cash paid during the year for income taxes $ 1,764 $ 9,261
========= =========
Non-cash investing activities:
Decline on unrealized appreciation of investments $ (12,719) $ (1,581)
========= =========
<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 December 31, 1996 and March 31, 1996
consisted of (in thousands):
December 31, 1996 March 31, 1996
----------------- --------------
Cash and cash equivalents $135,307 $105,628
Short-term investments 42,020 42,355
-------- --------
$177,327 $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 appreciation reported
as a separate component of stockholders' equity. For the three and nine months
ended December 31, 1996, the Company realized gains before taxes of $1,244,000
and $6,700,000, respectively, on sales of marketable securities.
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
December 31, 1996 and March 31, 1996 consisted of (in thousands):
December 31, 1996 March 31, 1996
----------------- --------------
Raw materials and work in process $ 5,666 $ 2,160
Finished goods 13,011 12,544
------- -------
$18,677 $14,704
======= =======
Note 6. Accrued Liabilities
Accrued liabilities at December 31, 1996 and March 31, 1996 consisted of (in
thousands):
December 31, 1996 March 31, 1996
----------------- --------------
Accrued expenses $ 52,023 $ 18,203
Accrued royalties 36,676 16,889
Accrued compensation and benefits 17,816 11,480
Accrued income taxes 19,618 10,477
Deferred income taxes 1,977 5,878
Deferred revenue 678 679
-------- ---------
$128,788 $ 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 nine months ended December 31, 1996 and 1995 is presented below (in
thousands).
North South Asia
America Europe Pacific Japan Eliminations Total
-------- -------- -------- -------- ------------ --------
Three months ended December 31, 1996
Net revenues from unaffiliated $146,928 $101,614 $ 10,025 $ 12,514 $ -- $271,081
customers
Intersegment net revenues 28,186 2,795 -- 56 (31,037) --
-------- -------- -------- -------- -------- --------
Total net revenues $175,114 $104,409 $ 10,025 $ 12,570 $(31,037) $271,081
======== ======== ======== ======== ======== ========
Operating income (loss) $ 32,672 $ 22,067 $ 2,687 $ (1,643) $ -- $ 55,783
Identifiable assets $382,826 $146,347 $ 14,288 $ 21,384 $ -- $564,845
Nine months ended December 31, 1996
Net revenues from unaffiliated $271,169 $165,341 $ 20,998 $ 23,467 $ -- $480,975
customers
Intersegment net revenues 42,951 5,044 -- 67 (48,062) --
-------- -------- -------- -------- -------- --------
Total net revenues $314,120 $170,385 $ 20,998 $ 23,534 $(48,062) $480,975
======== ======== ======== ======== ======== ========
Operating income (loss) $ 28,281 $ 26,804 $ 4,891 $ (5,333) $ -- $ 54,643
Three months ended December 31, 1995
Net revenues from unaffiliated $143,106 $ 72,449 $ 8,168 $ 16,352 $ -- $240,075
customers
Intersegment net revenues 24,687 2,894 13 10 (27,604) --
-------- -------- -------- -------- -------- --------
Total net revenues $167,793 $ 75,343 $ 8,181 $ 16,362 $(27,604) $240,075
======== ======== ======== ======== ======== ========
Operating income $ 22,916 $ 14,496 $ 1,877 $ 1,780 $ -- $ 41,069
Identifiable assets $307,120 $ 86,258 $ 10,204 $ 21,663 $ -- $425,245
Nine months ended December 31, 1995
Net revenues from unaffiliated $253,257 $114,524 $ 16,084 $ 30,768 $ -- $414,633
customers
Intersegment net revenues 37,980 6,478 32 75 (44,565) --
-------- -------- -------- -------- -------- --------
Total net revenues $291,237 $121,002 $ 16,116 $ 30,843 $(44,565) $414,633
======== ======== ======== ======== ======== ========
Operating income $ 17,219 $ 22,328 $ 3,626 $ 659 $ -- $ 43,832
8
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Note 8. Foreign Currency
In order to reduce the effects of foreign currency fluctuations on its results
of operations, the Company, during the quarter ended December 31, 1996, began
selectively utilizing forward foreign currency exchange contracts to hedge its
exposure on certain intercompany transactions. These financial instruments are
designed to minimize exposure and reduce risk from exchange rate fluctuations in
the normal course of business from the inception of the contract until its
expiration. Realized gains and losses from these hedges are recognized as
interest expense and other and are offset by corresponding foreign currency
gains and losses on hedged transactions.
