UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended December 31, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ______ to_____ Commission File No. 0-17948 ELECTRONIC ARTS INC. (Exact name of registrant as specified in its charter) Delaware 94-2838567 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 209 Redwood Shores Parkway Redwood City, California 94065 (Address of principal executive offices) (Zip Code) (650) 628-1500 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO _____ ------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock Par Value February 6, 2002 --------------------- --------- ---------------- Class A common stock $0.01 137,939,831
ELECTRONIC ARTS INC. AND SUBSIDIARIES INDEX <TABLE> <CAPTION> Part I - Financial Information Page - -------------------------------- ---- <S> <C> Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets at December 31, 2001 and March 31, 2001 3 Condensed Consolidated Statements of Operations for the Three Months Ended December 31, 2001 and 2000 and the Nine Months Ended December 31, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2001 and 2000 5 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 53 Part II - Other Information - --------------------------- Item 1. Legal Proceedings 55 Item 4. Submission of Matters to a Vote of Security Holders 55 Item 6. Exhibits and Reports on Form 8-K 55 Signatures 56 - ---------- </TABLE> 2
PART I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands) (unaudited) <TABLE> <CAPTION> December 31, March 31, 2001 2001 ------------------------------ <S> <C> <C> ASSETS Current assets: Cash, cash equivalents and short-term investments $ 486,842 $ 466,492 Marketable securities 7,282 10,022 Receivables, less allowances of $139,898 and $89,833, respectively 463,384 174,449 Inventories, net 24,918 15,686 Deferred income taxes 57,126 57,082 Other current assets 129,537 94,996 ---------- ---------- Total current assets 1,169,089 818,727 Property and equipment, net 322,790 337,199 Long-term investments 8,400 8,400 Investments in affiliates 18,213 19,052 Goodwill and other intangibles, net 116,161 136,764 Long-term deferred income taxes 2,945 2,926 Other assets 57,775 55,850 ---------- ---------- $1,695,373 $1,378,918 ========== ========== LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 153,699 $ 73,061 Accrued and other liabilities 367,537 266,965 ---------- ---------- Total current liabilities 521,236 340,026 Minority interest in consolidated joint venture 3,592 4,545 Stockholders' equity: Preferred stock, $0.01 par value. Authorized 10,000,000 shares - - Common stock Class A common stock, $0.01 par value. Authorized 400,000,000 shares; issued 137,950,866 and 134,714,464 shares; outstanding 137,670,866 and 134,714,464 shares, respectively 1,380 1,347 Class B common stock, $0.01 par value. Authorized 100,000,000 shares; issued and outstanding 6,233,413 and 6,250,000 shares, respectively 62 63 Paid-in capital 632,930 540,354 Treasury stock, at cost; 280,000 shares at December 31, 2001 (11,922) - Retained earnings 559,500 505,286 Accumulated other comprehensive loss (11,405) (12,703) ---------- ---------- Total stockholders' equity 1,170,545 1,034,347 ---------- ---------- $1,695,373 $1,378,918 ========== ========== </TABLE> See accompanying notes to condensed consolidated financial statements. 3
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended December 31, December 31, 2001 2000 2001 2000 -------------------------------------------------------- <S> <C> <C> <C> <C> Net revenues $ 832,878 $ 640,319 $ 1,254,984 $ 1,015,018 Cost of goods sold 400,853 306,797 607,642 505,364 ----------- ----------- ----------- ----------- Gross profit 432,025 333,522 647,342 509,654 ----------- ----------- ----------- ----------- Operating expenses: Marketing and sales 93,875 65,389 179,699 138,845 General and administrative 31,833 28,480 80,451 76,981 Research and development 97,406 109,604 285,766 278,940 Amortization of intangibles 6,359 4,681 19,309 14,051 Restructuring and asset impairment charges 14,051 -- 14,051 -- ----------- ----------- ----------- ----------- Total operating expenses 243,524 208,154 579,276 508,817 ----------- ----------- ----------- ----------- Operating income 188,501 125,368 68,066 837 Interest and other income, net 3,515 2,690 10,292 10,628 ----------- ----------- ----------- ----------- Income before provision for income taxes and minority interest 192,016 128,058 78,358 11,465 Provision for income taxes 59,525 39,698 24,291 3,554 ----------- ----------- ----------- ----------- Income before minority interest 132,491 88,360 54,067 7,911 Minority interest in consolidated joint venture (199) (382) 147 (1,113) ----------- ----------- ----------- ----------- Net income $ 132,292 $ 87,978 $ 54,214 $ 6,798 =========== =========== =========== =========== Class A common stock: Net income: Basic $ 138,998 $ 95,416 $ 72,387 $ 21,942 =========== =========== =========== =========== Diluted $ 132,292 $ 87,978 $ 54,214 $ 6,798 =========== =========== =========== =========== Net income per share: Basic $ 1.01 $ 0.72 $ 0.53 $ 0.17 Diluted $ 0.92 $ 0.63 $ 0.38 $ 0.05 Number of shares used in computation: Basic 137,103 132,339 136,457 130,716 Diluted 143,399 138,904 142,847 137,372 Class B common stock: Net loss, net of retained interest in EA.com $ (6,706) $ (7,438) $ (18,173) $ (15,144) =========== =========== =========== =========== Net loss per share: Basic $ (1.11) $ (1.24) $ (3.02) $ (2.52) Diluted $ (1.11) $ (1.24) $ (3.02) $ (2.52) Number of shares used in computation: Basic 6,028 6,000 6,023 6,000 Diluted 6,028 6,000 6,023 6,000 </TABLE> See accompanying notes to condensed consolidated financial statements. 4
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (unaudited) <TABLE> <CAPTION> Nine Months Ended December 31, 2001 2000 ---------------------- <S> <C> <C> Operating activities: Net income $ 54,214 $ 6,798 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Minority interest in consolidated joint venture (147) 1,113 Equity in net (gain) loss of affiliates (2,134) 452 Gain on sale of affiliate (200) (214) Depreciation and amortization 83,551 50,272 Non-cash restructuring and asset impairment charges 6,503 -- Loss on sale of fixed assets 372 1,542 Bad debt expense 7,142 6,091 Tax benefit from exercise of stock options 16,789 15,332 Change in assets and liabilities: Receivables (296,077) (128,488) Inventories (9,232) 3,134 Other assets (46,892) (9,814) Accounts payable 80,638 (29,511) Accrued and other liabilities 95,364 83,652 Deferred income taxes (497) 966 --------- --------- Net cash provided by (used in) operating activities (10,606) 1,325 --------- --------- Investing activities: Proceeds from sale of property and equipment 258 3,958 Purchase of marketable securities, net -- (2,479) Proceeds from sale of affiliate 570 -- Capital expenditures (40,056) (104,860) Investment in affiliates, net 2,918 662 Change in short-term investments, net (64,624) 22,443 --------- --------- Net cash used in investing activities (100,934) (80,276) --------- --------- Financing activities: Proceeds from sales of shares through employee stock plans and other plans 75,819 60,862 Purchase of treasury shares (11,922) -- --------- --------- Net cash provided by financing activities 63,897 60,862 --------- --------- Translation adjustment 2,369 (3,886) --------- --------- Decrease in cash and cash equivalents (45,274) (21,975) Beginning cash and cash equivalents 419,812 246,265 --------- --------- Ending cash and cash equivalents 374,538 224,290 Short-term investments 112,304 71,087 --------- --------- Ending cash, cash equivalents and short-term investments $ 486,842 $ 295,377 ========= ========= </TABLE> 5
