FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended December 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ______ to_____ Commission File No. 0-17948 ELECTRONIC ARTS INC. (Exact name of registrant as specified in its charter) Delaware 94-2838567 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 209 Redwood Shores Parkway Redwood City, California 94065 (Address of principal executive offices) (Zip Code) (650) 628-1500 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock February 8, 2001 --------------------- ---------------- $0.01 par value per share 133,003,609
ELECTRONIC ARTS INC. AND SUBSIDIARIES INDEX Page ---- Part I - Financial Information Item 1. Consolidated Financial Statements Consolidated Balance Sheets at December 31, 2000 and March 31, 2000 3 Consolidated Statements of Operations for the Three Months Ended December 31, 2000 and 1999 and the Nine Months Ended December 31, 2000 and 1999 4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2000 and 1999 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 3. Quantitative and Qualitative Disclosures About Market Risk 45 Part II - Other Information Item 1. Legal Proceedings 47 Item 4. Submission of Matters to a Vote of Security Holders 47 Item 6. Exhibits and Reports on Form 8-K 47 Signatures 48 Exhibit Index 49 2
PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) (unaudited) <TABLE> <CAPTION> December 31, March 31, 2000 2000 ----------- ----------- <S> <C> <C> ASSETS Current assets: Cash, cash equivalents and short-term investments $ 295,377 $ 339,804 Marketable securities 17,249 236 Receivables, less allowances of $82,660 and $65,067, respectively 356,484 234,087 Inventories, net 19,852 22,986 Deferred income taxes 27,143 26,963 Other current assets 93,305 81,247 ----------- ----------- Total current assets 809,410 705,323 Property and equipment, net 340,187 285,466 Long-term investments 8,400 8,400 Investments in affiliates 18,780 22,601 Goodwill and other intangibles, net 103,889 117,236 Other assets 56,610 53,286 ----------- ----------- $ 1,337,276 $ 1,192,312 =========== =========== LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 68,192 $ 97,703 Accrued and other liabilities 251,861 167,599 ----------- ----------- Total current liabilities 320,053 265,302 Minority interest in consolidated joint venture 4,307 3,617 Stockholders' equity: Preferred stock, $0.01 par value. Authorized 10,000,000 shares -- -- Common Stock Class A common stock, $0.01 par value. Authorized 400,000,000 shares; issued and outstanding 132,733,250 and 128,869,088 shares, respectively 1,327 1,288 Class B common stock, $0.01 par value. Authorized 100,000,000 shares; issued and outstanding 6,250,000 and 6,000,000, respectively 63 60 Paid-in capital 488,190 412,038 Retained earnings 523,166 516,368 Accumulated other comprehensive income (loss) 170 (6,361) ----------- ----------- Total stockholders' equity 1,012,916 923,393 ----------- ----------- $ 1,337,276 $ 1,192,312 =========== =========== <FN> See accompanying notes to consolidated financial statements. </FN> </TABLE> 3
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended December 31, December 31, -------------------------- -------------------------- 2000 1999 2000 1999 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Net revenues $ 640,319 $ 600,691 $ 1,015,018 $ 1,125,698 Cost of goods sold 306,146 299,423 502,828 562,821 ----------- ----------- ----------- ----------- Gross profit 334,173 301,268 512,190 562,877 ----------- ----------- ----------- ----------- Operating expenses: Marketing and sales 65,394 67,475 138,850 147,422 General and administrative 28,480 28,237 76,981 68,246 Research and development 110,250 73,424 281,471 187,025 Amortization of intangibles 4,681 2,596 14,051 7,800 ----------- ----------- ----------- ----------- Total operating expenses 208,805 171,732 511,353 410,493 ----------- ----------- ----------- ----------- Operating income 125,368 129,536 837 152,384 Interest and other income, net 2,690 4,382 10,628 11,653 ----------- ----------- ----------- ----------- Income before provision for income taxes and minority interest 128,058 133,918 11,465 164,037 Provision for income taxes 39,698 41,214 3,554 50,852 ----------- ----------- ----------- ----------- Income before minority interest 88,360 92,704 7,911 113,185 Minority interest in consolidated joint venture (382) 157 (1,113) 134 ----------- ----------- ----------- ----------- Net income $ 87,978 $ 92,861 $ 6,798 $ 113,319 =========== =========== =========== =========== Net income per share: Basic N/A $ 0.73 N/A $ 0.91 Diluted N/A $ 0.69 N/A $ 0.86 Number of shares used in computation: Basic N/A 126,651 N/A 124,780 Diluted N/A 134,955 N/A 131,670 Class A common stock: Net income: Basic $ 95,416 N/A $ 21,942 N/A =========== =========== Diluted $ 87,978 N/A $ 6,798 N/A =========== =========== Net income per share: Basic $ 0.72 N/A $ 0.17 N/A Diluted $ 0.63 N/A $ 0.05 N/A Number of shares used in computation: Basic 132,339 N/A 130,716 N/A Diluted 138,904 N/A 137,372 N/A Class B common stock: Net loss, net of retained interest in EA.com $ (7,438) N/A $ (15,144) N/A =========== =========== Net loss per share: Basic $ (1.24) N/A $ (2.52) N/A Diluted $ (1.24) N/A $ (2.52) N/A Number of shares used in computation: Basic 6,000 N/A 6,000 N/A Diluted 6,000 N/A 6,000 N/A </TABLE> See accompanying notes to consolidated financial statements. 4
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (unaudited) <TABLE> <CAPTION> Nine Months Ended December 31, ---------------------- 2000 1999 --------- --------- <S> <C> <C> Operating activities: Net income $ 6,798 $ 113,319 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Minority interest in consolidated joint venture 1,113 (134) Equity in net (income) loss of affiliates 452 (625) Gain on sale of affiliate (214) (842) Depreciation and amortization 50,272 31,430 Loss on sale of fixed assets 1,542 402 Gain on sale of marketable securities -- (6,063) Provision for doubtful accounts 6,091 6,427 Tax benefit from exercise of stock options 15,332 24,797 Change in assets and liabilities, net of acquisitions: Receivables (128,488) (234,879) Inventories 3,134 (462) Other assets (9,814) (71,249) Accounts payable (29,511) 26,092 Accrued liabilities 83,652 53,016 Deferred income taxes 966 (535) --------- --------- Net cash provided by (used in) operating activities 1,325 (59,306) --------- --------- Investing activities: Proceeds from sale of property and equipment 3,958 56 Proceeds from sales of marketable securities, net -- 7,037 Purchase of marketable securities, net (2,479) -- Proceeds from sale of affiliate -- 8,842 Capital expenditures (104,860) (85,023) Investment in affiliates, net 662 (2,949) Change in short-term investments, net 22,443 (20,630) Acquisition of subsidiaries, net of cash acquired -- (582) --------- --------- Net cash used in investing activities (80,276) (93,249) --------- --------- Financing activities: Proceeds from sales of shares through employee stock plans and other plans 60,862 68,477 --------- --------- Net cash provided by financing activities 60,862 68,477 --------- --------- Translation adjustment (3,886) (718) --------- --------- Decrease in cash and cash equivalents (21,975) (84,796) Beginning cash and cash equivalents 246,265 242,208 --------- --------- Ending cash and cash equivalents 224,290 157,412 Short-term investments 71,087 89,758 --------- --------- Ending cash, cash equivalents and short-term investments $ 295,377 $ 247,170 ========= ========= </TABLE> 5
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (Dollars in thousands) (unaudited) Nine Months Ended December 31, -------------------- 2000 1999 ------- ------- Supplemental cash flow information: Cash paid during the year for income taxes $10,706 $ 9,711 ======= ======= Non-cash investing activities: Change in unrealized appreciation of investments and marketable securities $ 9,458 $(4,441) ======= ======= See accompanying notes to consolidated financial statements. 6
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The condensed consolidated financial statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim period. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. Certain amounts have been reclassified to conform to the fiscal 2001 presentation. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Electronic Arts Inc. (the "Company") Annual Report on Form 10-K for the fiscal year ended March 31, 2000 as filed with the Securities and Exchange Commission ("Commission") on June 29, 2000. Note 2. Fiscal Year The Company's fiscal year is reported on a 52/53-week period that ends on the Saturday nearest to March 31 in each year. The results of operations for fiscal 2001 will contain 53 weeks. Accordingly, the results of operations for the first three quarters of fiscal 2001 and the first three quarters of fiscal 2000 contain 40 weeks and 39 weeks, respectively. The results of operations for the fiscal quarter ended June 30, 2000 and the fiscal quarter ended June 30, 1999 contain 14 weeks and 13 weeks, respectively. Since the results of an additional week are not material, and for clarity of presentation, all fiscal periods are treated as ending on a calendar month. Note 3. Approval of the Tracking Stock Proposal On March 22, 2000, the shareholders of Electronic Arts approved the "Tracking Stock Proposal" which authorized the issuance of a new series of common stock, designated as Class B common stock ("Tracking Stock"). The Tracking Stock is intended to reflect the performance of Electronic Arts' online and e-Commerce division ("EA.com"). As a result of the approval of the Tracking Stock Proposal, Electronic Arts' existing common stock has been re-classified as Class A common stock ("Class A Stock") and that stock reflects the performance of Electronic Arts' other businesses ("EA Core"). Note 4. Stock Split On August 14, 2000, the Company's Board of Directors authorized a two-for-one stock split of its Class A common stock which was distributed on September 8, 2000 in the form of a stock dividend for shareholders of record at the close of business on August 25, 2000. All authorized and outstanding share and per share amounts of Class A common stock in the accompanying consolidated financial statements for all periods have been restated to reflect the stock split. 7
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Note 5. Prepaid Royalties Prepaid royalties consist primarily of prepayments for manufacturing royalties, original equipment manufacturer (OEM) fees and license fees paid to celebrities and professional sports organizations for use of their trade name. Also included in prepaid royalties are prepayments made to independent software developers under development arrangements that have alternative future uses. Prepaid royalties are expensed at the contractual or effective royalty rate as cost of goods sold based on actual net product sales. Management evaluates the future realization of prepaid royalties quarterly and charges to income any amounts that management deems unlikely to be realized through product sales. Royalty advances are classified as current and non-current assets based upon estimated net product sales for the following year. The current portion of prepaid royalties, included in other current assets, was $51,501,000 and $54,970,000 at December 31, 2000 and March 31, 2000, respectively. The long-term portion of prepaid royalties, included in other assets, was $9,326,000 and $11,373,000 at December 31, 2000 and March 31, 2000, respectively. Note 6. Inventories Inventories are stated at the lower of cost or market. Inventories at December 31, 2000 and March 31, 2000 consisted of (in thousands): December 31, March 31, 2000 2000 -------- -------- Raw materials and work in process $ 1,141 $ 920 Finished goods 18,711 22,066 -------- -------- $ 19,852 $ 22,986 ======== ======== Note 7. Accrued and Other Liabilities Accrued liabilities at December 31, 2000 and March 31, 2000 consisted of (in thousands): December 31, March 31, 2000 2000 -------- -------- Accrued expenses $ 77,650 $ 37,840 Accrued compensation and benefits 67,469 59,580 Accrued royalties 54,430 36,566 Accrued income taxes 26,543 22,682 Deferred revenue 17,098 1,847 Warranty reserve 7,863 8,886 Deferred income taxes 808 198 -------- -------- $251,861 $167,599 ======== ======== 8
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Note 8. Segment Information In 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise". SFAS No. 131 establishes standards for the reporting by public business enterprises of information about product lines, geographic areas and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company's chief operating decision maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region and by product lines for purposes of making operating decisions and assessing financial performance. As a result of the issuance of Class B common stock, which is intended to reflect the performance of EA.com, management considers EA.com to be a separate reportable segment. Accordingly, prior period information has been restated to disclose separate segments. The Company operates in two principal business segments globally: * Electronic Arts core ("EA Core") business segment: creation, marketing and distribution of entertainment software. * EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and related advertising. Please see the discussion regarding segment reporting in the MD&A. 9