At December 31, 1996, the Company had foreign exchange contracts to purchase and
sell approximately $20,700,000 in foreign currencies, primarily German
Deutschmarks and British Pounds. The Company considers any potential gains and
losses from these contracts to be immaterial.
9
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 20 to 25, 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
December 31, December 31,
1996 1995 % change
------------------- ------------------ -----------------
Consolidated Net Revenues
Three Months Ended $271,081,000 $240,075,000 12.9%
Nine Months Ended $480,975,000 $414,633,000 16.0%
North America Net Revenues
Three Months Ended $146,928,000 $143,106,000 2.7%
as a percentage of net revenues 54.2% 59.6%
Nine Months Ended $271,169,000 $253,257,000 7.1%
as a percentage of net revenues 56.4% 61.1%
International Net Revenues
Three Months Ended $124,153,000 $96,969,000 28.0%
as a percentage of net revenues 45.8% 40.4%
Nine Months Ended $209,806,000 $161,376,000 30.0%
as a percentage of net revenues 43.6% 38.9%
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 2.7% for the three months ended
December 31, 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 ("Saturn"), and the continued growth of the PC
CD market. Total North American PC CD and CD-Videogame revenue increased
$54,309,000 to $90,372,000 for the three months ended December 31, 1996 in
comparison to the same period in the prior year, while 16-bit net revenues
decreased $46,006,000, or 52.9%, to $40,955,000.
10
For the nine months ended December 31, 1996, North America net revenue increased
$17,912,000 compared to the same period in the prior year due to the transition
of sales mix to products for PC CD and CD-Videogames noted above. Net revenues
from the sale of PC CD and CD-Videogame products increased $110,388,000 while
sales of 16-bit products decreased $75,366,000 in comparison to the prior year.
This net increase was partially offset by decreased Affiliated Label sales which
include arrangements for the exclusive distribution of certain PC and 3DO
products to two key accounts on behalf of third party publishers. As this
program was initiated during the quarter ended June 30, 1995, Affiliated Label
sales during the nine months ended December 31, 1995 included this initial sell
in.
International net revenues increased 28.0% for the three months ended December
31, 1996 compared to the same period last year. The increase was primarily due
to a 40.3% increase in European net revenues consisting of higher sales of
PlayStation, PC CD and AL products. Total net revenues in Europe were
$101,614,000 for the three months ended December 31, 1996 compared to
$72,449,000 in the same period last year.
The increase in European net revenues was offset by a decrease in net revenue of
$3,838,000 or 23.5% in Japan. Net revenues in Japan for the quarter ended
December 31, 1996 were $12,514,000 compared to $16,352,000 for the corresponding
period in the prior year. The decrease was primarily due to the delay in getting
localized products into the market, the delay of J-League Soccer for the
Nintendo 64 ("N64") and no significant sales of products for 16-bit platforms.
Revenues in the current fiscal quarter were comprised primarily of sales from
PlayStation and PC CD products compared to sales of 3DO and SNES products in the
same period of the prior year.
For the three months ended December 31, 1996, sales in the South Asia Pacific
region increased by 22.7% to $10,025,000 compared to $8,168,000 in the prior
year due to increased sales of PlayStation and Affiliated Label CD titles offset
by lower revenues on Sega Genesis ("Genesis") products.
International net revenues for the nine months ended December 31, 1996 increased
$48,430,000, or 30.0%, in comparison to prior year. The increase resulted from
the worldwide transition from 16-bit cartridge based systems to 32-bit
CD-Videogame consoles and the continued growth of the PC CD market. For the nine
months ended December 31, 1996 net revenues from the sales of 32-bit PC CD and
CD-Videogame products increased $65,055,000 over all regions while sales of
16-bit products decreased $31,032,000 or 58.0% 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.