ELECTRONIC ARTS INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (Dollars in thousands) (unaudited) Nine Months Ended December 31, 2001 2000 ------------------ Supplemental cash flow information: - ----------------------------------- Cash paid during the year for income taxes $ 7,582 $10,706 ======= ======= Non-cash investing activities: - ------------------------------ Change in unrealized appreciation (depreciation) of investments and marketable securities $(1,443) $ 9,458 ======= ======= See accompanying notes to condensed consolidated financial statements. 6
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 1. Basis of Presentation The condensed consolidated financial statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. Certain amounts have been reclassified to conform to the fiscal 2002 presentation. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Electronic Arts Inc. (the "Company") Annual Report on Form 10-K for the fiscal year ended March 31, 2001 as filed with the Securities and Exchange Commission ("Commission") on June 29, 2001. Note 2. Fiscal Year and Fiscal Quarter The Company's fiscal year is reported on a 52/53-week period that ends on the Saturday nearest to March 31 in each year. The results of operations for fiscal 2002 will contain 52 weeks. The results of operations for fiscal 2001 contained 53 weeks. Accordingly, the results of operations for the first three quarters of fiscal 2002 and the first three quarters of fiscal 2001 contain 39 weeks and 40 weeks, respectively. For clarity of presentation, all fiscal periods are treated as ending on a calendar month end. Note 3. Tracking Stock On March 22, 2000, the shareholders of Electronic Arts authorized the issuance of a new series of common stock, designated as Class B common stock ("Tracking Stock"). The Tracking Stock is intended to reflect the performance of Electronic Arts' online and e-Commerce division ("EA.com"). As a result of the approval of the Tracking Stock Proposal, Electronic Arts' existing common stock has been re-classified as Class A common stock and that stock reflects the performance of Electronic Arts' other businesses ("EA Core"). Note 4. Common Stock At the Company's Annual Meeting of Stockholders, held on August 1, 2001, the stockholders elected to amend the 2000 Class A Equity Incentive Plan to increase by 6,000,000 the number of shares of the Company's Class A common stock reserved for issuance under the Plan. 7
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Note 5. Treasury Stock In September 2001, the Board of Directors approved a plan to purchase up to two million shares of the Company's Class A common stock. For the nine months ended December 31, 2001, the Company repurchased 280,000 shares for approximately $11,922,000 under the program. None of these shares were reissued as of December 31, 2001. Note 6. Prepaid Royalties Prepaid royalties consist primarily of prepayments for manufacturing royalties, original equipment manufacturer (OEM) fees and license fees paid to celebrities, professional sports organizations and other organizations for use of their trade name and content. Also included in prepaid royalties are prepayments made to independent software developers under development arrangements that have alternative future uses. Prepaid royalties are expensed at the contractual or effective royalty rate as cost of goods sold based on actual net product sales. Management evaluates the future realization of prepaid royalties quarterly and charges to the Statement of Operations any amounts that management deems unlikely to be realized through product sales. Royalty advances are classified as current and non-current assets based upon estimated net product sales for the following year. The current portion of prepaid royalties, included in other current assets, was $68,545,000 and $46,264,000 at December 31, 2001 and March 31, 2001, respectively. The long-term portion of prepaid royalties, included in other assets, was $11,363,000 and $9,664,000 at December 31, 2001 and March 31, 2001, respectively. Note 7. Inventories Inventories are stated at the lower of cost or market. Inventories at December 31, 2001 and March 31, 2001 consisted of (in thousands): =============================================================================== December 31, 2001 March 31, 2001 - ------------------------------------------------------------------------------- Raw materials and work in process $ 3,216 $ 976 Finished goods 21,702 14,710 - ------------------------------------------------------------------------------- $ 24,918 $ 15,686 =============================================================================== 8
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Note 8. Accrued and Other Liabilities Accrued and other liabilities at December 31, 2001 and March 31, 2001 consisted of (in thousands): ============================================================================== December 31, 2001 March 31, 2001 - ------------------------------------------------------------------------------ Accrued royalties $ 115,860 $ 55,997 Accrued compensation and benefits 81,306 75,603 Accrued expenses 77,756 67,957 Accrued income taxes 64,114 42,371 Deferred revenue 15,527 16,967 Warranty reserve 12,974 8,070 - ------------------------------------------------------------------------------ $ 367,537 $ 266,965 ============================================================================== Note 9. Segment Information Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures About Segments of An Enterprise And Related Information", establishes standards for the reporting by public business enterprises of information about operating segments, product lines, geographic areas and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company's chief operating decision maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region and by product lines for purposes of making operating decisions and assessing financial performance. The Company operates in two principal business segments globally: . EA Core business segment: creation, marketing and distribution of entertainment software. . EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising. Please see the discussion regarding segment reporting in the MD&A. 9