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Information about Electronic Arts business segments is presented below for the three and nine months ended December 31, 2000 and 1999 (in thousands): <TABLE> <CAPTION> Three Months Ended December 31, 2000 ----------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 629,145 $ 11,174 $ -- $ 640,319 Group sales 752 -- (752)(a) -- ----------- ----------- ----------- ----------- Total net revenues 629,897 11,174 (752) 640,319 ----------- ----------- ----------- ----------- Cost of goods sold from unaffiliated customers 304,036 2,110 -- 306,146 Group cost of goods sold -- 752 (752)(a) -- ----------- ----------- ----------- ----------- Total cost of goods sold 304,036 2,862 (752) 306,146 ----------- ----------- ----------- ----------- Gross profit 325,861 8,312 -- 334,173 Operating expenses: Marketing and sales 56,690 4,233 4,471 (c) 65,394 General and administrative 25,722 2,758 -- 28,480 Research and development 65,081 25,544 19,625 (b) 110,250 Network development and support -- 19,625 (19,625)(b) -- Carriage fee -- 4,471 (4,471)(c) -- Amortization of intangibles 3,184 1,497 -- 4,681 ----------- ----------- ----------- ----------- Total operating expenses 150,677 58,128 -- 208,805 ----------- ----------- ----------- ----------- Operating income (loss) 175,184 (49,816) -- 125,368 Interest and other income, net 2,456 234 -- 2,690 ----------- ----------- ----------- ----------- Income (loss) before provision for income taxes and minority interest 177,640 (49,582) -- 128,058 Provision for income taxes 39,698 -- -- 39,698 ----------- ----------- ----------- ----------- Income (loss) before minority interest 137,942 (49,582) -- 88,360 Minority interest in consolidated joint venture (382) -- -- (382) ----------- ----------- ----------- ----------- Net income (loss) before retained interest in EA.com $ 137,560 $ (49,582) $ -- $ 87,978 =========== =========== =========== =========== Interest income $ 3,147 $ 22 $ -- $ 3,169 Depreciation and amortization 7,539 11,150 -- 18,689 Identifiable assets 1,172,112 165,164 -- 1,337,276 Capital expenditures 10,192 7,807 -- 17,999 </TABLE> 10
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) <TABLE> <CAPTION> Three Months Ended December 31, 1999 ----------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 595,761 $ 4,930 $ -- $ 600,691 Group sales 557 -- (557)(a) -- ----------- ----------- ----------- ----------- Total net revenues 596,318 4,930 (557) 600,691 ----------- ----------- ----------- ----------- Cost of goods sold from unaffiliated customers 297,883 1,540 -- 299,423 Group cost of goods sold -- 557 (557)(a) -- ----------- ----------- ----------- ----------- Total cost of goods sold 297,883 2,097 (557) 299,423 ----------- ----------- ----------- ----------- Gross profit 298,435 2,833 -- 301,268 Operating expenses: Marketing and sales 66,192 1,283 -- 67,475 General and administrative 26,545 1,692 -- 28,237 Research and development 55,318 12,240 5,866 (b) 73,424 Network development and support -- 5,866 (5,866)(b) -- Carriage fee -- -- -- -- Amortization of intangibles 2,567 29 -- 2,596 ----------- ----------- ----------- ----------- Total operating expenses 150,622 21,110 -- 171,732 ----------- ----------- ----------- ----------- Operating income (loss) 147,813 (18,277) -- 129,536 Interest and other income, net 4,382 -- -- 4,382 ----------- ----------- ----------- ----------- Income (loss) before provision for income taxes and minority interest 152,195 (18,277) -- 133,918 Provision for income taxes 41,214 -- -- 41,214 ----------- ----------- ----------- ----------- Income (loss) before minority interest 110,981 (18,277) -- 92,704 Minority interest in consolidated joint venture 157 -- -- 157 ----------- ----------- ----------- ----------- Net income (loss) $ 111,138 $ (18,277) $ -- $ 92,861 =========== =========== =========== =========== Interest income $ 3,301 $ -- $ -- $ 3,301 Depreciation and amortization 10,186 589 -- 10,775 Identifiable assets 1,127,445 53,324 -- 1,180,769 Capital expenditures 33,303 4,382 -- 37,685 </TABLE> 11
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) <TABLE> <CAPTION> Nine Months Ended December 31, 2000 ----------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 985,754 $ 29,264 $ -- $ 1,015,018 Group sales 1,795 -- (1,795)(a) -- ----------- ----------- ----------- ----------- Total net revenues 987,549 29,264 (1,795) 1,015,018 ----------- ----------- ----------- ----------- Cost of goods sold from unaffiliated customers 496,620 6,208 -- 502,828 Group cost of goods sold -- 1,795 (1,795)(a) -- ----------- ----------- ----------- ----------- Total cost of goods sold 496,620 8,003 (1,795) 502,828 ----------- ----------- ----------- ----------- Gross profit 490,929 21,261 -- 512,190 Operating expenses: Marketing and sales 126,702 7,677 4,471 (c) 138,850 General and administrative 69,611 7,370 -- 76,981 Research and development 182,935 59,712 38,824 (b) 281,471 Network development and support -- 38,824 (38,824)(b) -- Carriage fee -- 4,471 (4,471)(c) -- Amortization of intangibles 9,645 4,406 -- 14,051 ----------- ----------- ----------- ----------- Total operating expenses 388,893 122,460 -- 511,353 ----------- ----------- ----------- ----------- Operating income (loss) 102,036 (101,199) -- 837 Interest and other income, net 10,387 241 -- 10,628 ----------- ----------- ----------- ----------- Income (loss) before provision for income taxes and minority interest 112,423 (100,958) -- 11,465 Provision for income taxes 3,554 -- -- 3,554 ----------- ----------- ----------- ----------- Income (loss) before minority interest 108,869 (100,958) -- 7,911 Minority interest in consolidated joint venture (1,113) -- -- (1,113) ----------- ----------- ----------- ----------- Net income (loss) before retained interest in EA.com $ 107,756 $ (100,958) $ -- $ 6,798 =========== =========== =========== =========== Interest income $ 11,546 $ 71 $ -- $ 11,617 Depreciation and amortization 29,449 20,823 -- 50,272 Capital expenditures 39,442 65,418 -- 104,860 </TABLE> 12
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) <TABLE> <CAPTION> Nine Months Ended December 31, 1999 ----------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 1,111,598 $ 14,100 $ -- $ 1,125,698 Group sales 1,465 -- (1,465)(a) -- ----------- ----------- ----------- ----------- Total net revenues 1,113,063 14,100 (1,465) 1,125,698 ----------- ----------- ----------- ----------- Cost of goods sold from unaffiliated customers 558,845 3,976 -- 562,821 Group cost of goods sold -- 1,465 (1,465)(a) -- ----------- ----------- ----------- ----------- Total cost of goods sold 558,845 5,441 (1,465) 562,821 ----------- ----------- ----------- ----------- Gross profit 554,218 8,659 -- 562,877 Operating expenses: Marketing and sales 145,417 2,005 -- 147,422 General and administrative 65,924 2,322 -- 68,246 Research and development 152,077 22,877 12,071 (b) 187,025 Network development and support -- 12,071 (12,071)(b) -- Carriage fee -- -- -- -- Amortization of intangibles 7,742 58 -- 7,800 ----------- ----------- ----------- ----------- Total operating expenses 371,160 39,333 -- 410,493 ----------- ----------- ----------- ----------- Operating income (loss) 183,058 (30,674) -- 152,384 Interest and other income, net 11,653 -- -- 11,653 ----------- ----------- ----------- ----------- Income (loss) before provision for income taxes and minority interest 194,711 (30,674) -- 164,037 Provision for income taxes 50,852 -- -- 50,852 ----------- ----------- ----------- ----------- Income (loss) before minority interest 143,859 (30,674) -- 113,185 Minority interest in consolidated joint venture 134 -- -- 134 ----------- ----------- ----------- ----------- Net income (loss) $ 143,993 $ (30,674) $ -- $ 113,319 =========== =========== =========== =========== Interest income $ 9,903 $ -- $ -- $ 9,903 Depreciation and amortization 30,680 750 -- 31,430 Capital expenditures 71,716 13,307 -- 85,023 <FN> - ---------- (a) Represents elimination of intercompany sales of Electronic Arts packaged goods products to EA.com, and represents elimination of royalties paid to Electronic Arts by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support to Research and Development. (c) Represents reclassification of amortization of the AOL Carriage Fee to Marketing. </FN> </TABLE> 13
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Information about the Company's operations in North America and foreign areas for the three and nine months ended December 31, 2000 and 1999 is presented below: <TABLE> <CAPTION> (In thousands) Asia Pacific North (excluding America Europe Japan) Japan Eliminations Total ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> Three months ended December 31, 2000 Net revenues from unaffiliated customers $ 416,904 $ 189,943 $ 19,887 $ 13,585 $ -- $ 640,319 Intercompany revenues 3,692 11,161 3,569 2,071 (20,493) -- ---------- ---------- ---------- ---------- ---------- ---------- Total net revenues 420,596 201,104 23,456 15,656 (20,493) 640,319 ========== ========== ========== ========== ========== ========== Operating income 82,257 39,588 2,941 1,411 (829) 125,368 Interest income 2,598 494 77 -- -- 3,169 Depreciation and amortization 15,393 2,932 218 146 -- 18,689 Identifiable assets 876,560 406,952 29,083 24,681 -- 1,337,276 Capital expenditures 15,361 2,202 328 108 -- 17,999 Long-lived assets 323,825 160,420 4,146 3,967 -- 492,358 Nine months ended December 31, 2000 Net revenues from unaffiliated customers $ 641,502 $ 291,786 $ 41,526 $ 40,204 $ -- $1,015,018 Intercompany revenues 8,971 19,979 10,126 2,071 (41,147) -- ---------- ---------- ---------- ---------- ---------- ---------- Total net revenues 650,473 311,765 51,652 42,275 (41,147) 1,015,018 ========== ========== ========== ========== ========== ========== Operating income (loss) 2,547 (11,624) 4,812 4,800 302 837 Interest income 8,847 2,430 340 -- -- 11,617 Depreciation and amortization 41,053 8,202 591 426 -- 50,272 Capital expenditures 88,796 14,683 999 382 -- 104,860 Three months ended December 31, 1999 Net revenues from unaffiliated customers $ 366,467 $ 210,855 $ 16,976 $ 6,393 $ -- $ 600,691 Intercompany revenues 16,031 11,499 1,755 -- (29,285) -- ---------- ---------- ---------- ---------- ---------- ---------- Total net revenues 382,498 222,354 18,731 6,393 (29,285) 600,691 ========== ========== ========== ========== ========== ========== Operating income (loss) 86,896 41,670 1,723 (437) (316) 129,536 Interest income 2,693 542 66 -- -- 3,301 Depreciation and amortization 7,748 2,652 154 221 -- 10,775 Identifiable assets 751,490 383,204 32,257 13,818 -- 1,180,769 Capital expenditures 16,238 20,731 432 284 -- 37,685 Long-lived assets 211,827 137,151 3,518 3,821 -- 356,317 Nine months ended December 31, 1999 Net revenues from unaffiliated customers $ 694,125 $ 367,649 $ 42,430 $ 21,494 $ -- $1,125,698 Intercompany revenues 23,751 24,145 4,660 -- (52,556) -- ---------- ---------- ---------- ---------- ---------- ---------- Total net revenues 717,876 391,794 47,090 21,494 (52,556) 1,125,698 ========== ========== ========== ========== ========== ========== Operating income (loss) 114,520 35,535 3,907 (222) (1,356) 152,384 Interest income 8,676 1,071 156 -- -- 9,903 Depreciation and amortization 22,216 8,099 396 719 -- 31,430 Capital expenditures 36,700 46,883 1,024 416 -- 85,023 </TABLE> 14
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Information about the Company's net revenues by product line for the three and nine months ended December 31, 2000 and 1999 is presented below: Three Months Ended Nine Months Ended (In thousands) December 31, December 31, ----------------------- ----------------------- 2000 1999 2000 1999 ---------- ---------- ---------- ---------- PC $ 153,246 $ 123,771 $ 305,396 $ 289,154 PlayStation 183,309 291,002 277,967 471,690 PlayStation 2 144,611 -- 157,629 -- N64 49,241 57,066 60,008 114,873 Online Subscription 6,753 3,941 22,209 10,915 License, OEM and Other 5,218 8,488 14,953 16,532 Advertising 2,591 -- 2,591 -- Affiliated label 95,350 116,423 174,265 222,534 ---------- ---------- ---------- ---------- $ 640,319 $ 600,691 $1,015,018 $1,125,698 ========== ========== ========== ========== Note 9. Comprehensive Income The components of comprehensive income, net of tax, for the three and nine months ended December 31, 2000 and 1999 were as follows: <TABLE> <CAPTION> (In thousands) Three Months Ended Nine Months Ended December 31, December 31, ---------------------- ---------------------- 2000 1999 2000 1999 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net income $ 87,978 $ 92,861 $ 6,798 $ 113,319 --------- --------- --------- --------- Other comprehensive income (loss): Change in unrealized appreciation (depreciation) of investments, net of a tax provision (benefit) of $(112), $117, $(536) and $519 (100) 248 9,994 1,103 Reclassification adjustment for gains realized in net income for 1999, net of a tax benefit of $(1,528) and $(1,940) -- (3,249) -- (4,123) Foreign currency translation adjustments 2,280 (4,666) (3,463) (1,171) --------- --------- --------- --------- Total other comprehensive income (loss) 2,180 (7,667) 6,531 (4,191) --------- --------- --------- --------- Total comprehensive income $ 90,158 $ 85,194 $ 13,329 $ 109,128 ========= ========= ========= ========= </TABLE> The currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries. Note 10. Earnings (Loss) Per Share The following summarizes the computations of Basic Earnings Per Share ("EPS") and Diluted EPS. Basic EPS is computed as net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock-based compensation plans including stock options, restricted stock awards, warrants and other convertible securities using the treasury stock method. 15