11
EA Studio Net Revenues:
32-bit Videogame Product Net Revenues
December 31, December 31,
1996 1995 % change
------------------- ------------------- -------------
Three Months Ended $96,050,000 $33,739,000 184.7%
as a percentage of net revenues 35.4% 14.0%
Nine Months Ended $177,368,000 $46,075,000 285.0%
as a percentage of net revenues 36.9% 11.1%
The Company released nine 32-bit CD-Videogame products during the quarter ended
December 31, 1996 comprised of five for the PlayStation (Soviet Strike, FIFA
Soccer 97, NHL 97, NBA Live 97, and Crusader: No Remorse) and four for the
Saturn (NHL 97, Andretti Racing, PGA Tour Golf 97 and Crusader: No Remorse)
compared to six PlayStation, five 3DO titles and three Saturn titles released in
the same period last year. All 32-bit CD-Videogame revenues for the quarter
ended December 31, 1996 were from sales of PlayStation and Saturn products. In
the prior year, 21% of 32-bit CD-Videogame revenues for the quarter ended
December 31, 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 of PlayStation and Saturn is attributable to the greater
installed base of these 32-bit consoles.
For the nine months ended December 31,1996, total 32-bit Videogame revenue
increased $131,293,000 compared to the same period in the prior year. The bulk
of this increase was attributable to PlayStation sales which were $151,052,000,
compared to $24,485,000 for the nine months ended December 31, 1995. Net
revenues from the sales of other 32-bit products were $26,316,000 primarily from
Sega Saturn in the current year compared to $21,590,000 primarily 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. The Company expects revenues from 32-bit CD-Videogame
products to continue to grow in fiscal 1997, but as revenues for these products
increase, the Company does not expect to maintain these growth rates.
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.
12
Personal Computer-based CD Product Net Revenues
December 31, December 31,
1996 1995 % change
------------------- ------------------- -------------
Three Months Ended $73,156,000 $45,222,000 61.8%
as a percentage of net revenues 27.0% 18.9%
Nine Months Ended $139,393,000 $95,242,000 46.4%
as a percentage of net revenues 29.0% 23.0%
The Company released six new PC CD titles and two supplemental data disks for
previously released titles in the quarter ended December 31, 1996, all for
MS-DOS and Windows based personal computers, including FIFA Soccer 97, NBA Live
97, Privateer 2: The Darkening, and Syndicate Wars. In the same period last
year, five PC titles and two titles for the Macintosh were released. The
increase in sales of PC CD products is attributable to the growth in the PC
market worldwide, growth in the sports category and the expansion of the
Company's direct distribution worldwide. The primary increase in PC CD sales was
in North America and Europe which increased $20,342,000 and $8,327,000,
respectively, for the three months ended December 31, 1996 in comparison to the
same period last year. Though PC CD revenue is expected to grow in fiscal 1997,
it is not expected to grow at as high a rate as in prior periods.
16-bit Videogame Product Net Revenues December 31, December 31,
1996 1995 % change
------------------- ------------------- -------------
Three Months Ended $56,770,000 $125,183,000 (54.7%)
as a percentage of net revenues 20.9% 52.1%
Nine Months Ended $81,704,000 $188,102,000 (56.6%)
as a percentage of net revenues 17.0% 45.3%
The Company released six new 16-bit videogames, including three for the Super
Nintendo Entertainment System ("SNES") and three for the Genesis, during the
quarter ended December 31, 1996. Genesis cartridge sales were $35,093,000 for
the three months ended December 31, 1996 compared to $82,115,000 for the same
period in the prior year when six titles were released. SNES sales were
$21,677,000 for the three months ended December 31, 1996 compared to $43,068,000
for the same period last year. Three SNES titles were released in the third
quarter of fiscal 1996.