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Information about the Company's business segments is presented below for the three and nine months ended December 31, 2001 and 2000 (in thousands): <TABLE> <CAPTION> - --------------------------------------------------------------------------------------------------------------------------- Three Months Ended December 31, 2001 EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - --------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $ 810,930 $ 21,948 $ - $ 832,878 Group sales 1,877 - (1,877) (a) - - --------------------------------------------------------------------------------------------------------------------------- Total net revenues 812,807 21,948 (1,877) 832,878 - --------------------------------------------------------------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 397,138 3,715 - 400,853 Group cost of goods sold - 1,877 (1,877) (a) - - --------------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 397,138 5,592 (1,877) 400,853 - --------------------------------------------------------------------------------------------------------------------------- Gross profit 415,669 16,356 - 432,025 Operating expenses: Marketing and sales 84,192 5,217 4,466 (c) 93,875 General and administrative 29,116 2,717 - 31,833 Research and development 66,030 13,935 17,441 (b) 97,406 Network development and support - 14,858 (14,858)(b) - Customer relationship management - 2,583 (2,583)(b) - Carriage fee - 4,466 (4,466)(c) - Amortization of intangibles 3,205 3,154 - 6,359 Restructuring and asset impairment charges - 14,051 - 14,051 - --------------------------------------------------------------------------------------------------------------------------- Total operating expenses 182,543 60,981 - 243,524 - --------------------------------------------------------------------------------------------------------------------------- Operating income (loss) 233,126 (44,625) - 188,501 Interest and other income (expense), net 3,597 (82) - 3,515 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 236,723 (44,707) - 192,016 Provision for income taxes 59,525 - - 59,525 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest 177,198 (44,707) - 132,491 Minority interest in consolidated joint venture (199) - - (199) - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 176,999 $ (44,707) $ - $ 132,292 =========================================================================================================================== Interest income $ 3,025 $ 8 $ - $ 3,033 Depreciation and amortization 13,438 14,819 - 28,257 Identifiable assets 1,502,949 192,424 - 1,695,373 Capital expenditures 8,660 1,685 - 10,345 </TABLE> 10
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) <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 2,761 - 306,797 Group cost of goods sold - 752 (752)(a) - - --------------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 304,036 3,513 (752) 306,797 - --------------------------------------------------------------------------------------------------------------------------- Gross profit 325,861 7,661 - 333,522 Operating expenses: Marketing and sales 56,690 4,233 4,466 (c) 65,389 General and administrative 25,722 2,758 - 28,480 Research and development 65,081 23,223 21,300 (b) 109,604 Network development and support - 18,640 (18,640)(b) - Customer relationship management - 2,660 (2,660)(b) - Carriage fee - 4,466 (4,466)(c) - Amortization of intangibles 3,184 1,497 - 4,681 - --------------------------------------------------------------------------------------------------------------------------- Total operating expenses 150,677 57,477 - 208,154 - --------------------------------------------------------------------------------------------------------------------------- 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> 11
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) <TABLE> <CAPTION> =========================================================================================================================== Nine Months Ended December 31, 2001 EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - --------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $1,201,407 $ 53,577 $ - $1,254,984 Group sales 2,927 - (2,927)(a) - - --------------------------------------------------------------------------------------------------------------------------- Total net revenues 1,204,334 53,577 (2,927) 1,254,984 - --------------------------------------------------------------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 598,395 9,247 - 607,642 Group cost of goods sold - 2,927 (2,927)(a) - - --------------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 598,395 12,174 (2,927) 607,642 - --------------------------------------------------------------------------------------------------------------------------- Gross profit 605,939 41,403 - 647,342 Operating expenses: Marketing and sales 150,002 16,299 13,398 (c) 179,699 General and administrative 72,535 7,916 - 80,451 Research and development 185,138 45,232 55,396 (b) 285,766 Network development and support - 46,903 (46,903)(b) - Customer relationship management - 8,493 (8,493)(b) - Carriage fee - 13,398 (13,398)(c) - Amortization of intangibles 9,615 9,694 - 19,309 Restructuring and asset impairment charges - 14,051 - 14,051 - --------------------------------------------------------------------------------------------------------------------------- Total operating expenses 417,290 161,986 - 579,276 - --------------------------------------------------------------------------------------------------------------------------- Operating income (loss) 188,649 (120,583) - 68,066 Interest and other income (expense), net 10,865 (573) - 10,292 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 199,514 (121,156) - 78,358 Provision for income taxes 24,291 - - 24,291 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest 175,223 (121,156) - 54,067 Minority interest in consolidated joint venture 147 - - 147 - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 175,370 $ (121,156) $ - $ 54,214 =========================================================================================================================== Interest income $ 12,493 $ 43 $ - $ 12,536 Depreciation and amortization 38,267 45,284 - 83,551 Capital expenditures 27,609 12,447 - 40,056 </TABLE> 12
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (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 8,744 - 505,364 Group cost of goods sold - 1,795 (1,795)(a) - - --------------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 496,620 10,539 (1,795) 505,364 - --------------------------------------------------------------------------------------------------------------------------- Gross profit 490,929 18,725 - 509,654 Operating expenses: Marketing and sales 126,702 7,677 4,466 (c) 138,845 General and administrative 69,611 7,370 - 76,981 Research and development 182,935 55,562 40,443 (b) 278,940 Network development and support - 34,096 (34,096)(b) - Customer relationship management - 6,347 (6,347)(b) - Carriage fee - 4,466 (4,466)(c) - Amortization of intangibles 9,645 4,406 - 14,051 - --------------------------------------------------------------------------------------------------------------------------- Total operating expenses 388,893 119,924 - 508,817 - --------------------------------------------------------------------------------------------------------------------------- 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> (a) Represents elimination of intercompany sales of EA Core packaged goods products to EA.com, and represents elimination of royalties paid to EA Core by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. (c) Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. 13