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Net income (loss) per share was calculated on a consolidated basis until Class A common stock and Class B common stock were created as a result of the approval of the Tracking Stock Proposal, see Note 3. Subsequent to the approval of the Tracking Stock Proposal, net income (loss) per share is computed individually for Class A common stock and Class B common stock. (in thousands, except per share amounts): <TABLE> <CAPTION> Three months ended December 31, ------------------------------------------------------- 2000 2000 2000 1999 Class A common Class A common Class B Electronic stock-EA Core stock-EA Core common Arts common Basic Diluted stock-EA.com stock -------- -------- -------- -------- <S> <C> <C> <C> <C> Net income (loss) $ 95,416 $ 87,978 $ (7,438) $ 92,861 -------- -------- -------- -------- Shares used to compute net income (loss) per share: Weighted-average common shares 132,339 132,339 6,000 126,651 Dilutive stock equivalents -- 6,565 -- 8,304 -------- -------- -------- -------- Dilutive potential common shares 132,339 138,904 6,000 134,955 ======== ======== ======== ======== Net income (loss) per share: Basic $ 0.72 N/A $ (1.24) $ 0.73 Diluted N/A $ 0.63 $ (1.24) $ 0.69 Nine months ended December 31, ------------------------------------------------------- 2000 2000 2000 1999 Class A common Class A common Class B Electronic stock-EA Core stock-EA Core common Arts common Basic Diluted stock-EA.com stock -------- -------- -------- -------- Net income (loss) $ 21,942 $ 6,798 $(15,144) $113,319 -------- -------- -------- -------- Shares used to compute net income (loss) per share: Weighted-average common shares 130,716 130,716 6,000 124,780 Dilutive stock equivalents -- 6,656 -- 6,890 -------- -------- -------- -------- Dilutive potential common shares 130,716 137,372 6,000 131,670 ======== ======== ======== ======== Net income (loss) per share: Basic $ 0.17 N/A $ (2.52) $ 0.91 Diluted N/A $ 0.05 $ (2.52) $ 0.86 </TABLE> 16
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The Diluted EPS calculation for Class A common stock, presented above, includes the potential dilution from the conversion of Class B common stock to Class A common stock in the event that the initial public offering for Class B common stock does not occur. Net income used for the calculation of Diluted EPS for Class A common stock is $87,978,000 and $6,798,000 for the three and nine months ended December 31, 2000, respectively. This net income includes the remaining 15% interest in EA.com, which is directly attributable to outstanding Class B shares, which would be included in the Class A common stock EPS calculation in the event that the initial public offering for Class B common stock does not occur. Excluded from the above computation of weighted-average shares for diluted EPS were options to purchase 4,142,646 and 2,617,667 shares of common stock for the three and nine months ended December 31, 2000, respectively, as the options' exercise price was greater than the average market price of the common shares. For the three and nine months ended December 31, 2000, the weighted-average exercise price of the respective options was $49.55 and $46.99, respectively. Excluded from the above computation of weighted-average shares for diluted EPS were options to purchase 151,256 and 293,456 shares of common stock for the three and nine months ended December 31, 1999, respectively, as the options' exercise price was greater than the average market price of the common shares. For the three and nine months ended December 31, 1999, the weighted-average exercise price of the respective options was $45.97 and $37.57, respectively. Note 11. New Accounting Pronouncements In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation (an interpretation of APB Opinion No. 25)". FIN 44 clarifies the application of APB Opinion No. 25 for certain issues: (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. Generally, FIN 44 is effective July 1, 2000. The adoption of FIN 44 did not have a material impact on the Company's consolidated financial position or results of operations. In March 2000, the Emerging Issues Task Force issued No. 00-03 ("EITF 00-03"), "Application of AICPA SOP 97-2, "Software Revenue Recognition," to Arrangements That Include the Right to Use Software Stored on Another Entity's Hardware", which discusses the effect on revenue recognition of a software vendor's obligation to host its software that previously was licensed to a customer. The EITF has reached the conclusion that, if the customer is unable to utilize the software on the customer's hardware or contract with another party unrelated to the vendor to host the software, then the arrangement with the customer is outside the scope of SOP 97-2 and should be treated as a service contract. The adoption of 17
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) EITF 00-03 did not have a material impact on the Company's financial position and results of operations. In March 2000, the Emerging Issues Task Force issued No. 00-02 ("EITF 00-02"), "Accounting for Web Site Development Costs". EITF 00-02 states that all costs relating to software used to operate a web site and relating to development of initial graphics and web page design should be accounted for using Statement of Position ("SOP") 98-1. Under this SOP, costs incurred in the preliminary project stage should be expensed as incurred, as should most training and data conversion costs. External direct costs of materials and services and internal direct payroll-related costs should be capitalized once certain criteria are met. EITF 00-02 is effective for all fiscal quarters beginning after June 30, 2000. The Company's accounting policy for internal-use software, as required by SOP 98-1, incorporated the requirements of EITF 00-02. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101("SAB 101"), "Revenue Recognition," which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC. SAB 101 is effective the fourth fiscal quarter of fiscal years beginning after December 15, 1999 as amended by SAB 101B. The Company believes the adoption of SAB 101 will not have a material impact on the Company's financial position and results of operations. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No. 133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133" which establish accounting and reporting standards for derivative instruments and hedging activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning of the first quarter of the fiscal year beginning after June 15, 2000. The Company is determining the effect of SFAS 133, 137 and 138 on its financial statements. 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q and, in particular, the following "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements about circumstances that have not yet occurred. All statements, trend analysis and other information contained below relating to markets, our products and trends in revenue, as well as other statements including words such as "anticipate", "believe" or "expect" and statements in the future tense are forward-looking statements. These forward-looking statements are subject to business and economic risks and actual events or our actual future results could differ materially from those set forth in the forward-looking statements due to such risks and uncertainties. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results and performance include, but are not limited to, those discussed under the heading "Risk Factors" below at pages 35 to 44, as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 2000 as filed with the Securities and Exchange Commission on June 29, 2000 and other documents filed with the Commission. We derive revenues primarily from shipments of entertainment software, which includes EA Studio products for dedicated entertainment systems (that we call video game systems or consoles such as PlayStation, PlayStation 2 and Nintendo 64), EA Studio personal computer products (or PC), Co- Publishing products that are co-published and distributed by us, and Affiliated Label (or AL) products that are published by third parties and distributed by us. We also derive revenues from licensing of EA Studio products and AL products through hardware companies (or OEM), online subscription, advertising and e-Commerce revenues. Information about our net revenues for North America and foreign areas for the three and nine months ended December 31, 2000 and 1999 is summarized below (in thousands): December 31, December 31, Increase/ 2000 1999 (Decrease) % change ----------- ----------- ---------- -------- Net Revenues for the Three Months Ended: North America $ 416,904 $ 366,467 $ 50,437 13.8% ----------- ----------- ---------- ------ Europe 189,943 210,855 (20,912) (9.9%) Asia Pacific 19,887 16,976 2,911 17.1% Japan 13,585 6,393 7,192 112.5% ----------- ----------- ---------- ------ International 223,415 234,224 (10,809) (4.6%) ----------- ----------- ---------- ------ Consolidated Net Revenues $ 640,319 $ 600,691 $ 39,628 6.6% =========== =========== ========== ====== 19
December 31, December 31, Increase/ 2000 1999 (Decrease) % change ----------- ----------- ---------- -------- Net Revenues for the Nine Months Ended: North America $ 641,502 $ 694,125 $ (52,623) (7.6%) ----------- ----------- ---------- ------ Europe 291,786 367,649 (75,863) (20.6%) Asia Pacific 41,526 42,430 (904) (2.1%) Japan 40,204 21,494 18,710 87.0% ----------- ----------- ---------- ------ International 373,516 431,573 (58,057) (13.5%) ----------- ----------- ---------- ------ Consolidated Net Revenues $ 1,015,018 $ 1,125,698 $ (110,680) (9.8%) =========== =========== ========== ====== North America Net Revenues The increase in North America net revenues for the three months ended December 31, 2000, compared to the same period last year was primarily due to: * The launch of PlayStation 2 platform in North America generated $97,800,000 in revenue for the quarter from titles such as Madden NFL 2001, SSX and NHL 2001. * A 32% increase in PC revenues due to the shipment of key releases including Command & Conquer Red Alert 2 and American McGee's Alice and continued strong sales of The Sims and The Sims: Livin' Large. * These increases were offset by a 34% decrease in PlayStation revenues related to the console transition. With the exception of Madden NFL 2001, which was released in the second quarter of the current fiscal year, all franchise titles are showing a significant decrease from prior year releases. * These increases were also partially offset by a decrease in N64 revenues due to the console transition. We released two titles in the current quarter compared to three in the comparable prior year period. The decrease in North America net revenues for the nine months ended December 31, 2000, compared to the same period last year was primarily due to: * A 43% decrease in PlayStation revenues due to the console transition to PlayStation 2. We released 16 titles in the nine months ended December 31, 2000 compared to 20 in the comparable prior year period. * A 48% decrease in N64 revenues also related to the console transition. We released three titles in the nine months ended December 31, 2000 compared to seven in the comparable prior year period. * These decreases were partially offset by a 23% increase in PC revenues due to the strong sales of The Sims, Command & Conquer Red Alert 2 and The Sims: Livin' Large. International Net Revenues The decrease in international net revenues for the three months ended December 31, 2000, compared to the same period last year was primarily attributable to: * Europe's net revenues decreased 10% primarily due to market weakness, the PlayStation 2 console transition as well as weakness in the Euro currency. PlayStation revenues 20
decreased 41% compared to the same period last year but were partially offset by revenues generated from PlayStation 2 titles, such as FIFA 2001 and SSX. * European AL sales decreased 33% due to a weaker market, fewer hit titles and product release slips from large ALs as compared to the prior year. * Offset by Asia Pacific's net revenues, which increased 17% mainly in PC revenues, due to the release of Command & Conquer Red Alert 2 in the current period, and revenues generated from PlayStation 2 titles. * Offset by Japan's net revenues, which increased 113% due to revenues generated from PlayStation 2 titles, such as FIFA Soccer World Championship and SSX. The decrease in international net revenues for the nine months ended December 31, 2000, compared to the same period last year was primarily attributable to: * Europe's net revenues decreased 21% primarily due to market weakness, lower AL sales due to product release slips and fewer hit titles released in the current year, lower PC sales with fewer titles shipping in the period, the strong sales of Command & Conquer Tiberian Sun for the PC in the comparable prior year period, and weakness in the Euro currency. In addition, PlayStation revenue decreased 37% due to fewer titles shipping during the console transition period with most franchise titles showing significant decreases from the prior year releases. * Asia Pacific's net revenues decreased 2%, mainly due to the decrease in PlayStation revenues as there were no significant new titles released in the current year. This was offset by sales of PlayStation 2 titles such as SSX and FIFA 2001. * Offset by Japan's net revenues which increased 87% compared to the prior year primarily due to the shipment of PlayStation 2 titles such as FIFA Soccer World Championship, FIFA 2001 and SSX. Information about our net revenues by product line for the three and nine months ended December 31, 2000 and 1999 is presented below (in thousands): December 31, December 31, Increase/ 2000 1999 (Decrease) % change ----------- ----------- ----------- -------- Net Revenues for the Three Months Ended: EA Studio: PC $ 153,246 $ 123,771 $ 29,475 23.8% PlayStation 183,309 291,002 (107,693) (37.0%) PlayStation 2 144,611 -- 144,611 N/A N64 49,241 57,066 (7,825) (13.7%) Online Subscriptions 6,753 3,941 2,812 71.4% License, OEM and Other 5,218 8,488 (3,270) (38.5%) Advertising 2,591 -- 2,591 N/A ----------- ----------- ----------- ----- 544,969 484,268 60,701 12.5% Affiliated Label: 95,350 116,423 (21,073) (18.1%) ----------- ----------- ----------- ----- Consolidated Net Revenues $ 640,319 $ 600,691 $ 39,628 6.6% =========== =========== =========== ===== 21
