UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended June 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from __________ to _________
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
209 Redwood Shores Parkway
Redwood City, California 94065
(Address of principal executive offices) (Zip Code)
(650) 628-1500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock Par Value August 9, 2001
--------------------- --------- --------------
Class A common stock $0.01 136,624,162
ELECTRONIC ARTS INC. AND SUBSIDIARIES
INDEX
Part I - Financial Information Page
- ------------------------------ ----
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at
June 30, 2001 and March 31, 2001 3
Consolidated Statements of Operations for the Three Months
Ended June 30, 2001 and 2000 4
Consolidated Statements of Cash Flows for
the Three Months Ended June 30, 2001 and 2000 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 38
Part II - Other Information
- ---------------------------
Item 1. Legal Proceedings 40
Item 4. Submission of Matters to a Vote of Security Holders 40
Item 6. Exhibits and Reports on Form 8-K 40
Signatures 41
- ----------
2
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(unaudited)
June 30, March 31,
2001 2001
---------------------------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 460,194 $ 466,492
Marketable securities 8,768 10,022
Receivables, less allowances of $84,596 and $89,833, respectively 76,991 174,449
Inventories, net 16,020 15,686
Deferred income taxes 56,807 57,082
Other current assets 114,826 94,996
---------- ----------
Total current assets 733,606 818,727
Property and equipment, net 337,358 337,199
Long-term investments 8,400 8,400
Investments in affiliates 15,686 19,052
Goodwill and other intangibles, net 130,278 136,764
Long-term deferred taxes 2,875 2,926
Other assets 60,775 55,850
---------- ----------
$1,288,978 $1,378,918
========== ==========
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 59,168 $ 73,061
Accrued and other liabilities 187,837 266,965
---------- ----------
Total current liabilities 247,005 340,026
Minority interest in consolidated joint venture 4,310 4,545
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 10,000,000 shares - -
Common stock
Class A common stock, $0.01 par value. Authorized 400,000,000 shares;
issued and outstanding 136,415,329 and 134,714,464 shares, respectively 1,364 1,347
Class B common stock, $0.01 par value. Authorized 100,000,000 shares;
issued and outstanding 6,250,000 shares 63 63
Paid-in capital 588,738 540,354
Retained earnings 460,032 505,286
Accumulated other comprehensive loss (12,534) (12,703)
---------- ----------
Total stockholders' equity 1,037,663 1,034,347
---------- ----------
$1,288,978 $1,378,918
========== ==========
See accompanying notes to consolidated financial statements.
3
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
Three Months Ended
June 30,
2001 2000
-------------------------------
Net revenues $181,950 $154,799
Cost of goods sold 89,029 77,952
-------- --------
Gross profit 92,921 76,847
-------- --------
Operating expenses:
Marketing and sales 40,804 35,193
General and administrative 23,215 22,209
Research and development 90,805 79,168
Amortization of intangibles 6,475 4,654
-------- --------
Total operating expenses 161,299 141,224
-------- --------
Operating loss (68,378) (64,377)
Interest and other income, net 2,717 3,836
-------- --------
Loss before benefit from income taxes and minority interest (65,661) (60,541)
Benefit from income taxes (20,355) (18,768)
-------- --------
Loss before minority interest (45,306) (41,773)
Minority interest in consolidated joint venture 52 (498)
-------- --------
Net loss $(45,254) $(42,271)
========= ========
Class A common stock:
Net loss:
Basic $(39,375) $(38,614)
========= ========
Diluted $(45,254) $(42,271)
========= ========
Net loss per share:
Basic $ (0.29) $ (0.30)
Diluted $ (0.33) $ (0.33)
Number of shares used in computation:
Basic 135,730 129,135
Diluted 136,382 129,787
Class B common stock:
Net loss, net of retained interest in EA.com $ (5,879) $ (3,657)
========= ========
Net loss per share:
Basic $ (0.98) $ (0.61)
Diluted $ (0.98) $ (0.61)
Number of shares used in computation:
Basic 6,020 6,000
Diluted 6,020 6,000
See accompanying notes to consolidated financial statements.
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(unaudited)
Three Months
Ended June 30,
2001 2000
---------------------------
Operating activities:
Net loss $(45,254) $(42,271)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Minority interest in consolidated joint venture (52) 498
Equity in net loss of affiliates 290 600
Gain on sale of affiliate (200) -
Depreciation and amortization 22,889 15,024
Carriage fee amortization 4,466 -
Loss on sale of fixed assets 221 108
Provision for doubtful accounts 1,144 725
Tax benefit from exercise of stock options 14,441 -
Change in assets and liabilities:
Receivables 96,314 148,388
Inventories (334) (2,719)
Other assets (29,275) (2,382)
Accounts payable (13,893) (50,130)
Accrued and other liabilities (81,003) (65,640)
Deferred income taxes 61 84
-------- --------
Net cash provided by (used in) operating activities (30,185) 2,285
-------- --------
Investing activities:
Proceeds from sale of property and equipment 165 317
Purchase of marketable securities, net - (12)
Proceeds from sale of affiliate 570 -
Capital expenditures (15,030) (50,668)
Investment in affiliates, net 3,021 2,221
Change in short-term investments, net (16,375) 1,018
-------- --------
Net cash used in investing activities (27,649) (47,124)
-------- --------
Financing activities:
Proceeds from sales of Class A shares through employee stock
plans and other plans 33,960 6,577
-------- --------
Net cash provided by financing activities 33,960 6,577
-------- --------
Translation adjustment 1,285 (3,547)
-------- --------
Decrease in cash and cash equivalents (22,589) (41,809)
Beginning cash and cash equivalents 419,812 246,265
-------- --------
Ending cash and cash equivalents 397,223 204,456
Short-term investments 62,971 92,488
-------- --------
Ending cash, cash equivalents and short-term investments $460,194 $296,944
======== ========
5
ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
(unaudited)
Three Months
Ended June 30,
2001 2000
---------------------------
Supplemental cash flow information:
- ----------------------------------
Cash paid during the year for income taxes $ 2,719 $ 3,641
======= =======
Non-cash investing activities:
- -----------------------------
Change in unrealized appreciation of investments and marketable
securities $(1,883) $(1,116)
======= =======
See accompanying notes to consolidated financial statements.
6
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Basis of Presentation
The condensed consolidated financial statements are unaudited and reflect all
adjustments (consisting only of normal recurring accruals) that, in the opinion
of management, are necessary for a fair presentation of the results for the
interim periods presented. The results of operations for the current interim
period are not necessarily indicative of results to be expected for the current
year or any other period. Certain amounts have been reclassified to conform to
the fiscal 2002 presentation.
These condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto included in the
Electronic Arts Inc. (the "Company") Annual Report on Form 10-K for the fiscal
year ended March 31, 2001 as filed with the Securities and Exchange Commission
("Commission") on June 29, 2001.
Note 2. Fiscal Year and Fiscal Quarter
The Company's fiscal year is reported on a 52/53-week period that ends on the
Saturday nearest to March 31 in each year. The results of operations for fiscal
2002 will contain 52 weeks. The results of operations for fiscal 2001 contained
53 weeks. Accordingly, the results of operations for the fiscal quarters ended
June 30, 2001 and 2000 contain 13 weeks and 14 weeks, respectively. For clarity
of presentation, all fiscal periods are treated as ending on a calendar month
end.
Note 3. Tracking Stock
On March 22, 2000, the shareholders of Electronic Arts authorized the issuance
of a new series of common stock, designated as Class B common stock ("Tracking
Stock"). The Tracking Stock is intended to reflect the performance of Electronic
Arts' online and e-Commerce division ("EA.com"). As a result of the approval of
the Tracking Stock Proposal, Electronic Arts' existing common stock has been re-
classified as Class A common stock and that stock reflects the performance of
Electronic Arts' other businesses ("EA Core").
Note 4. Common Stock
Stock Split
On August 14, 2000, the Company's Board of Directors authorized a two-for-one
stock split of its Class A common stock which was distributed on September 8,
2000 in the form of a stock dividend for shareholders of record at the close of
business on August 25, 2000. All authorized and outstanding share and per share
amounts of Class A common stock in the accompanying consolidated financial
statements for all periods have been restated to reflect the stock split.
7
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Class A Equity Incentive Plan
At the Company's Annual Meeting of Stockholders, held on August 1, 2001, the
stockholders elected to amend the 2000 Class A Equity Incentive Plan to increase
by 6,000,000 the number of shares of the Company's Class A common stock reserved
for issuance under the Plan.
Note 5. Prepaid Royalties
Prepaid royalties consist primarily of prepayments for manufacturing royalties,
original equipment manufacturer (OEM) fees and license fees paid to celebrities
and professional sports organizations for use of their trade name. Also
included in prepaid royalties are prepayments made to independent software
developers under development arrangements that have alternative future uses.
Prepaid royalties are expensed at the contractual or effective royalty rate as
cost of goods sold based on actual net product sales. Management evaluates the
future realization of prepaid royalties quarterly and charges to the Statement
of Operations any amounts that management deems unlikely to be realized through
product sales. Royalty advances are classified as current and non-current
assets based upon estimated net product sales for the following year. The
current portion of prepaid royalties, included in other current assets, was
$65,029,000 and $46,264,000 at June 30, 2001 and March 31, 2001, respectively.
The long-term portion of prepaid royalties, included in other assets, was
$17,150,000 and $9,664,000 at June 30, 2001 and March 31, 2001, respectively.
Note 6. Inventories
Inventories are stated at the lower of cost or market. Inventories at June 30,
2001 and March 31, 2001 consisted of (in thousands):
- --------------------------------------------------------------------------------
June 30, 2001 March 31, 2001
Raw materials and work in process $ 1,276 $ 976
Finished goods 14,744 14,710
- --------------------------------------------------------------------------------
$16,020 $15,686
- --------------------------------------------------------------------------------
8
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Note 7. Accrued and Other Liabilities
Accrued and other liabilities at June 30, 2001 and March 31, 2001 consisted of
(in thousands):
- --------------------------------------------------------------------------------
June 30, 2001 March 31, 2001
Accrued expenses $ 60,489 $ 67,957
Accrued compensation and benefits 51,496 75,603
Accrued royalties 48,966 55,997
Deferred revenue 14,964 16,967
Warranty reserve 7,972 8,070
Accrued income taxes 3,950 42,371
- --------------------------------------------------------------------------------
$187,837 $266,965
- --------------------------------------------------------------------------------
Note 8. Segment Information
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures About
Segments of An Enterprise And Related Information", establishes standards for
the reporting by public business enterprises of information about operating
segments, product lines, geographic areas and major customers. The method for
determining what information to report is based on the way that management
organizes the operating segments within the Company for making operational
decisions and assessments of financial performance.