Genesis cartridge sales were $58,292,000 for the nine months ended December 31,
1996 compared to $130,819,000 for the same period in the prior year. SNES sales
were $23,412,000 for the nine months ended December 31, 1996 compared to
$57,283,000 for the same period in the prior year.
The Company's net revenues derived from 16-bit videogames declined 54.7% during
the third quarter of fiscal 1997 and 56.6% for the nine months ended December
31, 1996 compared to the same periods in the prior year. As discussed above and
in prior filings, 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 for the remainder of fiscal 1997
and in fiscal 1998. For the nine months ended December 31, 1996, the Company
released a total of nine new titles for the 16-bit videogame consoles in
comparison to seventeen titles in the same period last year. The Company's
current year releases were comprised of key sports titles targeted for holiday
season release. The Company has no planned releases of 16-bit videogames for the
remainder of fiscal 1997.
13
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
December 31, December 31,
1996 1995 % change
------------------- ------------------- -------------
Three Months Ended $7,919,000 $7,978,000 (0.7%)
as a percentage of net revenues 2.9% 3.3%
Nine Months Ended $16,368,000 $20,001,000 (18.2%)
as a percentage of net revenues 3.4% 4.8%
The slight decrease in license/OEM net revenues for the three months ended
December 31, 1996 compared to the same period last year was primarily due to
increased licensing activities in Europe offset by a decline in North America
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 nine months ended December 31, 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.
14
Other Net Revenues
December 31, December 31,
1996 1995 % change
------------------- -------------------- --------------
Three Months Ended $120,000 $3,729,000 (96.8%)
as a percentage of net revenues 0.1% 1.6%
Nine Month Ended $377,000 $8,059,000 (95.3%)
as a percentage of net revenues 0.0% 2.0%
Other revenues include 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
December 31, December 31,
1996 1995 % change
------------------- ------------------- -------------
Three Months Ended $37,066,000 $24,224,000 53.0%
as a percentage of net revenues 13.7% 10.1%
Nine Months Ended $65,765,000 $57,154,000 15.1%
as a percentage of net revenues 13.7% 13.8%
The increase in Affiliated Label net revenues for the three months ended
December 31, 1996 compared to the prior year period reflects higher sales of AL
products in Europe offset by a decrease in North America. Europe Affiliated
Label revenue for the three months ended December 31, 1996 increased to
$19,548,000 from $6,519,000 in the prior year primarily due to the release of
the first key title for the Sony PlayStation under an exclusive international
distribution agreement with Twentieth Century Fox Home Entertainment. The
decrease in North America AL revenue is attributable to the loss of a
significant affiliate at the end of the second quarter of fiscal 1997.
The increase in Affiliated Label net revenues for the nine months ended December
31, 1996 compared to the prior year reflects the increase in Europe Affiliated
Label revenue partially offset by a 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 and the loss
of an affiliate noted above.
Cost of Goods Sold
December 31, December 31,
1996 1995 % change
------------------- -------------------- --------------
Three Months Ended $135,529,000 $127,014,000 6.7%
as a percentage of net revenues 50.0% 52.9%
Nine Months Ended $239,473,000 $217,737,000 10.0%
as a percentage of net revenues 49.8% 52.5%
The decrease in costs of goods sold as a percentage of net revenues, for the
three and nine months ended December 31, 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.
15
Marketing and Sales
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $33,816,000 $30,914,000 9.4%
as a percentage of net revenues 12.5% 12.9%
Nine Months Ended $67,100,000 $57,477,000 16.7%
as a percentage of net revenues 13.9% 13.9%
The increase in marketing and sales expenses was primarily attributable to
increased TV advertising for titles released in the current quarter and the
continued expansion of the Company's worldwide distribution business. The
increase also reflected new sales and distribution offices in the international
market, including New Zealand, Singapore, Sweden and South Africa.