December 31, December 31, Increase/ 2000 1999 (Decrease) % change ----------- ----------- ----------- -------- Net Revenues for the Nine Months Ended: EA Studio: PC $ 305,396 $ 289,154 $ 16,242 5.6% PlayStation 277,967 471,690 (193,723) (41.1%) PlayStation 2 157,629 -- 157,629 N/A N64 60,008 114,873 (54,865) (47.8%) Online Subscriptions 22,209 10,915 11,294 103.5% License, OEM and Other 14,953 16,532 (1,579) (9.6%) Advertising 2,591 -- 2,591 N/A ----------- ----------- ----------- ----- 840,753 903,164 (62,411) (6.9%) Affiliated Label: 174,265 222,534 (48,269) (21.7%) ----------- ----------- ----------- ----- Consolidated Net Revenues $ 1,015,018 $ 1,125,698 $ (110,680) (9.8%) =========== =========== =========== ===== Personal Computer Product Net Revenues The increase in sales of PC products for the three and nine months ended December 31, 2000 was primarily attributable to the continued strong sales of The Sims, which shipped in the prior year. Key current year releases were Command and Conquer Red Alert 2 and The Sims: Livin' Large. We released five PC titles in the third quarter of the current fiscal year compared to ten for the same period last year. We released 13 PC titles in the nine months ended December 31, 2000 compared to 21 in the same period last year. PlayStation Product Net Revenues We released ten PlayStation titles in the third quarter of the current fiscal year and the same period last year. We released 16 PlayStation titles in the nine months ended December 31, 2000 compared to 20 in the same period last year. As expected, PlayStation sales decreased for the three months and nine months ended December 31, 2000 compared to the prior year primarily attributable to the PlayStation 2 platform transition. With the exception of Madden NFL, all of our franchises experienced significant decreases from the prior year release. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline in fiscal 2001. Under the terms of a licensing agreement with Sony Computer Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are authorized to develop and distribute CD-based software products compatible with the PlayStation. Pursuant to the Sony Agreement, we engage Sony to supply PlayStation CDs for distribution by us. Accordingly, we have limited ability to control our supply of PlayStation CD products or the timing of their delivery. See Risk Factors - "Our platform licensors are our chief competitors and frequently control the manufacturing of our video game products", below. PlayStation 2 Product Net Revenues We released ten titles worldwide for the three months and nine months ended December 31, 2000 for the PlayStation 2. Key releases for the quarter included Madden NFL 2001, SSX, FIFA 2001 and NHL 2001. Revenue was lower than expected due to the shortage of 22
PlayStation 2 hardware in the quarter resulting from component shortages which limited the number of units that could be manufactured, according to Sony. We anticipate that the hardware shortage will continue to have an adverse impact on our PlayStation 2 net revenues in the fourth quarter of the fiscal year 2001, but expect Sony to correct these issues for the next fiscal year. N64 Product Net Revenues We released two N64 titles in the third quarter of fiscal 2001 compared to three titles during the same period last year. We released three N64 titles in the nine months ended December 31, 2000 compared to seven in the same period last year. The expected decrease in N64 revenues for the three months and nine months ended December 31, 2000, compared to the same period last year was primarily due to fewer releases. The decrease is also due to the weaker market for Nintendo 64 products in the current year. We expect revenues for N64 products to continue to decline significantly in fiscal 2001. The key release for the quarter was The World Is Not Enough. Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64 cartridges for distribution by us. Accordingly, we have little ability to control our supply of N64 cartridges or the timing of their delivery. A shortage of microchips or other factors outside our control could impair our ability to obtain an adequate supply of cartridges. In connection with our purchases of N64 cartridges for distribution in North America, Nintendo requires us to provide irrevocable letters of credit prior to Nintendo's acceptance of purchase orders from us for purchases of these cartridges. For purchases of N64 cartridges for distribution in Japan and Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo maintains a policy of not accepting returns of N64 cartridges. Because of these and other factors, the carrying of an inventory of cartridges entails significant capital and risk. See Risk Factors - "Our platform licensors are our chief competitors and frequently control the manufacturing of our video game products", below. Online Net Revenues The increase in online revenues for the three and nine months ended December 31, 2000 as compared to the three and nine months ended December 31, 1999 was attributable to the following: * The average number of monthly customers for Ultima Online increased to over 200,000 for the three months ended December 31, 2000 as compared to over 130,000 for the same period last year and was over 196,000 for the nine months ended December 31, 2000 as compared to over 121,000 for the same period last year. This increase was due to continued strong sales of Ultima Online, the addition of new events and parties within the Ultima worlds and the release of Ultima Renaissance in April 2000. Ultima Renaissance added features including new houses and land mass. * We generated over $740,000 in revenues for Kesmai and Wordplay products in the current quarter and over $4,600,000 for the nine months ended December 31, 2000. These products were not part of EA.com last year due to the Kesmai acquisition in the fourth quarter of fiscal 2000. It is anticipated that revenues associated with these services will continue to decrease significantly as these products are either shut-down or converted into 23
our free, advertising supported offerings. Certain products will be retained as part of our new subscription offerings. License, OEM and Other Revenues The decrease in license, OEM and other revenues for the three and nine months ended December 31, 2000 was primarily a result of higher license revenue in the prior year of certain titles on the Game Boy platform. Advertising We began selling advertising following the launch of the EA.com/AOL Games Channel in October 2000. Affiliated Label Product Net Revenues The decrease in Affiliated Label net revenues for the three and nine months ended December 31, 2000 compared to the same periods last year was primarily due to the strong sales of Final Fantasy VIII in the prior year, our acquisition of DreamWorks Interactive, formerly an AL, in the fourth quarter of the prior year, fewer hit AL product releases and product release slips in Europe. Operations by Segment As a result of the approval of the issuance of a new series of common stock designated as Class B common stock, intended to reflect the performance of EA.com, management considers EA.com to be a separate reportable segment. Accordingly, prior period information has been restated to disclose this separate segment. We operate in two principal business segments globally: * Electronic Arts core ("EA Core") business segment: creation, marketing and distribution of entertainment software. * EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and related advertising. EA.com, a division of Electronic Arts Inc., represents Electronic Arts' online and e-Commerce businesses. EA.com's business includes subscription revenues collected for Internet game play on our websites, related website advertising, sales of packaged goods for Internet-only based games and sales of Electronic Arts games sold through EA.com websites. The statement of operations includes all revenues and costs directly attributable to EA.com, including charges for shared facilities, functions and services used by EA.com and provided by Electronic Arts. Certain costs and expenses have been allocated based on management's estimates of the cost of services provided to EA.com by Electronic Arts. 24
Information about our operations by segment for fiscal 2001 and 2000 is presented below (in thousands): <TABLE> <CAPTION> Three Months Ended December 31, 2000 ------------------------------------------------------ EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 629,145 $ 11,174 $ -- $ 640,319 Group sales 752 -- (752)(a) -- --------- --------- --------- --------- Total net revenues 629,897 11,174 (752) 640,319 --------- --------- --------- --------- Cost of goods sold from unaffiliated customers 304,036 2,110 -- 306,146 Group cost of goods sold -- 752 (752)(a) -- --------- --------- --------- --------- Total cost of goods sold 304,036 2,862 (752) 306,146 --------- --------- --------- --------- Gross profit 325,861 8,312 -- 334,173 Operating expenses: Marketing and sales 56,690 4,233 4,471 (c) 65,394 General and administrative 25,722 2,758 -- 28,480 Research and development 65,081 25,544 19,625 (b) 110,250 Network development and support -- 19,625 (19,625)(b) -- Carriage fee -- 4,471 (4,471)(c) -- Amortization of intangibles 3,184 1,497 -- 4,681 --------- --------- --------- --------- Total operating expenses 150,677 58,128 -- 208,805 --------- --------- --------- --------- Operating income (loss) 175,184 (49,816) -- 125,368 Interest and other income, net 2,456 234 -- 2,690 --------- --------- --------- --------- Income (loss) before provision for income taxes and minority interest 177,640 (49,582) -- 128,058 Provision for income taxes 39,698 -- -- 39,698 --------- --------- --------- --------- Income (loss) before minority interest 137,942 (49,582) -- 88,360 Minority interest in consolidated joint venture (382) -- -- (382) --------- --------- --------- --------- Net income (loss) before retained interest in EA.com $ 137,560 $ (49,582) $ -- $ 87,978 ========= ========= ========= ========= Allocation of retained interest (in thousands): Three Months Ended December 31, 2000 ------------------------------------------------------ EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- Net income (loss) before retained interest in EA.com $ 137,560 $ (49,582) $ -- $ 87,978 Net loss related to retained interest in EA.com (42,144) 42,144 -- -- --------- --------- --------- --------- Net income (loss) $ 95,416 $ (7,438) $ -- $ 87,978 ========= ========= ========= ========= </TABLE> 25
<TABLE> <CAPTION> Three Months Ended December 31, 1999 ------------------------------------------------------ EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 595,761 $ 4,930 $ -- $ 600,691 Group sales 557 -- (557)(a) -- --------- --------- --------- --------- Total net revenues 596,318 4,930 (557) 600,691 --------- --------- --------- --------- Cost of goods sold from unaffiliated customers 297,883 1,540 -- 299,423 Group cost of goods sold -- 557 (557)(a) -- --------- --------- --------- --------- Total cost of goods sold 297,883 2,097 (557) 299,423 --------- --------- --------- --------- Gross profit 298,435 2,833 -- 301,268 Operating expenses: Marketing and sales 66,192 1,283 -- 67,475 General and administrative 26,545 1,692 -- 28,237 Research and development 55,318 12,240 5,866 (b) 73,424 Network development and support -- 5,866 (5,866)(b) -- Carriage fee -- -- -- -- Amortization of intangibles 2,567 29 -- 2,596 --------- --------- --------- --------- Total operating expenses 150,622 21,110 -- 171,732 --------- --------- --------- --------- Operating income (loss) 147,813 (18,277) -- 129,536 Interest and other income, net 4,382 -- -- 4,382 --------- --------- --------- --------- Income (loss) before provision for income taxes and minority interest 152,195 (18,277) -- 133,918 Provision for income taxes 41,214 -- -- 41,214 --------- --------- --------- --------- Income (loss) before minority interest 110,981 (18,277) -- 92,704 Minority interest in consolidated joint venture 157 -- -- 157 --------- --------- --------- --------- Net income (loss) $ 111,138 $ (18,277) $ -- $ 92,861 ========= ========= ========= ========= </TABLE> 26