The Company's chief operating decision maker is considered to be the Company's
Chief Executive Officer ("CEO"). The CEO reviews financial information presented
on a consolidated basis accompanied by disaggregated information about revenues
by geographic region and by product lines for purposes of making operating
decisions and assessing financial performance.
The Company operates in two principal business segments globally:
. EA Core business segment: creation, marketing and distribution of
entertainment software.
. EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online, ongoing
management of subscriptions of online games and website advertising.
Please see the discussion regarding segment reporting in the MD&A.
9
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Information about the Company's business segments is presented below for the
three months ended June 30, 2001 and 2000 (in thousands):
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ----------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $ 165,551 $ 16,399 $ - $ 181,950
Group sales 518 - (518) (a) -
- ----------------------------------------------------------------------------------------------------------------------------
Total net revenues 166,069 16,399 (518) 181,950
- ----------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 85,937 3,092 - 89,029
Group cost of goods sold - 518 (518) (a) -
- ----------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 85,937 3,610 (518) 89,029
- ----------------------------------------------------------------------------------------------------------------------------
Gross profit 80,132 12,789 - 92,921
Operating expenses:
Marketing and sales 30,831 5,507 4,466 (c) 40,804
General and administrative 20,267 2,948 - 23,215
Research and development 55,383 15,633 19,789 (b) 90,805
Network development and support - 16,875 (16,875) (b) -
Customer relationship management - 2,914 (2,914) (b) -
Carriage fee - 4,466 (4,466) (c) -
Amortization of intangibles 3,205 3,270 - 6,475
- ----------------------------------------------------------------------------------------------------------------------------
Total operating expenses 109,686 51,613 - 161,299
- ----------------------------------------------------------------------------------------------------------------------------
Operating loss (29,554) (38,824) - (68,378)
Interest and other income (expense), net 3,089 (372) - 2,717
- ----------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (26,465) (39,196) - (65,661)
Benefit from income taxes (20,355) - - (20,355)
- ----------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (6,110) (39,196) - (45,306)
Minority interest in consolidated joint
venture 52 - - 52
- ----------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $ (6,058) $(39,196) $ - $ (45,254)
============================================================================================================================
Interest income $ 5,168 $ 19 $ - $ 5,187
Depreciation and amortization 11,463 11,426 - 22,889
Identifiable assets 1,083,923 205,055 - 1,288,978
Capital expenditures 7,833 7,197 - 15,030
10
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- ----------------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $146,046 $ 8,753 $ - $ 154,799
Group sales 360 - (360) (a) -
- ----------------------------------------------------------------------------------------------------------------------------
Total net revenues 146,406 8,753 (360) 154,799
- ----------------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 76,499 1,453 - 77,952
Group cost of goods sold - 360 (360) (a) -
- ----------------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 76,499 1,813 (360) 77,952
- ----------------------------------------------------------------------------------------------------------------------------
Gross profit 69,907 6,940 - 76,847
Operating expenses:
Marketing and sales 33,260 1,933 - 35,193
General and administrative 19,747 2,462 - 22,209
Research and development 53,659 16,492 9,017 (b) 79,168
Network development and support - 7,438 (7,438) (b) -
Customer relationship management - 1,579 (1,579) (b) -
Amortization of intangibles 3,240 1,414 - 4,654
- ----------------------------------------------------------------------------------------------------------------------------
Total operating expenses 109,906 31,318 - 141,224
- ----------------------------------------------------------------------------------------------------------------------------
Operating loss (39,999) (24,378) - (64,377)
Interest and other income (expense), net 3,841 (5) - 3,836
- ----------------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (36,158) (24,383) - (60,541)
Benefit from income taxes (18,768) - - (18,768)
- ----------------------------------------------------------------------------------------------------------------------------
Loss before minority interest (17,390) (24,383) - (41,773)
Minority interest in consolidated joint
venture (498) - - (498)
- ----------------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(17,888) $(24,383) $ - $ (42,271)
============================================================================================================================
Interest income $ 4,317 $ 28 $ - $ 4,345
Depreciation and amortization 10,164 4,860 - 15,024
Identifiable assets 892,731 144,263 - 1,036,994
Capital expenditures 14,130 36,538 - 50,668
(a) Represents elimination of intercompany sales of EA Core packaged goods
products to EA.com, and represents elimination of royalties paid to EA
Core by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support and
Customer Relationship Management to Research and Development.
(c) Represents reclassification of amortization of the Carriage Fee to
Marketing and Sales.
11
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Information about the Company's operations in the North America and foreign
areas for the three months ended June 30, 2001 and 2000 is presented below:
- ---------------------------------------------------------------------------------------------------------------------
(In thousands) Asia
Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
----------------------------------------------------------------------------------
Three months ended June 30, 2001
- --------------------------------
Net revenues from unaffiliated
customers $103,062 $ 59,812 $10,051 $ 9,025 $ - $ 181,950
Intercompany revenues 1,515 4,552 1,373 (176) (7,264) -
----------------------------------------------------------------------------------
Total net revenues 104,577 64,364 11,424 8,849 (7,264) 181,950
----------------------------------------------------------------------------------
Operating income (loss) (65,718) (3,640) 4 160 816 (68,378)
Interest income 4,583 536 68 - - 5,187
Depreciation and amortization 19,815 2,760 166 148 - 22,889
Identifiable assets 971,686 277,142 20,883 19,267 - 1,288,978
Capital expenditures 13,523 1,053 152 302 - 15,030
Long-lived assets 351,942 155,718 4,094 4,154 - 515,908
Three months ended June 30, 2000
- --------------------------------
Net revenues from unaffiliated
customers $ 71,756 $ 51,894 $12,112 $19,037 $ - $ 154,799
Intercompany revenues 3,976 4,481 4,018 - (12,475) -
----------------------------------------------------------------------------------
Total net revenues 75,732 56,375 16,130 19,037 (12,475) 154,799
----------------------------------------------------------------------------------
Operating income (loss) (46,500) (22,869) 1,417 2,597 978 (64,377)
Interest income 3,134 1,106 105 - - 4,345
Depreciation and amortization 12,470 2,249 138 167 - 15,024
Identifiable assets 669,655 316,441 25,532 25,366 - 1,036,994
Capital expenditures 41,793 8,425 376 74 - 50,668
Long-lived assets 285,386 154,849 3,928 4,111 - 448,274
- ---------------------------------------------------------------------------------------------------------------------
Information about the Company's net revenues by product line for the three
months ended June 30, 2001 and 2000 is presented below:
- ----------------------------------------------------------------
(In thousands) Three Months Ended
June 30,
2001 2000
- ----------------------------------------------------------------
PC $ 70,074 $ 70,357
PlayStation 2 50,519 10,281
PlayStation 14,042 29,501
Online Subscriptions 7,956 8,311
Advertising 7,661 -
License, OEM and Other 4,290 3,424
N64 2,402 606
Affiliated label 25,006 32,319
- ----------------------------------------------------------------
$181,950 $154,799
- ----------------------------------------------------------------
12
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Note 9. Comprehensive Loss
The components of comprehensive loss, net of tax, for the three months ended
June 30, 2001 and 2000 were as follows (in thousands):
- --------------------------------------------------------------------------------
Three Months Ended
June 30,
2001 2000
- --------------------------------------------------------------------------------
Net loss $(45,254) $(42,271)
- --------------------------------------------------------------------------------
Other comprehensive income (loss):
Change in unrealized depreciation of
investments, net of tax benefit of $(584) and
$(346) (1,299) (770)
Foreign currency translation adjustments 1,468 (3,570)
- --------------------------------------------------------------------------------
Total other comprehensive income (loss) 169 (4,340)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Total comprehensive loss $(45,085) $(46,611)
- --------------------------------------------------------------------------------
The currency translation adjustments are not adjusted for income taxes as they
relate to indefinite investments in non-U.S. subsidiaries.
Note 10. Net Loss Per Share
The following summarizes the computations of Basic Earnings Per Share ("EPS")
and Diluted EPS. Basic EPS is computed as net earnings divided by the weighted-
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur from common shares issuable through
stock-based compensation plans including stock options, restricted stock awards,
warrants and other convertible securities using the treasury stock method.
Net loss per share is computed individually for Class A common stock and Class B
common stock. Please see the discussion regarding segment reporting in the MD&A.
13
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
(in thousands, except per share amounts):
- ----------------------------------------------------------------------------------------------------
Three months ended June 30, 2001
Class A common Class A common Class B
stock-Basic stock-Diluted common stock
- ----------------------------------------------------------------------------------------------------
Net loss before retained
interest in EA.com $ (6,058) $(45,254) $(39,196)
Net loss related to retained interest
in EA.com (33,317) - 33,317
- ----------------------------------------------------------------------------------------------------
Net loss $(39,375) $(45,254) $ (5,879)
- ----------------------------------------------------------------------------------------------------
Shares used to compute net
loss per share:
Weighted-average common shares 135,730 135,730 6,020
Dilutive stock equivalents - 652 -
- ----------------------------------------------------------------------------------------------------
Dilutive potential common shares 135,730 136,382 6,020
====================================================================================================
Net loss per share:
Basic $(0.29) N/A $(0.98)
Diluted N/A $(0.33) $(0.98)
- ----------------------------------------------------------------------------------------------------
(in thousands, except per share amounts):
- ----------------------------------------------------------------------------------------------------
Three months ended June 30, 2000
Class A common Class A common Class B
stock-Basic stock-Diluted common stock
- ----------------------------------------------------------------------------------------------------
Net loss before retained
interest in EA.com $(17,888) $(42,271) $(24,383)
Net loss related to retained interest
in EA.com (20,726) - 20,726
- ----------------------------------------------------------------------------------------------------
Net loss $(38,614) $(42,271) $ (3,657)
- ----------------------------------------------------------------------------------------------------
Shares used to compute net
loss per share:
Weighted-average common shares 129,135 129,135 6,000
Dilutive stock equivalents - 652 -
- ----------------------------------------------------------------------------------------------------
Dilutive potential common shares 129,135 129,787 6,000
====================================================================================================
- ----------------------------------------------------------------------------------------------------
Net loss per share:
Basic $(0.30) N/A $(0.61)
Diluted N/A $(0.33) $(0.61)
- ----------------------------------------------------------------------------------------------------
The Diluted EPS calculation for Class A common stock, presented above, includes
the potential dilution from the conversion of Class B common stock to Class A
common stock in the event that the initial public offering for Class B common
stock does not occur. Net loss
14
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
used for the calculation of Diluted EPS for Class A common stock was $45,254,000
and $42,271,000 for the three months ended June 30, 2001 and 2000, respectively.