General and Administrative
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $12,184,000 $10,699,000 13.9%
as a percentage of net revenues 4.5% 4.5%
Nine Months Ended $31,941,000 $24,212,000 31.9%
as a percentage of net revenues 6.6% 5.8%
The increase in general and administrative expenses for the three months ended
December 31, 1996 compared to the same period last year was primarily
attributable to additional headcount and facility related expenses reflecting
the expansion of the Company's offices worldwide. The increase in general and
administrative expenses for the nine months ended December 31, 1996 compared to
the prior period last year resulted primarily from additional bad debt expense
related to potentially uncollectible 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
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $33,769,000 $30,379,000 11.2%
as a percentage of net revenues 12.4% 12.7%
Nine Months Ended $87,818,000 $71,375,000 23.0%
as a percentage of net revenues 18.3% 17.2%
The increase in research and development expenses for the three and nine months
ended December 31, 1996 was primarily due to higher average development costs
for CD-based products than for cartridge products. Additionally, for the nine
months ended December 31, 1996, reserves against artists advances and
depreciation expense increased compared to the prior year.
16
Operating Income
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $55,783,000 $41,069,000 35.8%
as a percentage of net revenues 20.6% 17.1%
Nine Months Ended $54,643,000 $43,832,000 24.7%
as a percentage of net revenues 11.4% 10.6%
Operating income increased for the three and nine months ended December 31, 1996
compared to the same periods last year due to higher revenues and increased
gross profit margins, partially offset by higher operating expenses related to
international expansion and higher development costs on CD-based products.
Interest and Other Income, Net
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $908,000 $2,522,000 (64.0%)
as a percentage of net revenues 0.3% 1.1%
Nine Months Ended $8,904,000 $4,803,000 85.4%
as a percentage of net revenues 1.9% 1.2%
Interest and other income decreased for the three months ended December 31, 1996
compared to the prior year due to foreign exchange losses and the non-recurring
prior year gain on sale of property and equipment offset by gains on sales of
marketable securities of $1,244,000. For the three months ended December 31,
1996, the Company incurred $878,000 in foreign exchange losses related to the
settlement of intercompany balances. As discussed at Note 8 in Item 1 of this
filing, the Company began utilizing foreign exchange contracts to hedge against
foreign currency fluctuations on certain intercompany transactions.
Interest and other income, net, increased for the nine months ended December 31,
1996 compared to the same period last year primarily due to gains on sales of
marketable securities of $6,700,000, offset by the prior year gains on sales of
property and equipment noted above.
Income Taxes
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $20,013,000 $13,705,000 46.0%
effective tax rate 35.3% 31.4%
Nine Months Ended $22,241,000 $15,320,000 45.2%
effective tax rate 35.0% 31.5%
The Company's effective tax rate increased for the three and nine months ended
December 31, 1996 due to the impact of the current year operating loss reported
in Japan by Electronic Arts Victor ("EAV") for which no benefit was provided.
17
Minority Interest in Consolidated Joint Venture
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended - ($620,000) 100.0%
as a percentage of net revenue 0.0% (0.3%)
Nine Months Ended $1,291,000 ($256,000) 604.3%
as a percentage of net revenue 0.3% (0.1%)
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. No minority interest
in EAV was recorded for the losses generated in the three months ended December
31, 1996 as VEI's interest in the net equity of EAV has fallen below zero.
Minority interest for the nine months ended December 31, 1996 reflects higher
reported losses for EAV compared to the same periods in the prior year.
Net Income
December 31, December 31,
1996 1995 % change
------------------- ------------------- --------------
Three Months Ended $36,678,000 $29,266,000 25.3%
as a percentage of net revenue 13.5% 12.2%
Nine Months Ended $42,597,000 $33,059,000 28.9%
as a percentage of net revenue 8.9% 8.0%
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.
18
Liquidity and Capital Resources
As of December 31, 1996, the Company's working capital was $242,860,000 compared
to $199,713,000 at March 31, 1996. Cash and short-term investments increased by
approximately $29,344,000 for the nine months ended December 31, 1996 as the
Company received $18,092,000 of cash from operations an,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 $50,935,000 at December 31, 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 December 31, 1996 increased $3,973,000 compared to March 31,
1996 as a result of increases in European inventory to accommodate growth
throughout the region and increases of PC CD and CD-Videogame inventories in
North America.