<TABLE> <CAPTION> Nine Months Ended December 31, 2000 ------------------------------------------------------ EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- ---------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 985,754 $ 29,264 $ -- $1,015,018 Group sales 1,795 -- (1,795)(a) -- --------- --------- --------- ---------- Total net revenues 987,549 29,264 (1,795) 1,015,018 --------- --------- --------- ---------- Cost of goods sold from unaffiliated customers 496,620 6,208 -- 502,828 Group cost of goods sold -- 1,795 (1,795)(a) -- --------- --------- --------- ---------- Total cost of goods sold 496,620 8,003 (1,795) 502,828 --------- --------- --------- ---------- Gross profit 490,929 21,261 -- 512,190 Operating expenses: Marketing and sales 126,702 7,677 4,471 (c) 138,850 General and administrative 69,611 7,370 -- 76,981 Research and development 182,935 59,712 38,824 (b) 281,471 Network development and support -- 38,824 (38,824)(b) -- Carriage fee -- 4,471 (4,471)(c) -- Amortization of intangibles 9,645 4,406 -- 14,051 --------- --------- --------- ---------- Total operating expenses 388,893 122,460 -- 511,353 --------- --------- --------- ---------- Operating income (loss) 102,036 (101,199) -- 837 Interest and other income, net 10,387 241 -- 10,628 --------- --------- --------- ---------- Income (loss) before provision for income taxes and minority interest 112,423 (100,958) -- 11,465 Provision for income taxes 3,554 -- -- 3,554 --------- --------- --------- ---------- Income (loss) before minority interest 108,869 (100,958) -- 7,911 Minority interest in consolidated joint venture (1,113) -- -- (1,113) --------- --------- --------- ---------- Net income (loss) before retained interest in EA.com $ 107,756 $(100,958) $ -- $ 6,798 ========= ========= ========= ========== Allocation of retained interest (in thousands): Nine Months Ended December 31, 2000 ------------------------------------------------------ EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- ---------- Net income (loss) before retained interest in EA.com $ 107,756 $(100,958) $ -- $ 6,798 Net loss related to retained interest in EA.com (85,814) 85,814 -- -- --------- --------- --------- ---------- Net income (loss) $ 21,942 $ (15,144) $ -- $ 6,798 ========= ========= ========= ========== </TABLE> 27
<TABLE> <CAPTION> Nine Months Ended December 31, 1999 ------------------------------------------------------ EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts ---------- --------- --------- ---------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $1,111,598 $ 14,100 $ -- $1,125,698 Group sales 1,465 -- (1,465)(a) -- ---------- --------- --------- ---------- Total net revenues 1,113,063 14,100 (1,465) 1,125,698 ---------- --------- --------- ---------- Cost of goods sold from unaffiliated customers 558,845 3,976 -- 562,821 Group cost of goods sold -- 1,465 (1,465)(a) -- ---------- --------- --------- ---------- Total cost of goods sold 558,845 5,441 (1,465) 562,821 ---------- --------- --------- ---------- Gross profit 554,218 8,659 -- 562,877 Operating expenses: Marketing and sales 145,417 2,005 -- 147,422 General and administrative 65,924 2,322 -- 68,246 Research and development 152,077 22,877 12,071 (b) 187,025 Network development and support -- 12,071 (12,071)(b) -- Carriage fee -- -- -- -- Amortization of intangibles 7,742 58 -- 7,800 ---------- --------- --------- ---------- Total operating expenses 371,160 39,333 -- 410,493 ---------- --------- --------- ---------- Operating income (loss) 183,058 (30,674) -- 152,384 Interest and other income, net 11,653 -- -- 11,653 ---------- --------- --------- ---------- Income (loss) before provision for income taxes and minority interest 194,711 (30,674) -- 164,037 Provision for income taxes 50,852 -- -- 50,852 ---------- --------- --------- ---------- Income (loss) before minority interest 143,859 (30,674) -- 113,185 Minority interest in consolidated joint venture 134 -- -- 134 ---------- --------- --------- ---------- Net income (loss) $ 143,993 $ (30,674) $ -- $ 113,319 ========== ========= ========= ========== <FN> - ---------- (a) Represents elimination of intercompany sales of Electronic Arts packaged goods products to EA.com, and represents elimination of royalties paid to Electronic Arts by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support to Research and Development. (c) Represents reclassification of amortization of the AOL carriage fee to marketing. </FN> </TABLE> 28
The following table presents pro-forma results of operations allocating taxes between EA Core and EA.com. Consolidated taxes have been allocated to EA Core and EA.com on a pro rata basis based on the consolidated effective tax rates, thereby giving EA.com the tax benefit of its losses which is utilized by the consolidated group. Such tax benefit could not be recognized by EA.com on a stand-alone basis. The sum of tax expense and tax benefit for EA Core and EA.com is the same as consolidated tax expense and tax benefit. This presentation represents how management analyzes each segment of the business (in thousands): <TABLE> <CAPTION> Three Months Ended December 31, 2000 ----------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- <S> <C> <C> <C> <C> Income (loss) before provision for (benefit from) income taxes and minority interest $ 177,640 $ (49,582) $ -- $ 128,058 Provision for (benefit from) income taxes 55,068 (15,370) -- 39,698 --------- --------- --------- --------- Income (loss) before minority interest 122,572 (34,212) -- 88,360 Minority interest in consolidated joint venture (382) -- -- (382) --------- --------- --------- --------- Net income (loss) $ 122,190 $ (34,212) $ -- $ 87,978 ========= ========= ========= ========= Three Months Ended December 31, 1999 ----------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- Income (loss) before provision for (benefit from) income taxes and minority interest $ 152,195 $ (18,277) $ -- $ 133,918 Provision for (benefit from) income taxes 46,755 (5,541) -- 41,214 --------- --------- --------- --------- Income (loss) before minority interest 105,440 (12,736) -- 92,704 Minority interest in consolidated joint venture 157 -- -- 157 --------- --------- --------- --------- Net income (loss) $ 105,597 $ (12,736) $ -- $ 92,861 ========= ========= ========= ========= Nine Months Ended December 31, 2000 ----------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- Income (loss) before provision for (benefit from) income taxes and minority interest $ 112,423 $(100,958) $ -- $ 11,465 Provision for (benefit from) income taxes 34,851 (31,297) -- 3,554 --------- --------- --------- --------- Income (loss) before minority interest 77,572 (69,661) -- 7,911 Minority interest in consolidated joint venture (1,113) -- -- (1,113) --------- --------- --------- --------- Net income (loss) $ 76,459 $ (69,661) $ -- $ 6,798 ========= ========= ========= ========= Nine Months Ended December 31, 1999 ----------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts --------- --------- --------- --------- Income (loss) before provision for (benefit from) income taxes and minority interest $ 194,711 $ (30,674) $ -- $ 164,037 Provision for (benefit from) income taxes 60,361 (9,509) -- 50,852 --------- --------- --------- --------- Income (loss) before minority interest 134,350 (21,165) -- 113,185 Minority interest in consolidated joint venture 134 -- -- 134 --------- --------- --------- --------- Net income (loss) $ 134,484 $ (21,165) $ -- $ 113,319 ========= ========= ========= ========= </TABLE> 29
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income Information about our costs and expenses, interest and other income, net, income taxes and net income for the three and nine months ended December 31, 2000 and 1999 is presented below: Percent of Net Percent of Net Revenues Revenues Three Months Nine Months Ended Dec 31, Ended Dec 31, -------------- ------------- 2000 1999 2000 1999 ---- ---- ---- ---- Cost of goods sold 47.8% 49.8% 49.5% 50.0% Marketing and sales 10.2 11.2 13.7 13.1 General and administrative 4.5 4.7 7.6 6.1 Research and development (includes Network development and support) 17.2 12.2 27.7 16.6 Amortization of intangibles 0.7 0.5 1.4 0.7 Interest and other income, net 0.4 0.7 1.0 1.0 Income taxes - effective tax rate 31.0 30.8 31.0 31.0 Net income 13.7% 15.5% 0.7% 10.1% Cost of Goods Sold. Cost of goods sold as a percentage of net revenues decreased for the three months and nine months ended December 31, 2000 compared to the same period last year primarily due to: * An increase in sales of higher margin PC titles. The current year included higher sales on higher margin internally developed titles such as The Sims, Command & Conquer Red Alert 2, and The Sims: Livin' Large. * The introduction of higher margin PlayStation 2 products in the current year. * A decrease in sales of lower margin AL and N64 titles. * Offset by a decrease in sales of PlayStation titles combined with the decrease in average margins on PlayStation products due to a decrease in the average sales price on front line and catalogue products. Marketing and Sales. Marketing and sales expenses for the three months ended December 31, 2000 decreased as a percentage of revenue, primarily attributed to: * Lower television and print advertising in North America and Europe. * Offset by an increase in EA.com marketing and sales expense due to increased staff required to support the live game site and advertising campaigns run on the AOL service promoting the Games Channel. In future periods, EA.com intends to further increase marketing and advertising spending in order to promote our game site and the Games Channel on AOL. * Offset by the amortization of the AOL carriage fee, which began with the launch of EA.com in October of the current fiscal year. The Carriage Fee will be amortized straight-line over the term of the AOL agreement. 30
Marketing and sales expenses for the nine months ended December 31, 2000 increased as a percentage of revenue, primarily attributed to: * Higher EA.com marketing and sales expense due to increased staff required to support the live game site and advertising campaigns run on the AOL service promoting the Games Channel. In future periods, EA.com intends to further increase marketing and advertising spending in order to promote our game site and the Games Channel on AOL. * The amortization of the AOL carriage fee, which began with the launch of EA.com in October of the current fiscal year. The Carriage Fee will be amortized straight-line over the term of the AOL agreement. * Offset by lower television and print advertising in North America and Europe due to fewer number of releases compared to the same period last year. * Offset by a decrease in cooperative advertising associated with lower revenues in North America. General and Administrative. General and administrative expenses increased for the three months ended December 31, 2000 in absolute dollars by 0.9% and increased 12.8% for the nine months ended December 31, 2000, primarily attributed to: * The expansion of the EA.com staff and additional administrative-related costs required to support the growth of the EA.com business. We anticipate a continued increase in the absolute dollars spent on general and administrative related expenses. * Increase in depreciation expense for Europe due to the implementation of a new transaction processing system. Research and Development (excluding Network Development and Support). Research and development expenses increased for the three months ended December 31, 2000 in absolute dollars by 34.1% and 38.7% for the nine months ended December 31, 2000, primarily attributed to: * Increase in research and development expenses by EA.com (including expenses incurred by EA core on behalf of EA.com) due to an increase in the number of online projects in development and increased development staff to support these products. This includes headcount-related costs associated with the acquisition of Kesmai in the fourth quarter of fiscal 2000. The type of games that will be in development will most likely increase in complexity and depth. To support this effort, EA.com may be required to increase its development and production expenses. * An increase in development spending for next generation console products including development for the PlayStation 2 console. * The increase is also due to research and development expenses related to the acquisition of DreamWorks Interactive, a software development company, in the fourth quarter of the prior fiscal year. Network Development and Support. The increase in network development and support expenses was primarily due to increased spending for the EA.com network infrastructure, the formation of the support organization for the live game site and the Games Channel on the AOL service and the amortization of capitalized costs associated with the pre-launch network infrastructure build including costs capitalized in accordance with SOP 98-1. The amortization cost for the quarter associated with the launch of the website in October 2000 was $1,900,000. 31
As a result, we expect network development and support expenses to increase in absolute dollars in the future. Amortization of Intangibles. The amortization of intangibles results primarily from the acquisitions of Westwood, Kesmai, DreamWorks Interactive, ABC Software and other acquisitions. Amortization of intangibles was $3,184,000 for EA Core and $1,497,000 for EA.com for the three months ended December 31, 2000. Amortization of intangibles was $2,567,000 for EA Core and $29,000 for EA.com for the three months ended December 31, 1999. Amortization of intangibles was $9,645,000 for EA Core and $4,406,000 for EA.com for the nine months ended December 31, 2000. Amortization of intangibles was $7,742,000 for EA Core and $58,000 for EA.com for the nine months ended December 31, 1999. Interest and Other Income, Net. Interest and other income, net, decreased in absolute dollars for the three months and nine months ended December 31, 2000 primarily due to gains on the sale of marketable securities in the prior year. Income Taxes. Our effective tax rate was 31% for the nine months ended December 31, 2000 and 1999. The effective tax rate was 31% and 30.8% for the three months ended December 31, 2000 and 1999, respectively. Net Income. In absolute dollars, reported net income decreased for the three months ended December 31, 2000 primarily related to higher product development expenses, as a percent of net revenues, compared to the same period last year. The increase in development expense is due to an increase in the number of products in development by EA Core and EA.com and higher network development and support costs in preparation for new online products and the launch of our game site on the worldwide web and the AOL service which occurred in October 2000. In absolute dollars, reported net income decreased for the nine months ended December 31, 2000 primarily related to lower revenues as well as higher costs and expenses compared to the same period last year. The decrease was also due to an increase in the number of products in development by EA Core and EA.com and higher network development and support costs in preparation for new online products and the launch of our game site on the worldwide web and the AOL service which occurred in October 2000. Excluding goodwill and non-cash compensation charges in the amount of $3,479,000, net of taxes, for the three months ended December 31, 2000, net income would have been $91,457,000. Excluding goodwill and non-cash compensation charges in the amount of $1,995,000, net of taxes, for the three months ended December 31, 1999, net income would have been $94,856,000. Excluding goodwill and non-cash compensation charges in the amount of $11,028,000, net of taxes, for the nine months ended December 31, 2000, net income would have been $17,826,000. Excluding goodwill and non-cash compensation charges in the amount of $5,833,000, net of taxes, for the nine months ended December 31, 1999, net income would have been $119,152,000. 32