This net loss includes the remaining 15% interest in EA.com, which is directly
attributable to outstanding Class B shares owned by third parties, which would
be included in the Class A common stock EPS calculation in the event that the
initial public offering for Class B common stock does not occur.
Due to the net loss attributable for the three months ended June 30, 2001 and
2000 on a diluted basis to Class A Stockholders, stock options have been
excluded from the Diluted EPS calculation as their inclusion would have been
antidilutive. Had net income been reported for these periods, an additional
6,115,000 and 4,991,000 shares would have been added to diluted potential common
shares for Class A common stock for the three months ended June 30, 2001 and
2000, respectively.
Due to the net loss attributable for the three months ended June 30, 2001 and
2000 on a diluted basis to Class B Stockholders, stock options have been
excluded from the Diluted EPS calculation as their inclusion would have been
antidilutive. Had net income been reported for the three months ended June 30,
2001, an additional 932,000 shares would have been added to diluted potential
common shares for Class B common stock. For the three months ended June 30,
2000, no additional shares would have been added to diluted potential common
shares for Class B common stock.
15
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
Note 11. Impact of Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133
"Accounting for Derivative Instruments and Hedging Activities", as amended by
SFAS 137 "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of FASB
Statement No. 133" and SFAS 138 "Accounting for Certain Derivative Instruments
and Certain Hedging Activities - an Amendment of FASB Statement No. 133" which
establishes accounting and reporting standards for derivative instruments and
hedging activities. The terms of SFAS 133 and SFAS 138 are effective as of the
beginning of the first quarter of the fiscal year beginning after June 15, 2000.
SFAS 133, as amended, requires that all derivative instruments be recorded on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company utilizes fair value
foreign exchange contracts to hedge foreign currency exposures of underlying
assets and liabilities, primarily certain intercompany receivables that are
denominated in foreign currencies. The Company adopted SFAS 133 on April 1,
2001. The adoption of SFAS 133 did not have a material impact on the Company's
consolidated financial position or results of operations.
In April 2001, the Emerging Issues Task Force issued No. 00-25 ("EITF 00-25"),
"Accounting for Consideration from a Vendor to a Retailer in Connection with the
Purchase or Promotion of the Vendor's Products", which states that consideration
from a vendor to a reseller of the vendor's products is presumed to be a
reduction of the selling prices of the vendor's products and, therefore, should
be characterized as a reduction of revenue when recognized in the vendor's
income statement. That presumption is overcome and the consideration can be
categorized as a cost incurred if, and to the extent that, a benefit is or will
be received from the recipient of the consideration. That benefit must meet
certain conditions described in EITF 00-25. The consensus should be applied no
later than in annual or interim financial statements for periods beginning after
December 15, 2001. The Company is currently evaluating the impact of this
consensus on its Statements of Operations.
In June 2001, the FASB issued SFAS 141 "Business Combinations", which addresses
financial accounting and reporting for business combinations and supersedes
Accounting Principles Board Opinion No. 16 ("APB 16"), "Business Combinations",
and SFAS 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises". All business combinations in the scope of SFAS 141 are to be
accounted for using one method, the purchase method. This Statement requires
that intangible assets be recognized as assets apart from goodwill if they meet
one of two criteria--the contractual-legal criterion or the separability
criterion. SFAS 141 also requires disclosure of the primary reasons for a
business combination and the allocation of the purchase price paid to the assets
acquired and liabilities assumed by major balance sheet caption. This Statement
does not change many of the provisions of APB 16 and SFAS 38 related to the
application of the
16
ELECTRONIC ARTS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(continued)
purchase method. Also, SFAS 141 does not change the requirement to write off
certain research and development assets acquired in a business combination as
required by FASB Interpretation No. 4, "Applicability of FASB Statement No. 2 to
Business Combinations Accounted for by the Purchase Method". The provisions of
SFAS 141 apply to all business combinations initiated after June 30, 2001 and
applies to all business combinations accounted for using the purchase method for
which the date of acquisition is July 1, 2001, or later.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets",
which supersedes APB 17, "Intangible Assets". SFAS 142 addresses the accounting
treatment for goodwill and other intangible assets acquired individually or with
a group of other assets upon their acquisition, but not acquired in a business
combination. This statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. With the adoption of SFAS 142, goodwill is no longer
subject to amortization over its estimated useful life; rather, goodwill will be
subject to at least an annual assessment for impairment by applying a fair-
value-based test. However, equity-method goodwill is not subject to the new
impairment rules. Also, if the benefit of an intangible asset is obtained
through contractual or other legal rights, or if the intangible asset can be
sold, transferred, licensed, rented or exchanged, an acquired intangible asset
should be separately recognized. The terms of SFAS 142 are effective as of the
beginning of the first quarter of the fiscal year beginning after December 15,
2001. Certain provisions of SFAS 142 shall be applied to goodwill and other
acquired intangible assets for which the acquisition date is after June 30,
2001. The Company is currently determining the effect of SFAS 142 on its
financial statements.
17
ITEM 2: Management's Discussion and Analysis Of Financial Condition and Results
Of Operations
This Quarterly Report, on Form 10-Q and, in particular, the following
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contains forward-looking statements about circumstances that have
not yet occurred. All statements, trend analysis and other information contained
below relating to markets, our products and trends in revenue, as well as other
statements including words such as "anticipate", "believe" or "expect" and
statements in the future tense are forward-looking statements. These forward-
looking statements are subject to business and economic risks and actual events
or our actual future results could differ materially from those set forth in the
forward-looking statements due to such risks and uncertainties. We will not
necessarily update information if any forward-looking statement later turns out
to be inaccurate. Risks and uncertainties that may affect our future results and
performance include, but are not limited to, those discussed under the heading
"Risk Factors" at pages 30 to 37, as well as in our Annual Report on Form 10-K
for the fiscal year ended March 31, 2001 as filed with the Securities and
Exchange Commission on June 29, 2001 and other documents filed with the
Commission.
We derive revenues primarily from shipments of entertainment software, which
includes EA Studio products for dedicated entertainment systems (that we call
video game systems or consoles such as PlayStation, PlayStation 2 and Nintendo
64), EA Studio personal computer products (or PC), Co-Publishing products that
are co-published and distributed by us, and Affiliated Label (or AL) products
that are published by third parties and distributed by us. We also derive
revenues from licensing of EA Studio products and AL products through hardware
companies (or OEM), selling subscriptions on our online gaming service, selling
advertisements on our online web pages and selling our packaged goods through
our online store.
Information about our net revenues for North America and foreign areas for the
three months ended June 30, 2001 and 2000 is summarized below (in thousands):
June 30, June 30, Increase/
2001 2000 (Decrease) % change
- -----------------------------------------------------------------------------
North America $103,062 $ 71,756 $ 31,306 43.6%
- -----------------------------------------------------------------------------
Europe 59,812 51,894 7,918 15.3%
Asia Pacific 10,051 12,112 (2,061) (17.0%)
Japan 9,025 19,037 (10,012) (52.6%)
- -----------------------------------------------------------------------------
International 78,888 83,043 (4,155) (5.0%)
- -----------------------------------------------------------------------------
Consolidated Net Revenues $181,950 $154,799 $ 27,151 17.5%
=============================================================================
North America Net Revenues
The increase in North America net revenues for the three months ended June 30,
2001 compared to the same period last year was primarily attributable to:
. PlayStation 2 revenues of $35,754,000 for the quarter from titles such as
NBA Street, Rumble Racing, Madden NFL 2001 and Tiger Woods PGA Tour 2001.
18
. Advertising revenues of $7,661,000 were generated for the quarter. We
commenced generating advertising revenues immediately following the launch of
our gamesite on the world wide web in October 2000. In addition, advertising
revenues were generated from Pogo Corporation's ("Pogo") websites subsequent
to the February 2001 acquisition.
. These increases were partially offset by a decrease in AL revenues
primarily due to the strong shipment of titles published by Square EA in the
prior year.
International Net Revenues
The decrease in international net revenues for the three months ended June 30,
2001 compared to the three months ended June 30, 2000 was attributable to the
following:
. Japan's net revenues decreased 53% compared to the prior year primarily due
to no new products shipping in the quarter and the strong sales of our first
PlayStation 2 title FIFA Soccer World Championship in the prior year, as well
as a significant decrease in PlayStation revenues due to the console
transition, no new products for the PlayStation and weakness in the Yen
currency. Japan did not benefit from our primary PlayStation 2 release during
the quarter, NBA Street, which did not ship in their market.
. Asia Pacific's net revenues decreased as PlayStation 2 revenues did not
offset the decline in PlayStation revenues. Asia Pacific did not benefit from
our primary PlayStation 2 release during the quarter, NBA Street, which did
not ship in their market. In addition, revenues were negatively affected by
exchange rate differences relative to the dollar.
. Offset by Europe's increase in net revenue by 15% primarily due to
PlayStation 2 sales and higher AL sales partially offset by the expected
decrease of revenues from PlayStation.