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Information about the Company's operations in the North America and foreign areas for the three and nine months ended December 31, 2001 and 2000 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, 2001 - ------------------------------------ Net revenues from unaffiliated customers $ 510,752 $279,601 $21,801 $20,724 $ - $ 832,878 Intercompany revenues 1,222 17,262 2,753 55 (21,292) - -------------------------------------------------------------------------------- Total net revenues 511,974 296,863 24,554 20,779 (21,292) 832,878 ================================================================================ Operating income 71,022 116,770 167 700 (158) 188,501 Interest income 2,742 254 37 - - 3,033 Depreciation and amortization 24,204 3,632 250 171 - 28,257 Identifiable assets 1,202,728 440,991 29,368 22,286 - 1,695,373 Capital expenditures 7,331 2,340 437 237 - 10,345 Long-lived assets 351,891 164,079 4,522 4,406 - 524,898 Nine months ended December 31, 2001 - ----------------------------------- Net revenues from unaffiliated customers $ 783,369 $392,615 $39,859 $39,141 $ - $1,254,984 Intercompany revenues 3,553 26,708 6,860 55 (37,176) - -------------------------------------------------------------------------------- Total net revenues 786,922 419,323 46,719 39,196 (37,176) 1,254,984 ================================================================================ Operating income (loss) (24,683) 92,648 (129) (302) 532 68,066 Interest income 10,974 1,392 170 - - 12,536 Depreciation and amortization 72,408 10,044 616 483 - 83,551 Capital expenditures 29,941 8,604 710 801 - 40,056 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 </TABLE> 14
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Information about the Company's net revenues by product line for the three and nine months ended December 31, 2001 and 2000 is presented below: <TABLE> <CAPTION> ====================================================================================== (In thousands) Three Months Ended Nine Months Ended December 31, December 31, 2001 2000 2001 2000 - -------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> PlayStation 2 $227,554 $144,611 $ 369,836 $ 157,629 PC 194,856 152,689 318,818 303,445 PlayStation 122,940 183,309 162,129 277,967 Xbox 44,629 - 44,629 - Game Boy Advance 30,543 - 30,543 - Nintendo GameCube 30,026 - 30,026 - Game Boy Color 24,176 - 28,455 - Advertising 10,556 2,591 25,317 2,591 License, OEM and Other 9,384 5,218 17,868 14,953 N64 8,437 49,241 17,064 60,008 Online Subscriptions 7,002 6,753 22,146 22,209 Online Packaged Goods 1,992 557 2,532 1,951 Affiliated Label 120,783 95,350 185,621 174,265 - -------------------------------------------------------------------------------------- $832,878 $640,319 $1,254,984 $1,015,018 ====================================================================================== </TABLE> Note 10. Comprehensive Income The components of comprehensive income, net of tax, for the three and nine months ended December 31, 2001 and 2000 were as follows (in thousands): <TABLE> <CAPTION> ====================================================================================================== Three Months Ended Nine Months Ended December 31, December 31, 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> Net income $132,292 $87,978 $54,214 $ 6,798 - ------------------------------------------------------------------------------------------------------ Other comprehensive income: Change in unrealized appreciation (depreciation) of investments, net of tax expense (benefit) of $356, $(112), $434 and $(536) 1,982 (100) (1,877) 9,994 Foreign currency translation adjustments (839) 2,280 3,175 (3,463) - ------------------------------------------------------------------------------------------------------ Total other comprehensive income 1,143 2,180 1,298 6,531 - ------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------ Total comprehensive income $133,435 $90,158 $55,512 $13,329 ====================================================================================================== </TABLE> The currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries. 15
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Note 11. Net 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. Net income (loss) per share is computed individually for Class A common stock and Class B common stock. Please see the discussion regarding segment reporting in the MD&A. <TABLE> <CAPTION> (in thousands, except per share amounts): - --------------------------------------------------------------------------------------------------------- Three months ended December 31, 2001 Class A common Class A common Class B common stock-Basic stock-Diluted stock - --------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Net income (loss) before retained interest in EA.com $176,999 $132,292 $(44,707) Net loss related to retained interest in EA.com (38,001) - 38,001 - --------------------------------------------------------------------------------------------------------- Net income (loss) $138,998 $132,292 $ (6,706) - --------------------------------------------------------------------------------------------------------- Shares used to compute net income (loss) per share: Weighted-average common shares 137,103 137,103 6,028 Dilutive stock equivalents - 6,296 - - --------------------------------------------------------------------------------------------------------- Dilutive potential common shares 137,103 143,399 6,028 ========================================================================================================= - --------------------------------------------------------------------------------------------------------- Net income (loss) per share: Basic $ 1.01 N/A $ (1.11) Diluted N/A $0.92 $ (1.11) - --------------------------------------------------------------------------------------------------------- </TABLE> 16