LIQUIDITY AND CAPITAL RESOURCES As of December 31, 2000, our working capital was $489,357,000 compared to $440,021,000 at March 31, 2000. Cash, cash equivalents and short-term investments decreased by approximately $44,427,000 during the nine months ended December 31, 2000 as we used $104,860,000 of cash in capital expenditures, offset by $60,862,000 provided through the sale of equity securities under our stock plans, $3,958,000 of proceeds from the sale of property and equipment and $1,325,000 provided by operating activities. Reserves for bad debts and sales returns increased from $65,067,000 at March 31, 2000 to $82,660,000 at December 31, 2000. Reserves have been charged for returns of product and price protection credits issued for products sold in prior periods. Management believes these reserves are adequate based on historical experience and its current estimate of potential returns and allowances. Our principal source of liquidity is $295,377,000 in cash, cash equivalents and short-term investments. Management believes the existing cash, cash equivalents, short-term investments, marketable securities and cash generated from operations will be sufficient to meet cash and investment requirements on both a short-term and long-term basis. Included in the amounts above is the following for the EA.com business: * To date, EA.com has been funded solely by Electronic Arts. No interest charge has been reflected in the accompanying consolidated financial statements. Excess cash generated from operations is transferred to Electronic Arts. We anticipate these funding procedures will continue in the near-term. Electronic Arts may, at its discretion, provide funds to EA.com under a debt arrangement, instead of treating such funding as a capital contribution. * During the nine months ended December 31, 2000, EA.com used $93,934,000 of cash in operations, $65,418,000 in capital expenditures for computer equipment, network infrastructure and related software (including $41,263,000 of consulting, hardware, software and direct payroll and payroll-related costs associated with the implementation of customized internal-use software), offset by $159,667,000 provided through the capital contribution from Electronic Arts. * As of December 31, 2000, the Company has $8,375,000 of capitalized costs associated with the effort to build the EA.com website and infrastructure that have been put into service related to SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". As of October 2000, EA.com began to amortize $39,100,000 of costs associated with this pronouncement. Impact of Recently Issued Accounting Standards In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation (an interpretation of APB Opinion No. 25)". FIN 44 clarifies the application of APB Opinion No. 25 for certain 33
issues: (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. Generally, FIN 44 is effective July 1, 2000. The adoption of FIN 44 did not have a material impact on the Company's consolidated financial position or results of operations. In March 2000, the Emerging Issues Task Force issued No. 00-03 ("EITF 00-03"), "Application of AICPA SOP 97-2, "Software Revenue Recognition," to Arrangements That Include the Right to Use Software Stored on Another Entity's Hardware", which discusses the effect on revenue recognition of a software vendor's obligation to host its software that previously was licensed to a customer. The EITF has reached the conclusion that, if the customer is unable to utilize the software on the customer's hardware or contract with another party unrelated to the vendor to host the software, then the arrangement with the customer is outside the scope of SOP 97-2 and should be treated as a service contract. The adoption of EITF 00-03 did not have a material impact on the Company's financial position and results of operations. In March 2000, the Emerging Issues Task Force issued No. 00-02 ("EITF 00-02"), "Accounting for Web Site Development Costs". EITF 00-02 states that all costs relating to software used to operate a web site and relating to development of initial graphics and web page design should be accounted for using Statement of Position ("SOP") 98-1. Under this SOP, costs incurred in the preliminary project stage should be expensed as incurred, as should most training and data conversion costs. External direct costs of materials and services and internal direct payroll-related costs should be capitalized once certain criteria are met. EITF 00-02 is effective for all fiscal quarters beginning after June 30, 2000. The Company's accounting policy for internal-use software, as required by SOP 98-1, incorporated the requirements of EITF 00-02. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101("SAB 101"), "Revenue Recognition," which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC. SAB 101 is effective the fourth fiscal quarter of fiscal years beginning after December 15, 1999 as amended by SAB 101B. The Company believes the adoption of SAB 101 will not have a material impact on the Company's financial position and results of operations. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No. 133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133" which establishes accounting and reporting standards for derivative instruments and hedging activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning of the first quarter of the fiscal year beginning after June 15, 2000. The Company is determining the effect of SFAS 133, 137 and 138 on its financial statements. 34
RISK FACTORS Electronic Arts' business is subject to many risks and uncertainties which may affect our future financial performance. Some of those important risks and uncertainties which may cause our operating results to vary or which may materially and adversely affect our operating results are as follows: Risk Factors Relating to Our Core Business Platform Transitions Such as the One Now Occurring Typically Depress the Market for Video Game Software Until New Platforms Achieve a Wide Market Acceptance When new video game platforms are announced or introduced into the market, consumers typically reduce their purchases of video games for current platforms in anticipation of new platforms being available. During that period, sales of our video game products can be expected to slow or even decline until new platforms have achieved a wide market and consumer acceptance. We are currently in such a transition. Sony shipped its PlayStation 2 product in Japan, North America and Europe in calendar year 2000. For the December quarter, manufacturing shortages, resulting in the delay of a significant number of shipments of PlayStation 2 units in North America and Europe, have adversely affected our results of operations. Consequently, these manufacturing shortages pose serious uncertainty for our current fourth quarter and fiscal year results. In addition, Nintendo and Microsoft have announced that their new console systems will be released in calendar year 2001. Current sales of our products for the existing PlayStation and Nintendo 64 platforms have been adversely affected. We expect this trend to continue until one or more of these new consoles achieve a wide installed base of consumers. New Video Game Platforms Create Additional Technical and Business Model Uncertainties Large portions of our revenues are derived from the sale of products for play on proprietary video game platforms such as the Sony PlayStation. The success of our products is significantly affected by acceptance of the new video game hardware systems and the life span of older hardware platforms and our ability to accurately predict which platforms will be most successful. Sometimes we will spend development and marketing resources on products designed for new video game systems that have not yet achieved large installed bases or will continue product development for older hardware platforms that may have shorter life cycles than we expected. Conversely, if we do not develop for a platform that achieves significant market acceptance, or discontinue development for a platform that has a longer life cycle than expected, our revenue growth may be adversely affected. For example, the Sega Dreamcast console launched in Japan in early 1999 and in the United States in September of 1999. We have developed no products for this platform. Had this platform achieved wide market acceptance, our revenue growth would have been adversely affected. Similarly, we released a variety of products for the new Sony platform, the PlayStation 2. The shortages of PlayStation 2 units has adversely affected our results, and if 35
that platform does not achieve wide acceptance by consumers, we will have spent a disproportionate amount of our resources for this platform. Additionally, we have not negotiated a publishing agreement with Nintendo for their next generation platform and we do not know whether the terms of this agreement will be favorable. Product Development Schedules Are Frequently Unreliable and Make Predicting Quarterly Results Difficult Product development schedules, particularly for new hardware platforms and high-end multimedia personal computers, or PCs, are difficult to predict because they involve creative processes, use of new development tools for new platforms and the learning process, research and experimentation associated with development for new technologies. For example, The World is Not Enough for the PlayStation 2 and EMPEROR: Battle for Dune for the PC, which were expected to ship in fiscal 2001 will not be released until fiscal 2002 due to development delays. Additionally, development risks for CD-ROM products can cause particular difficulties in predicting quarterly results because brief manufacturing lead times allow finalizing products and projected release dates late in a quarter. Our revenues and earnings are dependent on our ability to meet our product release schedules, and our failure to meet those schedules could result in revenues and earnings which fall short of analysts' expectations for any individual quarter and the fiscal year. Our Business Is Both Seasonal and Cyclical Our business is highly seasonal with a significant percentage of our revenues occurring in the December quarter. In our fourth quarter of fiscal 2001, we expect these seasonal trends to be magnified by general industry factors, including the current platform transition, the manufacturing shortages for the PlayStation 2 as noted above, and the economic slowdown in the United States. In addition, we are continuing to invest significantly in our online operation, EA.com. Our business is also cyclical; video game platforms have historically had a life cycle of four to six years, and decline as more advanced platforms are being introduced. As one group of platforms is reaching the end of its cycle and new platforms are emerging, buying patterns may change. Purchases of products for older platforms may slow at a faster rate than sales of new platforms. We are currently in such a platform transition. Sega introduced its latest platform in calendar year 1999, and Sony shipped its PlayStation 2 console in Japan, North America and Europe in calendar year 2000. Nintendo and Microsoft have announced that their new console systems will be released in calendar year 2001. Sales of our current products for the current Nintendo and Sony platforms have already been adversely affected, and we expect this trend to continue until one or more new platforms achieves a wide installed base of consumers. The Impact of e-Commerce and Online Games on Our Business Is Not Known While we do not currently derive significant revenues from online sales of our packaged products, we believe that such form of distribution will become a more significant factor in our business in the future. E-commerce is becoming an increasingly popular method for conducting business with consumers. How that form of distribution will affect the more traditional retail distribution, at which we have historically had success, and over what time period, is uncertain. In addition, we expect the number and popularity of online games to increase and become a significant factor in the interactive games business generally. We do not know how that 36