Information about our worldwide net revenues by product line for the three
months ended June 30, 2001 and 2000 is presented below (in thousands):
June 30, June 30, Increase/
2001 2000 (Decrease) % change
---------------------------------------------------
EA Studio:
- ----------
PC $ 70,074 $ 70,357 $ (283) (0.4%)
PlayStation 2 50,519 10,281 40,238 391.4%
PlayStation 14,042 29,501 (15,459) (52.4%)
Online Subscriptions 7,956 8,311 (355) (4.3%)
Advertising 7,661 - 7,661 N/A
N64 2,402 606 1,796 296.4%
License, OEM and Other 4,290 3,424 866 25.3%
---------------------------------------------------
156,944 122,480 34,464 28.1%
Affiliated Label: 25,006 32,319 (7,313) (22.6%)
- ----------------- ---------------------------------------------------
Consolidated Net Revenues $181,950 $154,799 $ 27,151 17.5%
===================================================
Personal Computer Product Net Revenues
PC sales in the quarter were relatively flat compared to the same quarter last
year. The release of Emperor: Battle for Dune in addition to the strong
catalogue sales of Black & White and The Sims: House Party compared to strong
sales of The Sims, Euro 2000, SimCity 3000 Unlimited and Shogun: Total War in
the prior year. In addition, we released one PC title in the first quarter of
the current fiscal year compared to four PC titles for the same period last
year.
19
Due to the sales of The Sims in fiscal 2001, we expect revenues from PC products
to be flat or lower in fiscal 2002.
PlayStation 2 Product Net Revenues
We released two titles in North America and Europe in the first quarter of
fiscal 2002 compared to one title released only in Japan for the same period
last year for the PlayStation 2. Releases for the quarter were NBA Street and
Rumble Racing. Revenues increased due to the higher number of new and
catalogue titles shipping worldwide in the current quarter compared to the one
title shipping in Japan in the same period last year. We expect revenues from
PlayStation 2 products to continue to grow in fiscal 2002.
PlayStation Product Net Revenues
We did not release any titles for the PlayStation console during the first
quarter of fiscal 2002 compared to one title released in the first quarter of
fiscal 2001. The expected decrease in PlayStation product sales was attributable
to no new titles released during the first quarter of the current year as
compared to one title shipped in the same period last year and general
PlayStation market decline as this platform is replaced by the PlayStation 2.
Sony released the PlayStation 2 worldwide in the prior year. Although our
PlayStation products are playable on the PlayStation 2 console, we expect sales
of current PlayStation products to continue to decline significantly in fiscal
2002. We expect to ship significantly fewer products for the PlayStation than
in the prior year.
Under the terms of a licensing agreement entered into with Sony Computer
Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are
authorized to develop and distribute CD-based software products compatible with
the PlayStation. Furthermore, under the terms of an additional licensing
agreement entered into with Sony Computer Entertainment of America as of April
2000 (the "PlayStation 2 Agreement"), as amended, we are authorized to develop
and distribute DVD-based software products compatible with the PlayStation 2.
Pursuant to these agreements, we engage Sony to supply its PlayStation and
PlayStation 2 CD's for distribution by us. Accordingly, we have limited ability
to control our supply of PlayStation and PlayStation 2 CD products or the timing
of their delivery.
Online Subscription Net Revenues
The slight decrease in online revenues for the three months ended June 30, 2001
as compared to the three months ended June 30, 2000 was attributable to the
following:
. A decrease for Kesmai and Worldplay online games. Revenues associated
with these services declined as the majority of the products have been
converted into our advertising-supported free offerings, incorporated
into our bundled subscription offerings, or gradually shut-down.
. Offset by an increase of online subscription revenues primarily from
Ultima Online and other products. At the end of the quarter, there were
approximately 210,000 subscribers to Ultima Online compared to
approximately 160,000 subscribers in the prior year.
20
Advertising Revenues
We commenced generating advertising revenues in the third quarter of the prior
fiscal year following the launch of our gamesite on the world wide web in
October 2000. We also generated advertising revenues from Pogo's websites
subsequent to the February 2001 acquisition.
Nintendo 64 Product Net Revenues
The increase in N64 revenues for the three months ended June 30, 2001 compared
to the same period last year was primarily due to the strong catalogue sales of
The World Is Not Enough. Although revenues increased in the current quarter
compared to the same period in the prior year, we expect revenues from N64
products to decline significantly in fiscal 2002.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64
cartridges for distribution by us. Accordingly, we have little ability to
control our supply of N64 cartridges or the timing of their delivery. A
shortage of microchips or other factors outside our control could impair our
ability to obtain an adequate supply of cartridges.
License, OEM and Other Revenues
The increase in license, OEM and other revenues was primarily a result of higher
revenues from sales of cluebooks.
Affiliated Label Product Net Revenues
AL product sales decreased during the current quarter compared to the same
period last year due to lower sales in North America partially offset by higher
sales in Europe. This decrease was mainly due to a decrease in revenues
generated from the distribution of titles by Square EA and fewer titles released
in the current year as compared to the same period last year.
Operations by Segment
The series of common stock designated as Class B (see Note 3) was approved to
reflect the performance of EA.com. Accordingly, management considers EA.com to
be a separate reportable segment. We operate in two principal business segments
globally:
. Electronic Arts Core ("EA Core") business segment: creation, marketing
and distribution of entertainment software.
. EA.com business segment: creation, marketing and distribution of
entertainment software which can be played or sold online, ongoing
management of subscriptions of online games and website advertising.
EA.com, a division of Electronic Arts Inc., represents Electronic Arts' online
and e-Commerce businesses. EA.com's business includes subscription revenues
collected for Internet game play on our websites, website advertising, sales of
packaged goods for Internet-only based games and sales of Electronic Arts games
sold through the EA.com web store. The Consolidated Statements of Operations
includes all revenues and costs directly attributable to EA.com, including
charges for shared facilities, functions and services used by EA.com and
provided by EA Core. Certain costs and expenses have been allocated based on
management's estimates of the cost of services provided to EA.com by EA Core.
21
Information about our operations by segment for the three months ended June 30,
2001 and 2000 is presented below (in thousands):
- --------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- --------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $165,551 $ 16,399 $ - $181,950
Group sales 518 - (518) (a) -
- --------------------------------------------------------------------------------------------------------------------
Total net revenues 166,069 16,399 (518) 181,950
- --------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 85,937 3,092 - 89,029
Group cost of goods sold - 518 (518) (a) -
- --------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 85,937 3,610 (518) 89,029
- --------------------------------------------------------------------------------------------------------------------
Gross profit 80,132 12,789 - 92,921
Operating expenses:
Marketing and sales 30,831 5,507 4,466 (c) 40,804
General and administrative 20,267 2,948 - 23,215
Research and development 55,383 15,633 19,789 (b) 90,805
Network development and support - 16,875 (16,875) (b) -
Customer relationship management - 2,914 (2,914) (b) -
Carriage fee - 4,466 (4,466) (c) -
Amortization of intangibles 3,205 3,270 - 6,475
- --------------------------------------------------------------------------------------------------------------------
Total operating expenses 109,686 51,613 - 161,299
- --------------------------------------------------------------------------------------------------------------------
Operating loss (29,554) (38,824) - (68,378)
Interest and other income (expense), net 3,089 (372) - 2,717
- --------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (26,465) (39,196) - (65,661)
Benefit from income taxes (20,355) - - (20,355)
- --------------------------------------------------------------------------------------------------------------------
Loss before minority interest (6,110) (39,196) - (45,306)
Minority interest in consolidated joint venture 52 - - 52
- --------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $ (6,058) $(39,196) $ - $(45,254)
====================================================================================================================
Allocation of retained interest (in thousands):
- -----------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- -----------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $ (6,058) $(39,196) $ - $(45,254)
Net loss related to retained interest in EA.com (33,317) 33,317 - -
- -----------------------------------------------------------------------------------------------------------------------
Net loss $(39,375) $ (5,879) $ - $(45,254)
=======================================================================================================================
22
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- -------------------------------------------------------------------------------------------------------------------
Net revenues from unaffiliated customers $146,046 $ 8,753 $ - $154,799
Group sales 360 - (360) (a) -
- -------------------------------------------------------------------------------------------------------------------
Total net revenues 146,406 8,753 (360) 154,799
- -------------------------------------------------------------------------------------------------------------------
Cost of goods sold from unaffiliated customers 76,499 1,453 - 77,952
Group cost of goods sold - 360 (360) (a) -
- -------------------------------------------------------------------------------------------------------------------
Total cost of goods sold 76,499 1,813 (360) 77,952
- -------------------------------------------------------------------------------------------------------------------
Gross profit 69,907 6,940 - 76,847
Operating expenses:
Marketing and sales 33,260 1,933 - 35,193
General and administrative 19,747 2,462 - 22,209
Research and development 53,659 16,492 9,017 (b) 79,168
Network development and support - 7,438 (7,438) (b) -
Customer relationship management - 1,579 (1,579) (b) -
Amortization of intangibles 3,240 1,414 - 4,654
- -------------------------------------------------------------------------------------------------------------------
Total operating expenses 109,906 31,318 - 141,224
- -------------------------------------------------------------------------------------------------------------------
Operating loss (39,999) (24,378) - (64,377)
Interest and other income (expense), net 3,841 (5) - 3,836
- -------------------------------------------------------------------------------------------------------------------
Loss before benefit from income
taxes and minority interest (36,158) (24,383) - (60,541)
Benefit from income taxes (18,768) - - (18,768)
- -------------------------------------------------------------------------------------------------------------------
Loss before minority interest (17,390) (24,383) - (41,773)
Minority interest in consolidated joint venture (498) - - (498)
- -------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(17,888) $(24,383) $ - $(42,271)
===================================================================================================================
Allocation of retained interest (in thousands):
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- -------------------------------------------------------------------------------------------------------------------
Net loss before retained interest in EA.com $(17,888) $(24,383) $ - $(42,271)
Net loss related to retained interest in EA.com (20,726) 20,726 - -
- -------------------------------------------------------------------------------------------------------------------
Net loss $(38,614) $ (3,657) $ - $(42,271)
===================================================================================================================
(a) Represents elimination of intercompany sales of EA Core packaged goods
products to EA.com, and represents elimination of royalties paid to EA Core
by EA.com for intellectual property rights.
(b) Represents reclassification of Network Development and Support and Customer
Relationship Management to Research and Development.