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) <TABLE> <CAPTION> (in thousands, except per share amounts): - ------------------------------------------------------------------------------------------------------ Nine months ended December 31, 2001 Class A common Class A common Class B common stock-Basic stock-Diluted stock - ------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> Net income (loss) before retained interest in EA.com $175,370 $ 54,214 $ (121,156) Net loss related to retained interest in EA.com (102,983) - 102,983 - ------------------------------------------------------------------------------------------------------ Net income (loss) $ 72,387 $ 54,214 $ (18,173) - ------------------------------------------------------------------------------------------------------ Shares used to compute net income (loss) per share: Weighted-average common shares 136,457 136,457 6,023 Dilutive stock equivalents - 6,390 - - ------------------------------------------------------------------------------------------------------ Dilutive potential common shares 136,457 142,847 6,023 ====================================================================================================== - ------------------------------------------------------------------------------------------------------ Net income (loss) per share: Basic $ 0.53 N/A $ (3.02) Diluted N/A $ 0.38 $ (3.02) - ------------------------------------------------------------------------------------------------------ <CAPTION> - ------------------------------------------------------------------------------------------------------ Three months ended December 31, 2000 Class A common Class A common Class B common stock-Basic stock-Diluted stock - ------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> Net income (loss) before retained interest in EA.com $137,560 $ 87,978 $ (49,582) Net loss related to retained interest in EA.com (42,144) - 42,144 - ------------------------------------------------------------------------------------------------------ Net income (loss) $ 95,416 $ 87,978 $ (7,438) - ------------------------------------------------------------------------------------------------------ Shares used to compute net income (loss) per share: Weighted-average common shares 132,339 132,339 6,000 Dilutive stock equivalents - 6,565 - - ------------------------------------------------------------------------------------------------------ Dilutive potential common shares 132,339 138,904 6,000 ====================================================================================================== - ------------------------------------------------------------------------------------------------------ Net income (loss) per share: Basic $ 0.72 N/A $ (1.24) Diluted N/A $ 0.63 $ (1.24) - ------------------------------------------------------------------------------------------------------ </TABLE> 17
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------ Nine months ended December 31, 2000 Class A common Class A common Class B common stock-Basic stock-Diluted stock - ------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> Net income (loss) before retained interest in EA.com $107,756 $ 6,798 $ (100,958) Net loss related to retained interest in EA.com (85,814) - 85,814 - ------------------------------------------------------------------------------------------------------ Net income (loss) $ 21,942 $ 6,798 $ (15,144) - ------------------------------------------------------------------------------------------------------ Shares used to compute net income (loss) per share: Weighted-average common shares 130,716 130,716 6,000 Dilutive stock equivalents - 6,656 - - ------------------------------------------------------------------------------------------------------ Dilutive potential common shares 130,716 137,372 6,000 ====================================================================================================== - ------------------------------------------------------------------------------------------------------ Net income (loss) per share: Basic $ 0.17 N/A $ (2.52) Diluted N/A $ 0.05 $ (2.52) - ------------------------------------------------------------------------------------------------------ </TABLE> 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 was $132,292,000 and $87,978,000 for the three months ended December 31, 2001 and 2000, respectively. Net income used for the calculation of Diluted EPS for Class A common stock was $54,214,000 and $6,798,000 for the nine months ended December 31, 2001 and 2000, respectively. This net income includes the remaining 15% interest in EA.com, which is directly attributable to outstanding Class B shares owned by third parties, which would be included in the Class A common stock EPS calculation in the event that the initial public offering for Class B common stock does not occur. Excluded from the above computation of weighted-average shares for Diluted EPS for Class A common stock were options to purchase 1,729,312 and 1,425,157 shares of common stock for the three and nine months ended December 31, 2001, respectively, as the options' exercise price was greater than the average market price of the common shares. Excluded from the above computation of weighted-average shares for Diluted EPS for Class A common stock 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. Due to the net loss attributable for the three and nine months ended December 31, 2001 and 2000 on a diluted basis to Class B Stockholders, stock options have been excluded from the 18
ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued) Diluted EPS calculation as their inclusion would have been antidilutive. Had net income been reported for the three and nine months ended December 31, 2001, an additional 828,000 and 884,000 shares would have been added to diluted potential common shares for Class B common stock, respectively. For the three and nine months ended December 31, 2000, an additional 1,016,000 and 287,000 shares would have been added to diluted potential common shares for Class B common stock. Note 12. Restructuring and Asset Impairment Charges During the quarter ended December 31, 2001, the Company announced a restructuring plan for EA.com to reduce its workforce and consolidate facilities. These restructuring and resulting asset impairment charges were necessary in order to focus on key online priorities and reduce EA.com's operating cost structure. The Company recorded total charges of $14,051,000, consisting of $3,763,000 for workforce reductions, $3,785,000 for consolidation of facilities and other administrative charges and $6,503,000 for the write-off of non-current assets. The restructuring plan resulted in the termination of approximately 240 personnel, or one-third of EA.com's workforce, which affected all departments across the organization. The estimated costs for consolidation of facilities is comprised of contractual rental commitments under real estate leases for unutilized office space offset by estimated future sub-lease income. Included in these costs are estimated costs to close offices or consolidate facilities in various locations and costs to writeoff a portion of the assets from these facilities. In addition, the restructuring efforts required an evaluation of asset impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", to write these depreciable assets and certain intangibles to their fair value. Restructuring and asset impairment charges for the three months ended December 31, 2001 were as follows (in thousands): <TABLE> <CAPTION> - ---------------------------------------------------------------------------------------------------- Expense Recorded Unutilized in the Quarter balance as of Ended Cash Non-cash December 31, December 31, 2001 Utilization Utilization 2001 - ---------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Workforce $ 3,763 $2,871 $ - $ 892 Facilities 3,785 132 - 3,653 Non-current assets 6,503 - 6,503 - - ---------------------------------------------------------------------------------------------------- Total $14,051 $3,003 $6,503 $4,545 ==================================================================================================== </TABLE> The restructuring accrual is included in accrued expenses in Note 8 of the Notes to Condensed Consolidated Financial Statements. 19