increase generally, or the emerging business of EA.com specifically, will affect the sales of packaged goods. Our Business, Our Products, and Our Distribution Are Subject to Increasing Regulation in Key Territories Legislation is increasingly introduced which may affect the content of our products and their distribution. For example, privacy rules in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory while of course the Internet recognizes no geographical boundaries. Other countries such as Germany have adopted laws regulating content transmitted over the Internet that are stricter than current United States laws. In the United States, in response to recent events, the federal and several state governments are considering content restrictions on products such as those made by us as well as restrictions on distribution of such products. Any one or more of these factors could harm our business. Our Platform Licensors Are Our Chief Competitors and Frequently Control the Manufacturing of Our Video Game Products Our agreements with hardware licensors, which are also our chief competitors, typically give significant control to the licensor over the approval and manufacturing of our products. This fact could, in certain circumstances, leave us unable to get our products approved, manufactured and shipped to customers. In most events, control of the approval and manufacturing process by the platform licensors increases both our manufacturing lead times and costs as compared to those we can achieve independently. For example, in prior years, we experienced delays in obtaining approvals for and manufacturing of PlayStation products which caused delays in shipping those products. The potential for additional delay or refusal to approve or manufacture our products continues with our platform licensors. Such occurrences would harm our business and adversely affect our financial performance. Proliferation and Assertion of Patents Poses Serious Risks to our Business Many patents have been issued that may apply to widely used game technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of existing games. Several such patents have been asserted against us. For example, we currently have a lawsuit pending regarding our publication of games that can be played both alone and with others over the Internet in which the patent holder has moved to enjoin the sale of EA personal computer products that can be played alone and over the Internet. Such claims can harm our business. We will incur substantial expenses in evaluating and defending against such claims, regardless of the merits of the claims. In the event that there is a determination that we have infringed a third party patent, we could incur significant monetary liability and be prevented from using the rights in the future. 37
Risk Factors Relating to Our Online Business Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate its Business and Prospects EA.com's business is still in the developing stages, so evaluating its business and prospects will be more difficult than would be the case for a more mature business. We will continue to encounter the risks and difficulties faced in launching a new business, and we may not achieve our goals or may be compelled to change the manner in which we seek to develop the business. These uncertainties as to the future operations of EA.com will increase the difficulty we face in completing and pursuing the essential plans for the development of the business and will also make it more difficult for our stockholders and securities analysts to predict the operating results of this business. EA.com Has a History of Losses and Expects To Continue To Incur Losses and May Never Achieve Profitability EA.com has incurred substantial losses to date, including the current fiscal year. We expect EA.com to continue to incur losses as it develops its business. EA.com will be required to maintain the significant support, service and product enhancement demands of online users, and we cannot be certain that EA.com will produce sufficient revenues from its operations to support these costs. Even if profitability is achieved, EA.com may not be able to sustain it over a period of time. Our Agreements with America Online May Not Prove Successful to the Development of EA.com's Business We have a series of agreements with America Online ("AOL") for the offering of our games for online play. These agreements require that we make substantial guaranteed payments to AOL and that we commit our resources to the pursuit of the online game opportunity. We cannot be assured that the substantial costs associated with the AOL agreements will be justified by the revenues generated from that relationship. In addition, restrictions included in the AOL agreements limiting other channels we may develop for offering online games may limit our ability to diversify our online distribution strategies. The success for us of the AOL agreements will also be a result of AOL's performance under the agreements, a factor over which we will have very little control. We Have Very Limited Experience with Online Games and May Not Be Able To Operate This Business Effectively Offering games solely for online play is a substantial departure from our traditional business of selling packaged software games. We have employed various pricing models, including subscription fees, "pay to play fees" and advertising. We have very little experience with developing optimal pricing strategies for online games and no experience in "pay to play" pricing or in securing advertising revenue for online services. Similarly, we are inexperienced in predicting usage patterns for our games. Because of our inexperience in this area, we may not be effective in achieving success that may otherwise be attainable from offering our games online. 38
Online Games Have Risks That Are Not Associated with Our Traditional Business Online games, particularly multiplayer games, pose risks to player enjoyment that do not generally apply to packaged game sales. Players frequently would not be acquainted with other players, which may adversely affect the playing experience. Social issues raised by a player's conduct may impact the experience for other players. We have not determined whether or how we might monitor or proctor player behavior that impairs the game experience. In addition, there are substantial technical challenges to be met both in the introduction of our games online and in maintaining an effective game playing environment over time. Also, hacking and spamming has become a serious problem for online sites, and significant hacking and spamming could seriously interfere with online game play. If these risks are not successfully controlled and technical challenges resolved, potential customers for our games may be unwilling to play in sufficient volume to allow us to attain or sustain profitability. We May Not Be Able To Obtain the Required Licenses To Offer Our Games Online If we are unable to reach terms with certain licensors for our games, we will not be able to offer certain of our games for online play. Many of Electronic Arts' most popular games feature characters, trademarks, people or concepts for which we have licenses from third parties. As an example, our EA SPORTS products typically contain content licensed from a sports and players' association. In certain instances, the terms of these licenses will not allow us to offer the games for online play without negotiating an additional license. We cannot be certain that the licensors will be amenable to a license for online games involving their content or, even if they are, that we will be able to reach terms with them for such use. We may be forced to agree to terms that ultimately materially impair the economic value to us of the online game market. Proliferation and Assertion of Patents Poses Serious Risks to the Business of EA.com Many patents have been issued that may apply to widely used Internet technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of older technologies. Several such patents have been asserted against us. For example, we currently have a lawsuit pending regarding our publication of games that can be played both alone and with others over the Internet in which the patent holder has moved to enjoin the sale of EA personal computer products that can be played alone and over the Internet. Such claims can harm our business. We will incur substantial expenses in evaluating and defending against such claims, regardless of the merits of the claims. In the event that there is a determination that we have infringed a third party patent, we could incur significant monetary liability and be prevented from using the rights in the future. Development of EA.com's Business Will Require Significant Capital, and We Cannot Be Assured That It Will Be Available EA.com will not be successful if it does not receive the very substantial financing that will be required to launch its business. Electronic Arts has agreed to provide a limited amount of funding to EA.com, but this financing alone will not be sufficient for the development of EA.com's business. Any additional funding that is obtained from EA may either be treated as a revolving credit advance or would increase EA's retained interest in EA.com and correspondingly decrease the interest of the holders of outstanding shares of Class B common stock. The attraction of additional equity or debt financing for EA.com from third parties may 39
not be possible or may only be possible on terms that result in significant dilution to Class A and Class B common stockholders or interest or other costs and debt-related restrictions on the operation of the business. If Use of the Internet Does Not Continue To Develop and Reliably Support the Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed EA.com's success depends upon growth in the use of the Internet as a medium for playing games. The use of the Internet for sophisticated games like ours is relatively new. Our business would be seriously harmed if: * use of the Internet does not continue to increase or increases more slowly than expected, * the infrastructure for the Internet does not effectively support online game play, * concerns over the secure transmission of confidential information over public networks inhibit the growth of the Internet as a means of conducting commercial transactions, or * government regulations regarding Internet content, privacy or other conditions impede the effectiveness of the Internet to users. Capacity Restraints May Restrict the Use of the Internet as a Forum for Game Play, Resulting in Decreased Demand for Our Products The Internet infrastructure may not be able to support the demands placed on it by increased usage or the limited capacity of networks to transmit large amounts of data. Other risks associated with commercial use of the Internet could slow its growth, including: * outages and other delays resulting from the inadequate reliability of the network infrastructure, * slow development of enabling technologies and complementary products, and * limited availability of cost-effective, high speed access. Delays in the development or adoption of new equipment standards or protocols required to handle increased levels of Internet activity, or increased governmental regulation, would cause the Internet to fail to gain, or lose, viability as a means of game playing. If these or any other factors cause use of the Internet for commerce to slow or decline, the Internet may not prove viable as a commercial marketplace. This, in turn, would result in decreased demand for EA.com's products and services. 40
To Become and Remain Competitive, EA.com Must Continually Develop and Expand New Content. This Is Inherently Risky and Expensive. EA.com's success depends on our ability to develop products and services for the EA.com site and our ability to continually expand the content on that site. Our agreement with AOL requires us to develop new games under our relationship with AOL. We cannot assure you that products will be developed on time, in a cost effective manner, or that they will be successful. We May Not Be Able To Respond to Rapid Technological Change The market for Internet products and services is characterized by rapid technological change and evolving industry standards. Both in completing the design and implementation of our network infrastructure and thereafter, we will be required to continually improve performance, features, reliability and capacity of our network infrastructure. We cannot assure you that we will be successful in responding rapidly or in a cost effective manner to such developments. Increasing Governmental Regulation of the Internet Could Limit the Market for Our Products As Internet commerce continues to evolve, we expect that federal, state and foreign governments will adopt laws and regulations covering issues such as user privacy, taxation of goods and services provided over the Internet, pricing, content and quality of products and services. It is possible that legislation could expose companies involved in electronic commerce to liability, taxation or other increased costs, any of which could limit the growth of electronic commerce generally. Legislation could dampen the growth in Internet usage and decrease its acceptance as a communications and commercial medium. If enacted, these laws and regulations could limit the market for EA.com's products. If We Do Not Maintain Our Relationship with Outside Consultants, Our Ability To Develop Our Online Business Will Be Impaired Because approximately 16% of the staff creating, designing, and developing the infrastructure for EA.com's website and network interface is being provided by outside consultants, losing the business relationship with such consultants would cause EA.com to lose an important component of its website implementation team. Given the intense competition for qualified technical consultants, EA.com may not be able to retain these consultants or, if necessary, replace them. If it cannot do so, its ability to develop its business will be impaired. Our Revenues Have Been Heavily Dependent on a Single Product and Would Be Adversely Affected if That Product's Popularity Were To Decline In the near term, EA.com's revenues to date have consisted primarily of revenues from sales of our online product Ultima Online, and we would be adversely affected if revenues from that product were to decline for any reason and not be replaced. We expect the online game market to become increasingly competitive, and it is possible that other producer's current or future games could cause our revenue from Ultima Online to decline. In addition, 41