(c) Represents reclassification of amortization of the Carriage Fee to Marketing
and Sales.
23
The following table presents pro-forma results of operations allocating taxes
between EA Core and EA.com. Consolidated taxes have been allocated to EA Core
and EA.com on a pro rata basis based on the consolidated effective tax rates,
thereby giving EA.com the tax benefit of its losses which is utilized by the
consolidated group. Such tax benefit could not be recognized by EA.com on a
stand-alone basis. The sum of tax expense and tax benefit for EA Core and EA.com
is the same as consolidated tax expense and tax benefit. This presentation
represents how management analyzes each segment of the business (in thousands):
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2001
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- -------------------------------------------------------------------------------------------------------------------
Loss before benefit from income taxes and
minority interest $(26,465) $(39,196) $ - $(65,661)
Benefit from income taxes (8,204) (12,151) - (20,355)
- -------------------------------------------------------------------------------------------------------------------
Loss before minority interest (18,261) (27,045) - (45,306)
Minority interest in consolidated joint
venture 52 - - 52
- -------------------------------------------------------------------------------------------------------------------
Net loss $(18,209) $(27,045) $ - $(45,254)
===================================================================================================================
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2000
EA Core Adjustments and
(excl. EA.com) EA.com Eliminations Electronic Arts
- -------------------------------------------------------------------------------------------------------------------
Loss before benefit from income taxes and
minority interest $(36,158) $(24,383) $ - $(60,541)
Benefit from income taxes (11,209) (7,559) - (18,768)
- -------------------------------------------------------------------------------------------------------------------
Loss before minority interest (24,949) (16,824) - (41,773)
Minority interest in consolidated joint venture (498) - - (498)
- -------------------------------------------------------------------------------------------------------------------
Net loss $(25,447) $(16,824) $ - $(42,271)
===================================================================================================================
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Loss
- -----------------------------------------------------------------------------
for both EA Core and EA.com Segments
- ------------------------------------
Cost of Goods Sold. Cost of goods sold for our packaged goods business
consists of actual product costs, royalties expense for celebrities,
professional sports organizations and independent software developers,
manufacturing royalties, expense for defective products and operations expense.
Cost of goods sold for our subscription business consists primarily of data
center and bandwidth costs associated with hosting our websites, credit card
fees and royalties for use of EA and third party properties.
Marketing and Sales. Marketing and sales expenses consist of personnel related
costs, advertising and marketing and promotional expenses. In addition,
marketing and sales includes the amortization of the AOL carriage and revenue
share fees ("Carriage Fee"), which began with the launch of EA.com in October
2000. The Carriage Fee is being amortized straight line over the term of the
AOL agreement.
General and Administrative. General and administrative expenses consist of
personnel and related expenses of executive and administrative staff, fees for
professional services such as legal and accounting and allowances for bad debts.
24
Research and Development. Research and development expenses consist of
personnel related costs, consulting and equipment depreciation, and customer
relationship management expenses associated with Electronic Arts' product and
online games. EA.com has research and development expenses incurred by
Electronic Arts' studios consisting of direct development costs and related
overhead costs (facilities, network and development management and supervision)
in connection with the development and production of EA.com online games.
Network Development and Support. Network development and support costs consist
of expenses associated with development of web content, depreciation on server
equipment to support online games, network infrastructure direct expenses and
depreciation, software licenses and maintenance, and network and management
overhead.
Cost of Goods Sold. Cost of goods sold as a percentage of revenues decreased to
49% for the three months ended June 30, 2001 as compared to 50% for the three
months ended June 30, 2000 due to:
. An increase, as a percentage of revenues, of higher margin PlayStation 2
products as compared to the prior year.
. High margin advertising revenues for the three months ended June 30, 2001.
. Offset by lower revenues and margins on the PlayStation products.
. Offset by lower margins on PC products compared to the prior year due to
high royalties on key products such as Black & White.
Marketing and Sales. Marketing and sales expenses increased in absolute dollars
by 16% primarily attributed to:
. Higher EA.com marketing and sales expenses due to increased staff required
to support the live game sites, increased advertising campaigns promoting the
Games Channel, and increased marketing and sales related headcount and
expenditures associated with Pogo.
. The amortization of the AOL carriage fee which began with the launch of
EA.com in October 2000.
. Offset by lower advertising in Japan and Europe, due to large programs in
the prior year for FIFA Soccer World Championship and Euro 2000.
General and Administrative. General and administrative expenses increased in
absolute dollars by 5% primarily due to:
. Additional staff and administrative related costs associated with the
acquisition of Pogo in February 2001.
. An increase in the bad debt provision due to higher revenues in the current
quarter compared to the same period last year.
Research and Development (excluding Network Development and Support and Customer
Relationship Management). The increase in absolute dollars by 1% for research
and development expenses (excluding network development and support and customer
relationship management) was due to a slight increase in development spending
for next generation console products including development for the PlayStation
2, Xbox and Nintendo Gamecube,
25
offset by a slight decrease in write-offs of royalty advances as compared to the
same period in the prior fiscal year.
Network Development and Support. Network development and support expenses
increased in absolute dollars by 127% due to:
. Increased spending on our network infrastructure to support the growth of
our live game sites.
. Increased headcount and network-related costs associated with Pogo.
. Depreciation of capitalized costs associated with the pre-launch network
infrastructure build.
. Immediate expense recognition of network infrastructure costs compared to the
capitalization of costs prior to the EA.com gamesite launch in October 2000
as required under Statement of Position 98-1.
Customer Relationship Management. Customer relationship management expenses
increased 85% due to the increased headcount to support the growth in the Ultima
Online subscriber base and the increase in the number of free games and
subscription offerings.
Amortization of Intangibles. The amortization of intangibles results primarily
from the acquisitions of Westwood, Pogo, Kesmai, Dreamworks, ABC Software and
other acquisitions. Amortization of intangibles was $3,205,000 for EA Core and
$3,270,000 for EA.com for the three months ended June 30, 2001. The increase in
the current quarter was due to the acquisition of Pogo.
Interest and Other Income, Net. Interest and other income, net, decreased in
absolute dollars primarily due to a write-off of an investment in an affiliate
in the current quarter.
Income Taxes. Our effective tax rate was 31% for the three months ended June 30,
2001 and 2000.
Net Loss. In absolute dollars, reported net loss increased primarily related to
higher costs and expenses compared to the same period last year. The increase in
expenses was due to the development of next generation console products in the
Core business and the investment in EA.com, including higher network development
and support costs for new online products and our game site and the Games
Channel on the AOL service.
Excluding goodwill and non-cash charges in the amount of $4,949,000, net of
taxes, in the current quarter, net loss would have been $40,305,000. Excluding
goodwill and non-cash charges in the amount of $3,598,000, net of taxes in the
prior year, net loss would have been $38,673,000.
26
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2001, our working capital was $486,601,000 compared to
$478,701,000 at March 31, 2001. Cash, cash equivalents and short-term
investments decreased by approximately $6,298,000 during the three months ended
June 30, 2001. We used $30,185,000 of cash from operations, $15,030,000 of cash
in capital expenditures, offset by $33,960,000 of cash generated through the
sale of equity securities under our stock plans during the three months ended
June 30, 2001.
Reserves for bad debts and sales returns decreased from $89,833,000 at March
31, 2001 to $84,596,000 at June 30, 2001. Reserves have been charged for returns
of product and price protection credits issued for products sold in prior
periods. Management believes these reserves are adequate based on historical
experience and its current estimate of potential returns and allowances.
Our principal source of liquidity is $460,194,000 in cash, cash equivalents
and short-term investments and $8,768,000 in marketable securities. Management
believes the existing cash, cash equivalents, short-term investments, marketable
securities and cash generated from operations will be sufficient to meet cash
and investment requirements on both a short-term and long-term basis.
Included in the amounts above is the following for the EA.com business:
. With the exception of the proceeds from the sale of stock and warrant to AOL
in fiscal 2000 in the amount of $20,000,000, to date, EA.com has been funded
solely by Electronic Arts. This funding has been accounted for as capital
contributions from Electronic Arts. Excess cash generated from operations is
transferred to Electronic Arts, and has been accounted for as a return of
capital. We anticipate these funding procedures will continue in the near-
term. However, Electronic Arts may, at its discretion, provide funds to
EA.com under a debt arrangement, instead of treating such funding as a
capital contribution.
. During the three months ended June 30, 2001, EA.com used $28,670,000 of cash
in operations, $7,197,000 in capital expenditures for computer equipment,
network infrastructure, internal use software and related third party
software, offset by $36,349,000 provided through the capital contributions
from Electronic Arts. As a result of the net operating loss generated, we
realized a tax benefit of approximately $12,151,000.
. During the three months ended June 30, 2000, EA.com used $33,942,000 of cash
in operations, $36,538,000 in capital expenditures for computer equipment,
network infrastructure and related software (including $15,243,000 of
consulting hardware, software and direct payroll and payroll-related costs
associated with the implementation of customized internal-use software),
offset by $68,543,000 provided through the capital contributions from
Electronic Arts. As a result of the net operating loss generated, we realized
a tax benefit of approximately $7,559,000.
27
Under the AOL agreement entered into in November 1999, EA.com is required to
pay $50,000,000 to AOL as a carriage fee and $31,000,000 as a minimum guaranteed
revenue share for revenues generated by subscriptions and other certain
commercial transactions on the EA.com site. Of these amounts, $25,000,000 in
carriage fee and $11,000,000 in revenue share were paid upon signing the
agreement with the remainder of the respective items due in four equal annual
installments beginning with the first anniversary of the initial payments.
EA.com paid AOL the first annual carriage payment of $6,250,000 and the first
annual revenue share payment of $5,000,000 in fiscal 2001. No payments were
made to AOL in the three months ended June 20, 2001.
EA.com also made a commitment to spend $15,000,000 in offline media
advertisements promoting our online games, including those on the AOL service,
during the term of the AOL agreement.
Future liquidity needs of EA.com will be met by Electronic Arts as Electronic
Arts intends to continue to fund the cash requirements of EA.com for the
foreseeable future.
Impact of Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS 137
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No.
133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB Statement No. 133" which establishes
accounting and reporting standards for derivative instruments and hedging
activities. The terms of SFAS 133 and SFAS 138 are effective as of the
beginning of the first quarter of the fiscal year beginning after June 15, 2000.