ITEM 2: Management's Discussion and Analysis Of Financial Condition and Results Of Operations This Quarterly Report, on Form 10-Q and, in particular, the following "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements about circumstances that have not yet occurred. All statements, trend analysis and other information contained below relating to markets, our products and trends in revenue, as well as other statements including words such as "anticipate", "believe" or "expect" and statements in the future tense are forward-looking statements. These forward-looking statements are subject to business and economic risks and actual events or our actual future results could differ materially from those set forth in the forward-looking statements due to such risks and uncertainties. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results and performance include, but are not limited to, those discussed under the heading "Risk Factors" at pages 45 to 52, as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 2001 as filed with the Securities and Exchange Commission on June 29, 2001 and other documents filed with the Commission. We derive revenues primarily from shipments of entertainment software, which includes EA Studio products for dedicated entertainment systems (that we call video game systems or consoles such as PlayStation, PlayStation 2, Xbox and Nintendo GameCube, and handheld systems such as Game Boy Advance), EA Studio personal computer products (or PC), Co-Publishing products that are co-published and distributed by us, and Affiliated Label (or AL) products that are published by third parties and distributed by us. We also derive revenues from licensing of EA Studio products and AL products through hardware companies (or OEM), selling subscriptions on our online gaming service, selling advertisements on our online web pages and selling our packaged goods through our online store. Information about our net revenues for North America and foreign areas for the three and nine months ended December 31, 2001 and 2000 is summarized below (in thousands): <TABLE> <CAPTION> December 31, December 31, 2001 2000 Increase % change ------------------------------------------------------------------------ <S> <C> <C> <C> <C> Net Revenues for the Three Months Ended: North America $510,752 $416,904 $ 93,848 22.5% ------------------------------------------------------------------------- Europe 279,601 189,943 89,658 47.2% Asia Pacific 21,801 19,887 1,914 9.6% Japan 20,724 13,585 7,139 52.6% ------------------------------------------------------------------------- International 322,126 223,415 98,711 44.2% ------------------------------------------------------------------------- Consolidated Net Revenues $832,878 $640,319 $192,559 30.1% ========================================================================= </TABLE> 20
<TABLE> <CAPTION> December 31, December 31, Increase/ 2001 2000 (Decrease) % change -------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net Revenues for the Nine Months Ended: North America $ 783,369 $ 641,502 $141,867 22.1% -------------------------------------------------------------------------- Europe 392,615 291,786 100,829 34.6% Asia Pacific 39,859 41,526 (1,667) (4.0)% Japan 39,141 40,204 (1,063) (2.6)% -------------------------------------------------------------------------- International 471,615 373,516 98,099 26.3% -------------------------------------------------------------------------- Consolidated Net Revenues $1,254,984 $1,015,018 $239,966 23.6% ========================================================================== </TABLE> North America Net Revenues The increase in North America net revenues for the three and nine months ended December 31, 2001 compared to the same periods last year was primarily attributable to: . A 57% increase in PlayStation 2 revenues for the quarter and 179% for the nine months ended December 31, 2001 due to the shipment of key titles such as Madden NFL 2002, James Bond 007...Agent Under Fire, NBA Live 2002, SSX Tricky and NASCAR Thunder 2002, a higher installed base of hardware and a strong catalogue business. PlayStation 2 launched in October of fiscal 2001. Consequently, fiscal 2001 includes three months of revenues as compared to nine months of revenues from the PlayStation 2 in fiscal 2002. . The launch of the Xbox platform in North America in November 2001 generated $44,629,000 in revenue from titles such as Madden NFL 2002, NBA Live 2002, NASCAR Thunder 2002, NHL 2002 and SSX Tricky. We commenced generating revenues for this platform following its North American launch in November 2001. . The launch of Nintendo GameCube in North America in November 2001 generated $27,511,000 for the quarter from key titles such as Madden NFL 2002, SSX Tricky and FIFA Soccer 2002. . New revenues were generated by Game Boy Advance of $18,690,000 for the quarter from key titles including Harry Potter and the Sorcerer's Stone and Madden NFL. Also, Game Boy Color generated new revenues of $10,345,000 for the quarter and $13,652,000 for the nine months ended December 31, 2001 for titles such as Harry Potter and the Sorcerer's Stone, Madden NFL 2002 and The World Is Not Enough. . Advertising revenues increased by 307% for the quarter and 877% for the nine months ended December 31, 2001 as we commenced generating advertising revenues immediately following the launch of our gamesite on the world wide web in October 2000. In addition, advertising revenues were generated from Pogo Corporation's ("Pogo") websites subsequent to the February 2001 acquisition. . These increases were partially offset by the continued expected decrease in Sony PlayStation, which had fewer titles shipping compared to the same periods in the prior year, and Nintendo 64 revenues due to a declining market. International Net Revenues The increase in international net revenues for the three months ended December 31, 2001 compared to the three months ended December 31, 2000 was attributable to the following: . Europe's net revenues increased 47% compared to the prior year primarily due to the shipment of Harry Potter and the Sorcerer's Stone on four platforms, higher PlayStation 2 21