popularity of Ultima Online could decline over time simply because of consumer preference for new game experiences. We Invest Very Heavily in Research and Development and Network Development and Support for EA.com, and We Cannot Be Assured That We Will Achieve Revenues That Validate This Level of Spending We have invested, and expect to continue to invest, very heavily in research and development and network development and support for our website and online games. We will need to expand EA.com's revenues substantially for it to achieve profitability with these levels of expenditure being required, and we may not be able to do so. If we cannot increase revenues to profitable levels, the value of EA.com will be impaired. In order to develop the broad games offerings that we envision for our online operations it will be necessary to engage in significant developmental efforts both to adapt existing EA games to the online format and to create new online games. Our agreements with AOL require us to maintain a substantial commitment to online game development and we cannot be assured that we will realize acceptable returns from this investment. Online Product Development Schedules Are Unreliable and Make Predicting Quarterly Results Difficult Online product development schedules, particularly for Internet based games are difficult to predict because they involve creative processes, use of new development tools, Internet latency issues, a learning process to better understand Internet based game mechanics, and research and experimentation associated with development for new online technologies. Additionally, development risks for Internet based products can cause particular difficulties in predicting quarterly results because of the challenges associated with game testing, live Beta testing, integration into network servers and integration on to the Games web site and may impact the release ("go live") dates of products during a particular quarter. Several online products currently under development are experiencing development delays and will be released later than planned. Our revenues and operating costs are dependent on our ability to meet our product "go live" schedules, and our failure to meet those schedules could result in revenues falling short of analysts' expectations, with no corresponding decrease in expenses, resulting in increased operating losses for EA.com. General Risk Factors Because of the Intense Competition for Qualified Technical, Creative, Marketing and Other Personnel, We May Not Be Able To Attract and Retain the Personnel Necessary for our Businesses The market for technical, creative, marketing and other personnel essential to the development of online businesses and management of our online and core businesses continues to be extremely competitive, and we may not be able to attract and retain the employees we need. In addition, the cost of real estate in the San Francisco Bay area - the location of our headquarters and largest studio has increased dramatically, and has made recruiting from other areas and relocating employees to our headquarters more difficult. If we cannot successfully 42
recruit and retain the employees we need, our ability to develop and manage our businesses will be impaired. Foreign Sales and Currency Fluctuations For the nine months ended December 31, 2000 international net revenues comprised 37% of total consolidated net revenues. For the fiscal year ended March 31, 2000 international net revenues comprised 40% of total consolidated net revenues. We expect foreign sales to continue to account for a significant and growing portion of our revenues. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies which may fluctuate. While we hedge against foreign currency fluctuations, we cannot control translation issues. For example, our European revenues in the nine months ended December 31, 2000 were adversely impacted by a devaluation of the Euro and British Pound as compared to the prior year. The devaluation will have an adverse effect for the year on our sales and net income. Any of these factors may significantly harm our business. Increased Difficulties in Forecasting Results During platform transition periods, where the success of our products is significantly impacted by the changing market for our products, forecasting our revenues and earnings is more difficult than in more stable or rising product markets. The demand for our products may decline during a transition faster than we anticipate, negatively impacting both revenues and earnings. At launch, Sony shipped only half of the number of PlayStation 2 units to retail in North America than it had originally planned, and it shipped significantly fewer units than planned at launch in Europe as well. Shortages were announced as being caused by shortages of components for manufacturing. Due to these shortages, our results of operations for the quarter ended December 31, 2000 have been adversely affected. Consequently, depending on the number and the timing of units actually available for the quarter ended March 31, 2001, these shortages may adversely impact our sales of PlayStation 2 products for the fourth quarter and fiscal year. We cannot predict the impact of recent actions and comments by the SEC and FASB Recent actions and comments from the SEC have focused on the integrity of financial reporting. In addition, the FASB and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, some of which represent a significant change from current industry practices. For example, in December 1999, the SEC issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB 101 provides guidance on the recognition, presentation, and disclosure of revenue in financial statements of all public registrants. In response to numerous requests for interpretive guidance of SAB 101, the effective date of the standard has been delayed twice. SAB 101 became effective during the first quarter of fiscal 2001. SAB 101 did not have a material effect on the underlying strength or weakness of our consolidated business operations as measured by the dollar value of our product shipments and cash flows. 43
Fluctuations in Stock Price Due to analysts' expectations of continued growth and other factors, any shortfall in earnings could have an immediate and significant adverse effect on the trading price of our common stock in any given period. As a result of the factors discussed in this report and other factors that may arise in the future, the market price of our common stock historically has been, and we expect will continue to be subject to significant fluctuations over a short period of time. These fluctuations may be due to factors specific to us, to changes in analysts' earnings estimates, or to factors affecting the computer, software, Internet, entertainment, media or electronics businesses or the securities markets in general. For example, during fiscal year ended March 31, 2000, the price per share of our common stock ranged from $22.82 to $60.47 and $26.59 to $55.38 during the nine months ended December 31, 2000. Because of these and other factors affecting our operating results and financial condition, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. 44
Item 3: Quantitative and Qualitative Disclosures About Market Risk Market Risk We are exposed to various market risks, including the changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from changes in market rates and prices. Foreign exchange contracts used to hedge foreign currency exposures and short-term investments are subject to market risk. We do not consider our cash and cash equivalents to be subject to interest rate risk due to their short maturities. We do not enter into derivatives or other financial instruments for trading or speculative purposes. Foreign Currency Exchange Rate Risk We utilize foreign exchange contracts to hedge foreign currency exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies thereby limiting our risk. Gains and losses on foreign exchange contracts are reflected in the income statement. At December 31, 2000, we had foreign exchange contracts, all with maturities of less than six months to purchase and sell approximately $395,982,000 in foreign currencies, primarily British Pounds, European Currency Units ("Euro"), Canadian Dollars, Japanese Yen and other currencies. Fair value represents the difference in value of the contracts at the spot rate and the forward rate. The counter parties to these contracts are substantial and creditworthy multinational commercial banks. The risks of counter party nonperformance associated with these contracts are not considered to be material. Notwithstanding our efforts to manage foreign exchange risks, there can be no assurances that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. The table below provides information about our foreign currency forward exchange contracts at December 31, 2000. The information is provided in U.S. dollar equivalents and presents the notional amount (forward amount), the weighted average contractual foreign currency exchange rates and fair value. Weighted- Average Contract Amount Contract Rate Fair Value --------------- ------------- ---------- (in thousands) (in thousands) Foreign currency to be sold under contract: British Pound $200,457 1.4675 $(3,850) Euro 91,578 0.9022 (4,068) Canadian Dollar 22,238 1.5064 (106) Japanese Yen 12,820 110.76 409 Sweden Krone 9,518 9.5611 (149) South African Rand 4,347 7.5914 (7) Australian Dollar 3,744 0.5349 (167) Norway Krone 3,131 8.9418 (48) Denmark Krone 3,043 8.2166 (113) Swiss Franc 2,367 1.6903 (115) Brazilian Real 902 1.9950 (21) -------- ------- ------- 45
Total $354,145 $(8,235) -------- ------- ------- Foreign currency to be purchased under contract: British Pound $ 41,837 1.4957 $(1,134) -------- ------- ------- Total $ 41,837 $(1,134) -------- ------- Grand Total $395,982 $(9,369) ======== ======= While the contract amounts provide one measurement of the volume of these transactions, they do not represent the amount of our exposure to credit risk. The amounts (arising from the possible inabilities of counterparties to meet the terms of their contracts) are generally limited to the amounts, if any, by which the counterparties' obligations exceed our obligations as these contracts can be settled on a net basis at our option. We control credit risk through credit approvals, limits and monitoring procedures. Interest Rate Risk Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We manage our interest rate risk by maintaining an investment portfolio primarily consisting of debt instruments of high credit quality and relatively short average maturities. We also manage our interest rate risk by maintaining sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity. At December 31, 2000, our cash equivalents, short-term and long-term investments included debt securities of $203,603,000. Notwithstanding our efforts to manage interest rate risks, there can be no assurances that we will be adequately protected against the risks associated with interest rate fluctuations. The table below presents the amounts and related weighted-average interest rates of our investment portfolio at December 31, 2000: Average Interest Rate Cost Fair Value ------------- -------- ---------- (Dollars in thousands) Cash equivalents Fixed rate 0.00% $ -- $ -- Variable rate 6.19% $124,116 $124,116 Short-term investments Fixed rate 4.07% $ 60,798 $ 61,087 Variable rate 6.22% $ 10,000 $ 10,000 Long-term investments Fixed rate 0.00% $ -- $ -- Variable rate 6.35% $ 8,400 $ 8,509 Maturity dates for short-term investments range from 6 months to 3 years. 46
PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is subject to pending claims. Management, after review and consultation with counsel, considers that any liability from the disposition of such lawsuits in the aggregate would not have a material adverse effect upon the consolidated financial position or results of operations of the Company. Item 4. Submission of Matters to a Vote of Security Holders None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - the following exhibit is filed as part of this report: 10.45 Master Lease and Deed of Trust by and between Registrant and Selco Service Corporation, dated December 6, 2000. (b) Reports on Form 8-K: None 47
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ELECTRONIC ARTS INC. (Registrant) /s/ E. STANTON MCKEE ------------------------------------------ DATED: E. STANTON MCKEE February 13, 2001 Executive Vice President and Chief Financial and Administrative Officer 48
ELECTRONIC ARTS INC. AND SUBSIDIARIES FORM 10-Q QUARTERLY REPORT FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2000 EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT TITLE PAGE - ------ ------------- ---- 10.45 Master Lease and Deed of Trust by and between Registrant and Selco Service Corporation, dated December 6, 2000 50 49