SFAS 133, as amended, requires that all derivative instruments be recorded on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company utilizes fair value
foreign exchange contracts to hedge foreign currency exposures of underlying
assets and liabilities, primarily certain intercompany receivables that are
denominated in foreign currencies. The Company adopted SFAS 133 on April 1,
2001. The adoption of SFAS 133 did not have a material impact on the Company's
consolidated financial position or results of operations.
In April 2001, the Emerging Issues Task Force issued No. 00-25 ("EITF 00-25"),
"Accounting for Consideration from a Vendor to a Retailer in Connection with the
Purchase or Promotion of the Vendor's Products", which states that consideration
from a vendor to a reseller of the vendor's products is presumed to be a
reduction of the selling prices of the vendor's products and, therefore, should
be characterized as a reduction of revenue when recognized in the vendor's
income statement. That presumption is overcome and the consideration can be
categorized as a cost incurred if, and to the extent that, a benefit is or will
be received from the recipient of the consideration. That benefit must meet
certain conditions described in EITF 00-25. The consensus should be applied no
later than in annual or interim financial statements for periods beginning after
December 15, 2001. The Company is currently evaluating the impact of this
consensus on its Statements of Operations.
28
In June 2001, the FASB issued SFAS 141 "Business Combinations", which addresses
financial accounting and reporting for business combinations and supersedes
Accounting Principles Board Opinion No. 16 ("APB 16"), "Business Combinations",
and SFAS 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises". All business combinations in the scope of SFAS 141 are to be
accounted for using one method, the purchase method. This Statement requires
that intangible assets be recognized as assets apart from goodwill if they meet
one of two criteria--the contractual-legal criterion or the separability
criterion. SFAS 141 also requires disclosure of the primary reasons for a
business combination and the allocation of the purchase price paid to the assets
acquired and liabilities assumed by major balance sheet caption. This Statement
does not change many of the provisions of APB 16 and SFAS 38 related to the
application of the purchase method. Also, SFAS 141 does not change the
requirement to write off certain research and development assets acquired in a
business combination as required by FASB Interpretation No. 4, "Applicability of
FASB Statement No. 2 to Business Combinations Accounted for by the Purchase
Method". The provisions of SFAS 141 apply to all business combinations initiated
after June 30, 2001 and applies to all business combinations accounted for using
the purchase method for which the date of acquisition is July 1, 2001, or later.
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets",
which supersedes APB 17, "Intangible Assets". SFAS 142 addresses the accounting
treatment for goodwill and other intangible assets acquired individually or with
a group of other assets upon their acquisition, but not acquired in a business
combination. This statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. With the adoption of SFAS 142, goodwill is no longer
subject to amortization over its estimated useful life; rather, goodwill will be
subject to at least an annual assessment for impairment by applying a fair-
value-based test. However, equity-method goodwill is not subject to the new
impairment rules. Also, if the benefit of an intangible asset is obtained
through contractual or other legal rights, or if the intangible asset can be
sold, transferred, licensed, rented or exchanged, an acquired intangible asset
should be separately recognized. The terms of SFAS 142 are effective as of the
beginning of the first quarter of the fiscal year beginning after December 15,
2001. Certain provisions of SFAS 142 shall be applied to goodwill and other
acquired intangible assets for which the acquisition date is after June 30,
2001. The Company is currently determining the effect of SFAS 142 on its
financial statements.
29
- --------------------------------------------------------------------------------
RISK FACTORS
Electronic Arts' business is subject to many risks and uncertainties which may
affect our future financial performance. Some of those important risks and
uncertainties which may cause our operating results to vary or which may
materially and adversely affect our operating results are as follows:
Risk Factors Relating to Our Core Business
Platform Transitions Such as the One Now Occurring Typically Depress the Market
for Video Game Software Until New Platforms Achieve a Wide Market Acceptance
When new video game platforms are announced or introduced into the market,
consumers typically reduce their purchases of video games for current platforms
in anticipation of new platforms being available. During that period, sales of
our video game products can be expected to slow or even decline until new
platforms have achieved a wide market and consumer acceptance. We are currently
in such a transition. Sony shipped its PlayStation 2 product in Japan, North
America and Europe in calendar year 2000. Nintendo announced that its new
console system, Nintendo GameCube, will be released in calendar year 2001 in
Japan and North America and in calendar year 2002 in Europe. Microsoft announced
that its new console system, Xbox, will be initially released in calendar year
2001 in North America, followed by releases in Japan and Europe. Delays in the
launch or shortages of these platforms could also adversely affect our sales of
products for these platforms. Current sales of our products for the existing
PlayStation and Nintendo 64 platforms have been adversely affected (by the
pending introduction of new platforms). We expect this trend to continue until
one or more of these new consoles achieve a wide installed base of consumers.
New Video Game Platforms Create Additional Technical and Business Model
Uncertainties
Large portions of our revenues are derived from the sale of products for play
on proprietary video game platforms such as the Sony PlayStation. The success of
our products is significantly affected by acceptance of the new video game
hardware systems and the life span of older hardware platforms and our ability
to accurately predict which platforms will be most successful.
Sometimes we will spend development and marketing resources on products
designed for new video game systems that have not yet achieved large installed
bases or will continue product development for older hardware platforms that may
have shorter life cycles than we expected. Conversely, if we do not develop for
a platform that achieves significant market acceptance, or discontinue
development for a platform that has a longer life cycle than expected, our
revenue growth may be adversely affected.
For example, the Sega Dreamcast console launched in Japan in early 1999 and in
the United States in September of 1999. We have developed no products for this
platform. Had this platform achieved wide market acceptance, our revenue growth
would have been adversely affected. Similarly, we released a variety of products
for the new Sony platform, the PlayStation 2. The shortages of PlayStation 2
units have adversely affected our results, and if that platform does not achieve
wide acceptance by consumers, we will have spent a disproportionate amount of
our resources for this platform. Similarly, we are developing products for the
Xbox and Nintendo GameCube. If these platforms do not achieve wide commercial
acceptance, our revenue growth will be adversely impacted.
30
Product Development Schedules Are Frequently Unreliable and Make Predicting
Quarterly Results Difficult
Product development schedules, particularly for new hardware platforms and
high-end multimedia personal computers, or PCs, are difficult to predict because
they involve creative processes, use of new development tools for new platforms
and the learning process, research and experimentation associated with
development for new technologies. For example, EMPEROR: Battle for Dune for the
PC, which was expected to ship in fiscal 2001 was not released until the first
quarter of fiscal 2002 due to development delays. Also, Agent Under Fire for the
PS2, which was expected to ship in fiscal 2001, is not planned for release until
fiscal 2002 due to development delays. Additionally, development risks for CD-
ROM and DVD products can cause particular difficulties in predicting quarterly
results because brief manufacturing lead times allow finalizing products and
projected release dates late in a quarter. Our revenues and earnings are
dependent on our ability to meet our product release schedules, and our failure
to meet those schedules could result in revenues and earnings which fall short
of analysts' expectations for any individual quarter and the fiscal year.
Our Business Is Both Seasonal and Cyclical
Our business is highly seasonal with a significant percentage of our revenues
occurring in the December quarter. In fiscal 2002, we expect these seasonal
trends to be magnified by general industry factors, including the current
platform transition, anticipated fall launches of the Xbox and Nintendo GameCube
in North America and the economic slowdown in the United States and other
territories. In addition, we are continuing to invest significantly in our
online operation, EA.com. Our business is also cyclical; video game platforms
have historically had a life cycle of four to six years, and decline as more
advanced platforms are being introduced. As one group of platforms is reaching
the end of its cycle and new platforms are emerging, buying patterns may change.
Purchases of products for older platforms may slow at a faster rate than sales
of new platforms. We are currently in such a platform transition. Sega
introduced its latest platform in calendar year 1999, and Sony shipped its
PlayStation 2 console in Japan, North America and Europe in calendar year 2000.
Nintendo announced that its new console system, Nintendo GameCube, will be
released in calendar year 2001 in Japan and North America and in calendar year
2002 in Europe. Microsoft announced that its new console system, Xbox, will be
released in calendar year 2001 in North America and followed by releases in
Japan and Europe. Sales of our current products for the current Nintendo and
Sony platforms have already been adversely affected, and we expect this trend to
continue.
The Impact of e-Commerce and Online Games on Our Business Is Not Known
While we do not currently derive significant revenues from online sales of our
packaged products, we believe that such form of distribution will become a more
significant factor in our business in the future. E-Commerce is becoming an
increasingly popular method for conducting business with consumers. How that
form of distribution will affect the more traditional retail distribution, at
which we have historically had success, and over what time period, is uncertain.
In addition, we expect the number and popularity of online games to increase and
become a significant factor in the interactive games business generally. We do
not know how that increase generally, or the emerging business of EA.com
specifically, will affect the sales of packaged goods.
Our Business, Our Products, and Our Distribution Are Subject to Increasing
Regulation in Key Territories
Legislation is increasingly introduced which may affect the content of our
products and their distribution. For example, privacy rules in the United States
and Europe impose various restrictions on our web sites. Those rules vary by
territory while of course the Internet recognizes no geographical boundaries.
Other countries such as Germany have adopted laws regulating content transmitted
over
31
the Internet that are stricter than current United States laws. In the United
States, in response to recent events, the federal and several state governments
are considering content restrictions on products such as those made by us as
well as restrictions on distribution of such products. Any one or more of these
factors could harm our business.
Our Platform Licensors Are Our Chief Competitors and Frequently Control the
Manufacturing of Our Video Game Products
Our agreements with hardware licensors, which are also our chief competitors,
typically give significant control to the licensor over the approval and
manufacturing of our products. This fact could, in certain circumstances, leave
us unable to get our products approved, manufactured and shipped to customers.
In most events, control of the approval and manufacturing process by the
platform licensors increases both our manufacturing lead times and costs as
compared to those we can achieve independently. For example, in prior years, we
experienced delays in obtaining approvals for and manufacturing of PlayStation
products which caused delays in shipping those products. The potential for
additional delay or refusal to approve or manufacture our products continues
with our platform licensors. Such occurrences would harm our business and
adversely affect our financial performance. Additionally, we have not negotiated
a publishing agreement with Nintendo for the Nintendo GameCube platform and we
do not know whether the terms of this agreement will be favorable.