revenues driven by key titles such as James Bond 007...Agent Under Fire and FIFA Soccer 2002, and higher AL revenue resulting primarily from the addition of Capcom as an AL in Europe. These increases were partially offset by the expected decrease of revenues from Sony PlayStation. . Japan's net revenues increased 53% compared to the prior year, in spite of an unfavorable exchange rate comparison of about 13%, primarily due to higher PlayStation sales for key title Harry Potter and the Sorcerer's Stone in the current fiscal year. . Asia Pacific net revenues increased 10% compared to the prior year primarily due to sales of key title Harry Potter and the Sorcerer's Stone on the PC, Game Boy Color and Game Boy Advance platforms, partially offset by decreases in PlayStation 2 sales, Nintendo 64 sales and an unfavorable exchange rate comparison. The increase in international net revenues for the nine months ended December 31, 2001 compared to the nine months ended December 31, 2000 was attributable to the following: . Europe net revenues increased by 35% compared to the prior year primarily due to higher PlayStation 2, AL and PC sales, partially offset by the expected decrease of revenues from Sony PlayStation. PlayStation 2 launched in November of fiscal 2001. Consequently, fiscal 2001 includes two months of revenues as compared to nine months of revenues from the PlayStation 2 in fiscal 2002. . The increase was partially offset by a decrease in Asia Pacific's net revenues of 4% compared to the prior year primarily due to the expected decrease in PlayStation and Nintendo 64 sales, an unfavorable exchange rate comparison and the later emergence of the PlayStation 2 in this market resulting in fewer hardware units in the area. Additionally, Asia Pacific did not benefit from our primary PlayStation 2 releases during the nine months ended December 31, 2001 which have more appeal to the North American market. . The increase was partially offset by Japan's net revenues, which decreased 3% compared to the prior year primarily due to the strong sales of our first PlayStation 2 title, FIFA Soccer World Championship, in the prior year and weakness in the Yen currency. Also, Japan did not benefit from our primary PlayStation 2 releases during the nine months ended December 31, 2001, which have more appeal to the North American market. 22
Information about our worldwide net revenues by product line for the three and nine months ended December 31, 2001 and 2000 is presented below (in thousands): <TABLE> <CAPTION> December 31, December 31, Increase/ 2001 2000 (Decrease) % change ----------------------------------------------------- <S> <C> <C> <C> <C> Net Revenues for the Three Months Ended: EA Studio: - --------- PlayStation 2 $227,554 $144,611 $ 82,943 57.4% PC 194,856 152,689 42,167 27.6% PlayStation 122,940 183,309 (60,369) (32.9)% Xbox 44,629 - 44,629 N/A Game Boy Advance 30,543 - 30,543 N/A Nintendo GameCube 30,026 - 30,026 N/A Game Boy Color 24,176 - 24,176 N/A Advertising 10,556 2,591 7,965 307.4% Online Subscriptions 7,002 6,753 249 3.7% License, OEM and Other 9,384 5,218 4,166 79.8% N64 8,437 49,241 (40,804) (82.9)% Online Packaged Goods 1,992 557 1,435 257.6% ----------------------------------------------------- 712,095 544,969 167,126 30.7% Affiliated Label: 120,783 95,350 25,433 26.7% - ----------------- ----------------------------------------------------- Consolidated Net Revenues $832,878 $640,319 $ 192,559 30.1% ===================================================== </TABLE> <TABLE> <CAPTION> December 31, December 31, Increase/ 2001 2000 (Decrease) % change ---------------------------------------------------------- <S> <C> <C> <C> <C> Net Revenues for the Nine Months Ended: EA Studio: - --------- PlayStation 2 $ 369,836 $157,629 $ 212,207 134.6% PC 318,818 303,445 15,373 5.1% PlayStation 162,129 277,967 (115,838) (41.7)% Xbox 44,629 - 44,629 N/A Game Boy Advance 30,543 - 30,543 N/A Nintendo GameCube 30,026 - 30,026 N/A Game Boy Color 28,455 - 28,455 N/A Advertising 25,317 2,591 22,726 877.1% Online Subscriptions 22,146 22,209 (63) (0.3)% License, OEM and Other 17,868 14,953 2,915 19.5% N64 17,064 60,008 (42,944) (71.6)% Online Packaged Goods 2,532 1,951 581 29.8% ---------------------------------------------------------- 1,069,363 840,753 228,610 27.2% Affiliated Label: 185,621 174,265 11,356 6.5% - ----------------- ---------------------------------------------------------- Consolidated Net Revenues $1,254,984 $1,015,018 $ 239,966 23.6% ========================================================== </TABLE> PlayStation 2 Product Net Revenues Revenues increased for the three and nine months ended December 31, 2001 due to the higher installed base of PlayStation 2 hardware and higher number of titles, including catalogue, available on the platform compared to the same periods last year. Major releases for the quarter include titles such as James Bond 007...Agent Under Fire, FIFA Soccer 2002, NBA Live 2002 and SSX Tricky. We 23
released six PlayStation 2 titles in the current quarter compared to ten in the same period last year. We released 12 PlayStation 2 titles for both the nine months ended December 31, 2001 and 2000. We expect revenues from PlayStation 2 products to continue to grow in fiscal 2002, but as revenues for these products increase, we do not expect to maintain these growth rates. Personal Computer Product Net Revenues The increase in sales of PC products for the three and nine months ended December 31, 2001 compared to the same periods last year was primarily due to the strong sales of major hits including Harry Potter and the Sorcerer's Stone, The Sims Hot Date Expansion Pack, The Sims House Party and Black and White in the current year. We released five PC titles in the third quarter of the current fiscal year and the same period last year. We released ten PC titles in the nine months ended December 31, 2001 compared to 13 in the same period last year. PlayStation Product Net Revenues We released four titles for the PlayStation console during the third quarter of fiscal 2002 compared to ten titles released in the third quarter of fiscal 2001. We released five PlayStation titles in the nine months ended December 31, 2001 compared to 16 titles in the same period last year. As expected, PlayStation sales decreased for the three and nine months ended December 31, 2001 compared to the prior year primarily attributable to the completed transition to next generation console systems and fewer titles released for the product during the current year. Sony released the PlayStation 2 worldwide in the prior year. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline significantly in fiscal 2002. Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are authorized to develop and distribute CD-based software products compatible with the PlayStation. Furthermore, under the terms of an additional licensing agreement entered into with Sony Computer Entertainment of America as of April 2000 (the "PlayStation 2 Agreement"), as amended, we are authorized to develop and distribute DVD-based software products compatible with the PlayStation 2. Pursuant to these agreements, we engage Sony to supply its PlayStation and PlayStation 2 CDs and DVDs for distribution by us. Accordingly, we have limited ability to control our supply of PlayStation and PlayStation 2 CD and DVD products or the timing of their delivery. Xbox Net Revenues Following the launch of the Xbox platform in North America in November 2001, we released our first six Xbox titles during the third quarter of fiscal 2002. Titles released included Madden NFL 2002, NBA Live 2002, NASCAR Thunder 2002, NHL 2002, SSX Tricky and F1 2001. Game Boy Advance Net Revenues We released our first two Game Boy Advance titles, Harry Potter and the Sorcerer's Stone and Madden NFL 2002, during the third quarter of fiscal 2002. Nintendo GameCube Net Revenues We released our first three Nintendo GameCube titles, Madden NFL 2002, SSX Tricky and FIFA Soccer 2002, during the third quarter of fiscal 2002 following the platform's launch in Japan in September 2001 and North America in November 2001. 24