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
December 31, 1996, EAV had approximately $8,600,000 outstanding on this line.
The Company's principal source of liquidity is $177,327,000 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.
19
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 and Nintendo, 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 June 30, 1997 due to continued development delays.
Likewise, J-League Soccer for the N64 in Japan did not ship as scheduled.
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.
20
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) which may not continue to grow
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. For
example, the Company currently plans only one product release for the N64, which
appears to be achieving initial market acceptance in the U.S.
The Company believes that investment in products for the 32-bit market,
including both PC CD and CD-Videogame platforms, particularly the Sony
PlayStation, is strategically important and the Company is therefore continuing
its aggressive development activities for these platforms. Although the
PlayStation has had significant market acceptance in all geographic territories
to date, there can be no assurance that its growth will continue at the present
rate. Also, the introduction and market acceptance of the N64 may have a
negative impact on the growth rate and acceptance of 32-bit 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 or components.
21
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. Additionally, nearly all of the
anticipated fourth quarter product releases are expected to be shipped in the
latter half of the quarter which, with the development and manufacturing risks
disclosed above, increases the risk that some of these products will not ship
during the quarter. 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.
Foreign Sales and Currency Fluctuations. For the nine months ended December 31,
1996, international net revenues increased by 30% or $48,430,000 in comparison
to the prior year and comprise 44% of total consolidated net revenues. The
Company expects that foreign sales will continue to account for a significant
portion of net revenues in future periods. Foreign sales are subject to inherent
risks, including unexpected changes in regulatory requirements, tariffs and
other barriers. There can be no assurance that these or other factors will not
have an adverse effect on the Company's future operating results.
Given the significant international mix of sales, which are primarily made in
local currencies, the Company believes that currency fluctuations could have an
adverse effect on the Company's results of operations.
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.
During fiscal year 1997 the Company released one product with significant video
content. In addition, the Company's agreements with SAG and AFTRA expire in June
1997, and there can be no assurances that the Company will be able to
renegotiate favorable terms.
22
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.
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 nine 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 N64 in Japan in June 1996 and began shipping the N64 in North America in
September of 1996. In December 1995, 3DO Company licensed its 64-bit M2
technology 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 30 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 have been
primarily for 32-bit platforms, and to a lesser degree for 16-bit videogame
systems. Additionally, the Company has no planned releases of 16-bit titles for
the remainder of Fiscal 1997. 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.
23
The 3DO Company. The Company currently owns approximately 9.0% 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 December 31, 1996, the price of
3DO stock had declined to $5.125.
Marketing and Distribution. As discussed above, the 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 for the exchange of PC products by resellers. The
Company also typically provides price protection for its PC, 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.
24
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 uncollectible 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 typically may be terminated by
either party at any time without cause. Distributors and retailers often carry
products that compete with those of the Company. Retailers of Electronic Arts'
products typically have a limited amount of shelf space and promotional
resources for which there is intense competition. There can be no assurance that
distributors and retailers will continue to purchase Electronic Arts' products
or provide Electronic Arts' products with adequate levels of shelf space and
promotional support.
Seasonality. The Company's business is highly seasonal. The Company typically
experiences its highest revenues and profits in the calendar year-end holiday
season and a seasonal low in revenues and profits in the quarter ending in June.
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.
25
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 claims 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:
Number Exhibit Title
- ------ -------------
10.35 Lease Agreement by and between Registrant and Donald Mattrick dated
October 16, 1996.
(b) No reports on Form 8-K were filed by the Registrant during the
three months ended December 31, 1996.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRONIC ARTS INC.
(Registrant)
/s/ E. STANTON MCKEE
--------------------
DATED: E. STANTON MCKEE
February 13, 1997 Senior Vice President and
Chief Financial and Administrative Officer
(Duly authorized officer)
27
ELECTRONIC ARTS INC. AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1996
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE PAGE
- ------ ------------- ----
10.35 Lease Agreement by and between Registrant and Don Mattrick 29
dated October 16, 1996.
28