Proliferation and Assertion of Patents Poses Serious Risks to our Business
Many patents have been issued that may apply to widely used game technologies.
Additionally, many recently issued patents are now being asserted against
Internet implementations of existing games. Several such patents have been
asserted against us. Such claims can harm our business. We will incur
substantial expenses in evaluating and defending against such claims, regardless
of the merits of the claims. In the event that there is a determination that we
have infringed a third party patent, we could incur significant monetary
liability and be prevented from using the rights in the future.
Risk Factors Relating to Our Online Business
Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate
its Business and Prospects
EA.com's business is still in the developing stages, so evaluating its
business and prospects will be more difficult than would be the case for a more
mature business. We will continue to encounter the risks and difficulties faced
in launching a new business, and we may not achieve our goals or may be
compelled to change the manner in which we seek to develop the business. These
uncertainties as to the future operations of EA.com will increase the difficulty
we face in completing and pursuing the essential plans for the development of
the business and will also make it more difficult for our stockholders and
securities analysts to predict the operating results of this business.
EA.com Has a History of Losses and Expects To Continue To Incur Losses and May
Never Achieve Profitability
EA.com has incurred substantial losses to date, including the first quarter of
fiscal year 2002. We expect EA.com to continue to incur losses as it develops
its business. EA.com will be required to maintain the significant support,
service and product enhancement demands of online users, and we cannot be
certain that EA.com will produce sufficient revenues from its operations to
support these costs. Even if profitability is achieved, EA.com may not be able
to sustain it over a period of time.
32
Our Agreements with America Online May Not Prove Successful to the Development
of EA.com's Business
We have a series of agreements with America Online ("AOL") for the offering
of our games for online play. These agreements require that we make substantial
guaranteed payments to AOL and that we commit our resources to the pursuit of
the online game opportunity. We cannot be assured that the substantial costs
associated with the AOL agreements will be justified by the revenues generated
from that relationship. In addition, restrictions included in the AOL agreements
limiting other channels we may develop for offering online games may limit our
ability to diversify our online distribution strategies. The success for us of
the AOL agreements will also be a result of AOL's performance under the
agreements, a factor over which we will have very little control.
We Have Very Limited Experience with Online Games and May Not Be Able To Operate
This Business Effectively
Offering games solely for online play is a substantial departure from our
traditional business of selling packaged software games. We have employed
various pricing models, including subscription fees, ''pay to play fees'' and
advertising. We have very little experience with developing optimal pricing
strategies for online games and no experience in ''pay to play'' pricing or in
securing advertising revenues for online services. Similarly, we are
inexperienced in predicting usage patterns for our games. Because of our
inexperience in this area, we may not be effective in achieving success that may
otherwise be attainable from offering our games online.
Online Games Have Risks That Are Not Associated with Our Traditional Business
Online games, particularly multiplayer games, pose risks to player enjoyment
that do not generally apply to packaged game sales. Players frequently would
not be acquainted with other players, which may adversely affect the playing
experience. Social issues raised by a player's conduct may impact the experience
for other players. We have not determined whether or how we might monitor or
proctor player behavior that impairs the game experience. In addition, there are
substantial technical challenges to be met both in the introduction of our games
online and in maintaining an effective game playing environment over time. Also,
hacking and spamming has become a serious problem for online sites, and
significant hacking and spamming could seriously interfere with online game
play. If these risks are not successfully controlled and technical challenges
resolved, potential customers for our games may be unwilling to play in
sufficient volume to allow us to attain or sustain profitability.
We May Not Be Able To Obtain the Required Licenses To Offer Our Games Online
If we are unable to reach terms with certain licensors for our games, we will
not be able to offer certain of our games for online play. Many of Electronic
Arts' most popular games feature characters, trademarks, people or concepts for
which we have licenses from third parties. As an example, our EA SPORTS products
typically contain content licensed from a sports and players' association. In
certain instances, the terms of these licenses will not allow us to offer the
games for online play without negotiating an additional license. We cannot be
certain that the licensors will be amenable to a license for online games
involving their content or, even if they are, that we will be able to reach
terms with them for such use. We may be forced to agree to terms that ultimately
materially impair the economic value to us of the online game market.
Proliferation and Assertion of Patents Poses Serious Risks to the Business of
EA.com
Many patents have been issued that may apply to widely used Internet
technologies. Additionally, many recently issued patents are now being asserted
against Internet implementations of older technologies. Several such patents
have been asserted against us. Such claims can harm our business.
33
We will incur substantial expenses in evaluating and defending against such
claims, regardless of the merits of the claims. In the event that there is a
determination that we have infringed a third party patent, we could incur
significant monetary liability and be prevented from using the rights in the
future.
Development of EA.com's Business Will Require Significant Capital, and We Cannot
Be Assured That It Will Be Available
EA.com will not be successful if it does not receive the very substantial
financing that will be required to develop its business. Electronic Arts has
agreed to provide a limited amount of funding to EA.com, but this financing
alone may not be sufficient for the development of EA.com's business. Any
additional funding that is obtained from EA may either be treated as a revolving
credit advance or would increase EA's retained interest in EA.com and
correspondingly decrease the interest of the holders of outstanding shares of
Class B common stock. The attraction of additional equity or debt financing for
EA.com from third parties may not be possible or may only be possible on terms
that result in significant dilution to Class A and Class B common stockholders
or interest or other costs and debt-related restrictions on the operation of the
business. To date, nearly all funding (except warrants and cash from revenues)
has been provided by EA.
If Use of the Internet Does Not Continue To Develop and Reliably Support the
Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed
EA.com's success depends upon growth in the use of the Internet as a medium
for playing games. The use of the Internet for sophisticated games like ours is
relatively new. Our business would be seriously harmed if:
. use of the Internet does not continue to increase or increases more slowly
than expected,
. the infrastructure for the Internet does not effectively support online
game play,
. concerns over the secure transmission of confidential information over
public networks inhibit the growth of the Internet as a means of conducting
commercial transactions, or
. government regulations regarding Internet content, privacy or other
conditions impede the effectiveness of the Internet to users.
Capacity Restraints May Restrict the Use of the Internet as a Forum for Game
Play, Resulting in Decreased Demand for Our Products
The Internet infrastructure may not be able to support the demands placed on
it by increased usage or the limited capacity of networks to transmit large
amounts of data. Other risks associated with commercial use of the Internet
could slow its growth, including:
. outages and other delays resulting from the inadequate reliability of the
network infrastructure,
. slow development of enabling technologies and complementary products, and
. limited availability of cost-effective, high speed access.
Delays in the development or adoption of new equipment standards or protocols
required to handle increased levels of Internet activity, or increased
governmental regulation, would cause the Internet to fail to gain, or lose,
viability as a means of game playing. If these or any other factors cause
34
use of the Internet for commerce to slow or decline, the Internet may not prove
viable as a commercial marketplace. This, in turn, would result in decreased
demand for EA.com's products and services.
To Become and Remain Competitive, EA.com Must Continually Develop and Expand New
Content. This Is Inherently Risky and Expensive.
EA.com's success depends on our ability to develop products and services for
the EA.com site and our ability to continually expand the content on that site.
Our agreement with AOL requires us to develop new games under our relationship
with AOL. We cannot assure you that products will be developed on time, in a
cost effective manner, or that they will be successful.
We May Not Be Able To Respond to Rapid Technological Change
The market for Internet products and services is characterized by rapid
technological change and evolving industry standards. Both in completing the
design and implementation of our network infrastructure and thereafter, we will
be required to continually improve performance, features, reliability and
capacity of our network infrastructure. We cannot assure you that we will be
successful in responding rapidly or in a cost effective manner to such
developments.
Increasing Governmental Regulation of the Internet Could Limit the Market for
Our Products
As Internet commerce continues to evolve, we expect that federal, state and
foreign governments will adopt laws and regulations covering issues such as user
privacy, taxation of goods and services provided over the Internet, pricing,
content and quality of products and services. It is possible that legislation
could expose companies involved in electronic commerce to liability, taxation or
other increased costs, any of which could limit the growth of electronic
commerce generally. Legislation could dampen the growth in Internet usage and
decrease its acceptance as a communications and commercial medium. If enacted,
these laws and regulations could limit the market for EA.com's products.
Our Revenues Have Been Heavily Dependent on a Single Product and Would Be
Adversely Affected if That Product's Popularity Were To Decline
In the near term, EA.com's revenues to date have consisted primarily of
revenues from sales of our online product Ultima Online, and we would be
adversely affected if revenues from that product were to decline for any reason
and not be replaced. We expect the online game market to become increasingly
competitive, and it is possible that other producer's current or future games
could cause our revenue from Ultima Online to decline. In addition, popularity
of Ultima Online could decline over time simply because of consumer preference
for new game experiences.
We Invest Very Heavily in Research and Development and Network Technology and
Operations for EA.com, and We Cannot Be Assured That We Will Achieve Revenues
That Validate This Level of Spending
We have invested, and expect to continue to invest, very heavily in research
and development and network technology and operations for our website and online
games. We will need to expand EA.com's revenues substantially for it to achieve
profitability with these levels of expenditure being required, and we may not be
able to do so. If we cannot increase revenues to profitable levels, the value of
EA.com will be impaired. In order to develop the broad game offerings that we
envision for our online operations it will be necessary to engage in significant
developmental efforts both to adapt existing EA games to the online format and
to create new online games. Our agreements with AOL require us to maintain a
substantial commitment to online game development and we cannot be assured that
we will realize acceptable returns from this investment.
35
Online Product Development Schedules Are Unreliable and Make Predicting
Quarterly Results Difficult
Online product development schedules, particularly for Internet based games
are difficult to predict because they involve creative processes, use of new
development tools, Internet latency issues, a learning process to better
understand Internet based game mechanics, and research and experimentation
associated with development for new online technologies. Additionally,
development risks for Internet based products can cause particular difficulties
in predicting quarterly results because of the challenges associated with game
testing, live Beta testing, integration into network servers and integration on
to the Games web site and may impact the release ("go live") dates of products
during a particular quarter. Several online products currently under development
are experiencing development delays and will be released later than planned. Our
revenues and operating costs are dependent on our ability to meet our product
"go live" schedules, and our failure to meet those schedules could result in
revenues falling short of analysts' expectations, with no corresponding decrease
in expenses, resulting in increased operating losses for EA.com.
General Risk Factors
Because of the Intense Competition for Qualified Technical, Creative, Marketing
and Other Personnel, We May Not Be Able To Attract and Retain the Personnel
Necessary for our Businesses
The market for technical, creative, marketing and other personnel essential to
the development of online businesses and management of our online and core
businesses continues to be extremely competitive, and we may not be able to
attract and retain the employees we need. In addition, the cost of real estate
in the San Francisco Bay area - the location of our headquarters and largest
studio has increased dramatically, and has made recruiting from other areas and
relocating employees to our headquarters more difficult. If we cannot
successfully recruit and retain the employees we need, our ability to develop
and manage our businesses will be impaired.
Foreign Sales and Currency Fluctuations
For the three months ended June 30, 2001 international net revenues comprised
43% of total consolidated net revenues. For the fiscal year ended March 31,
2001, international net revenues comprised 37% of total consolidated net
revenues. We expect foreign sales to continue to account for a significant and
growing portion of our revenues. Such sales are subject to unexpected regulatory
requirements, tariffs and other barriers. Additionally, foreign sales are
primarily made in local currencies which may fluctuate. While we hedge against
foreign currency fluctuations, we cannot control translation issues. For
example, our Japan and Asia Pacific revenues in the first quarter of fiscal 2002
were adversely impacted by a devaluation of the Yen and Australian Dollar as
compared to the prior year. The devaluation had an adverse effect for the
quarter on our sales and net income. Any of these factors may significantly
harm our business.
Increased Difficulties in Forecasting Results
During platform transition periods, where the success of our products is
significantly impacted by the changing market for our products, forecasting our
revenues and earnings is more difficult than in more stable or rising product
markets. The demand for our products may decline during a transition faster
than we anticipate, negatively impacting both revenues and earnings. At launch,
Sony shipped only half of the number of PlayStation 2 units to retail in North
America than it had originally planned,
36
and it shipped significantly fewer units than planned at launch in Europe as
well. Shortages were announced as being caused by shortages of components for
manufacturing. Due to these shortages, our results of operations for fiscal 2001
were adversely affected. Consequently, if Microsoft or Nintendo does not ship
the number of units planned for the Xbox and Nintendo Gamecube, our sales of
these products may be adversely affected in fiscal 2002.
We cannot predict the impact of recent actions and comments by the Securities
and Exchange Commission (SEC) and FASB
Recent actions and comments from the SEC have focused on the integrity of
financial reporting. In addition, the FASB and other regulatory accounting
agencies have recently introduced several new or proposed accounting standards,
some of which represent a significant change from current industry practices.
For example, in April 2001, the Emerging Issues Task Force issued No. 00-25
("EITF 00-25"), "Accounting for Consideration from a Vendor to a Retailer in
Connection with the Purchase or Promotion of the Vendor's Products". EITF 00-25
states that consideration from a vendor to a reseller of the vendor's products
is presumed to be a reduction of the selling prices of the vendor's products
and, therefore, should be characterized as a reduction of revenue when
recognized in the vendor's income statement. That presumption is overcome and
the consideration can be categorized as a cost incurred if, and to the extent
that, a benefit is or will be received from the recipient of the consideration.
That benefit must meet certain conditions described in EITF 00-25. The
consensus should be applied no later than in annual or interim financial
statements for periods beginning after December 15, 2001. The Company is
currently evaluating the impact of this consensus on its Statement of
Operations.
Fluctuations in Stock Price
Due to analysts' expectations of continued growth and other factors, any
shortfall in earnings could have an immediate and significant adverse effect on
the trading price of our common stock in any given period. As a result of the
factors discussed in this report and other factors that may arise in the future,
the market price of our common stock historically has been, and we expect will
continue to be, subject to significant fluctuations over a short period of time.
These fluctuations may be due to factors specific to us, to changes in analysts'
earnings estimates, or to factors affecting the computer, software, Internet,
entertainment, media or electronics businesses or the securities markets in
general. For example, during the fiscal year ended March 31, 2001, the price
per share of our Class A common stock ranged from $26.59 to $56.13 and $48.31 to
$63.04 during the three months ended June 30, 2001.
Because of these and other factors affecting our operating results and financial
condition, past financial performance should not be considered a reliable
indicator of future performance, and investors should not use historical trends
to anticipate results or trends in future periods.
37
Item 3: Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
- -----------
We are exposed to various market risks, including the changes in foreign
currency exchange rates and interest rates. Market risk is the potential loss
arising from changes in market rates and prices. Foreign exchange contracts
used to hedge foreign currency exposures and short-term investments are subject
to market risk. We do not consider our cash and cash equivalents to be subject
to interest rate risk due to their short maturities. We do not enter into
derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rate Risk
We utilize foreign exchange contracts to hedge foreign currency exposures of
underlying assets and liabilities, primarily certain intercompany receivables
that are denominated in foreign currencies, thereby, limiting our risk. Gains
and losses on foreign exchange contracts are reflected in the income statement.
At June 30, 2001, we had foreign exchange contracts, all with maturities of less
than four months to purchase and sell approximately $204,110,000 in foreign
currencies, primarily British Pounds, European Currency Units ("Euros"),
Canadian Dollars, Japanese Yen and other currencies.
Fair value represents the difference in value of the contracts at the spot rate
and the forward rate. The counterparties to these contracts are substantial and
creditworthy multinational commercial banks. The risks of counterparty
nonperformance associated with these contracts are not considered to be
material. Notwithstanding our efforts to manage foreign exchange risks, there
can be no assurances that our hedging activities will adequately protect us
against the risks associated with foreign currency fluctuations.
The following table below provides information about our foreign currency
forward exchange contracts at June 30, 2001. The information is provided in U.S.
dollar equivalents and presents the notional amount (forward amount), the
weighted average contractual foreign currency exchange rates and fair value.
- -----------------------------------------------------------------------------------------------------------------------
Weighted-Average
Contract Amount Contract Rate Fair Value
- -----------------------------------------------------------------------------------------------------------------------
(In thousands) (In thousands)
Foreign currency to be sold under contract:
British Pound $122,486 1.4210 $ 715
Canadian Dollar 22,092 1.5164 5
Euro 20,766 0.8652 385
Japanese Yen 11,854 119.7900 359
South African Rand 4,351 8.0448 -
Swedish Krona 2,056 10.6990 28
Norwegian Krone 1,519 9.2169 18
Danish Krone 1,035 8.6956 8
Australian Dollar 417 0.5214 8
- -----------------------------------------------------------------------------------------------------------------------
Total $186,576 $1,526
- -----------------------------------------------------------------------------------------------------------------------
Foreign currency to be purchased under
contract:
British Pound $ 17,534 1.4166 $ 127
- -----------------------------------------------------------------------------------------------------------------------
Total $ 17,534 $ 127
- -----------------------------------------------------------------------------------------------------------------------
Grand total $204,110 $1,653
- -----------------------------------------------------------------------------------------------------------------------
38
While the contract amounts provide one measurement of the volume of these
transactions, they do not represent the amount of our exposure to credit risk.
The amounts (arising from the possible inabilities of counterparties to meet the
terms of their contracts) are generally limited to the amounts, if any, by which
the counterparties' obligations exceed our obligations as these contracts can be
settled on a net basis at our option. We control credit risk through credit
approvals, limits and monitoring procedures.
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments in
our investment portfolio. We manage our interest rate risk by maintaining an
investment portfolio primarily consisting of debt instruments of high credit
quality and relatively short average maturities. We also manage our interest
rate risk by maintaining sufficient cash and cash equivalent balances such that
we are typically able to hold our investments to maturity. At June 30, 2001, our
cash equivalents, short-term and long-term investments included debt securities
of $391,256,000. Notwithstanding our efforts to manage interest rate risks,
there can be no assurances that we will be adequately protected against the
risks associated with interest rate fluctuations.
The table below presents the amounts and related weighted average interest rates
of our investment portfolio at June 30, 2001:
- -----------------------------------------------------------------------
Average
Interest Rate Cost Fair Value
- -----------------------------------------------------------------------
(Dollars in thousands)
Cash equivalents
Fixed rate 0.00% $ - $ -
Variable rate 3.11% $319,885 $319,885
Short-term investments
Fixed rate 4.15% $ 62,470 $ 62,971
Variable rate 0.00% $ - $ -
Long-term investments
Fixed rate 0.00% $ - $ -
Variable rate 6.35% $ 8,400 $ 8,621
- -----------------------------------------------------------------------
Maturity dates for short-term investments range from 3 months to 13 months.
39
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to pending claims and litigation. Management,
after review and consultation with counsel, considers that any
liability from the disposition of such lawsuits in the aggregate would
not have a material adverse effect upon the consolidated financial
position or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders, held on August 1,
2001, the stockholders elected the following individuals for one-year
terms to the Board of Directors: M. Richard Asher, William J. Byron,
Daniel H. Case III, Gary M. Kusin, Timothy Mott, Lawrence F. Probst
III, Leonard S. Coleman and Linda J. Srere. These individuals have
received a plurality of the votes eligible to vote, voting either in
person or by proxy.
In addition, the following matters were voted upon by the
Stockholders:
To amend the 2000 Class A Equity Incentive Plan to increase by
6,000,000 the number of shares of the Company's Class A common stock
reserved for issuance under the Plan.
Votes
-----------------------------------------------------------------
For Against Abstain
--- ------- -------
70,315,745 56,079,376 55,395
To ratify the appointment of KPMG LLP as our independent auditors for
the current fiscal year.
Votes
-----------------------------------------------------------------
For Against Abstain
--- ------- -------
126,225,725 211,389 13,402
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRONIC ARTS INC.
(Registrant)
/s/ E. STANTON MCKEE
---------------------------------
DATED: E. STANTON MCKEE
August 14, 2001 Executive Vice President and
Chief Financial and Administrative Officer
41