Game Boy Color Net Revenues We released one Game Boy Color title, Harry Potter and the Sorcerer's Stone, in the third quarter of fiscal 2002. Advertising Revenues We commenced generating advertising revenues in the third quarter of fiscal year 2001 following the launch of our gamesite on the world wide web and the AOL Games Channel in October 2000. In addition, we also generated advertising revenues in the three and nine months ended December 31, 2001 related to Pogo's websites subsequent to the February 2001 acquisition. Online Subscription Net Revenues The increase in online revenues for the three months ended December 31, 2001 and slight decrease in online revenues for the nine months ended December 31, 2001 as compared to the same periods in the prior year were primarily attributable to the following: . An increase in the number of paying customers for Ultima Online to 208,000 as of December 31, 2001 as compared to 185,000 as of December 31, 2000. . The launch of Motor City Online in late October 2001. The number of subscribers to Motor City Online was 26,000 as of December 31, 2001. Of these, 12,000 had reached the end of their free period and were paying monthly subscription fees. . These increases were offset by a decrease in subscription revenues for Kesmai and Worldplay online games (most of which were transferred to our free service when the EA/AOL site went live in October 2000) for the three and nine months ended December 31, 2001. License, OEM and Other Revenues The increase in license, OEM and other revenues for the three and nine months ended December 31, 2001 was primarily due to a new OEM agreement with a customer in Europe. Nintendo 64 Product Net Revenues We released no N64 titles in the three months ended December 31, 2001 compared to two titles in the same period of the prior year. We released one N64 title in the nine months ended December 31, 2001 compared to three titles in the nine months ended December 31, 2000. The expected decrease in N64 revenues for the three and nine months ended December 31, 2001 compared to the same periods last year was primarily due to the declining market for N64 products and fewer titles released on this platform in the current fiscal year. We expect revenues from N64 products to decline significantly in fiscal 2002. Under the terms of the N64 Agreement, we engage Nintendo to manufacture our N64 cartridges for distribution by us. Accordingly, we have little ability to control our supply of N64 cartridges or the timing of their delivery. A shortage of microchips or other factors outside our control could impair our ability to obtain an adequate supply of cartridges. 25
Affiliated Label Product Net Revenues AL product sales increased for the three and nine months ended December 31, 2001 compared to the same periods last year primarily due to strong sales of hit titles including Simpsons Road Rage as well as Devil May Cry and Resident Evil: Code Veronica resulting from new distribution deals with Capcom in the current year. Operations by Segment Management considers EA.com to be separate reportable segment. We operate in two principal business segments globally (see Note 3 of the Notes to Condensed Consolidated Financial Statements): . EA Core business segment: creation, marketing and distribution of entertainment software. . EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising. EA.com represents Electronic Arts' online and e-Commerce businesses. EA.com's business includes subscription revenues collected for Internet game play on our websites, website advertising, sales of packaged goods for Internet-only based games and sales of Electronic Arts games sold through the EA.com web store. The Consolidated Statements of Operations includes all revenues and costs directly attributable to EA.com, including charges for shared facilities, functions and services used by EA.com and provided by EA Core. Certain costs and expenses have been allocated based on management's estimates of the cost of services provided to EA.com by EA Core. 26
Information about our operations by segment for the three and nine months ended December 31, 2001 and 2000 is presented below (in thousands): <TABLE> <CAPTION> - --------------------------------------------------------------------------------------------------------------------- Three Months Ended December 31, 2001 EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - --------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $810,930 $ 21,948 $ - $832,878 Group sales 1,877 - (1,877) (a) - - --------------------------------------------------------------------------------------------------------------------- Total net revenues 812,807 21,948 (1,877) 832,878 - --------------------------------------------------------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 397,138 3,715 - 400,853 Group cost of goods sold - 1,877 (1,877) (a) - - --------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 397,138 5,592 (1,877) 400,853 - --------------------------------------------------------------------------------------------------------------------- Gross profit 415,669 16,356 - 432,025 Operating expenses: Marketing and sales 84,192 5,217 4,466 (c) 93,875 General and administrative 29,116 2,717 - 31,833 Research and development 66,030 13,935 17,441 (b) 97,406 Network development and support - 14,858 (14,858) (b) - Customer relationship management - 2,583 (2,583) (b) - Carriage fee - 4,466 (4,466) (c) - Amortization of intangibles 3,205 3,154 - 6,359 Restructuring and asset impairment charges - 14,051 - 14,051 - --------------------------------------------------------------------------------------------------------------------- Total operating expenses 182,543 60,981 - 243,524 - --------------------------------------------------------------------------------------------------------------------- Operating income (loss) 233,126 (44,625) - 188,501 Interest and other income (expense), net 3,597 (82) - 3,515 - --------------------------------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 236,723 (44,707) - 192,016 Provision for income taxes 59,525 - - 59,525 - --------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest 177,198 (44,707) - 132,491 Minority interest in consolidated joint venture (199) - - (199) - --------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $176,999 $(44,707) $ - $132,292 ===================================================================================================================== </TABLE> Allocation of retained interest (in thousands): <TABLE> <CAPTION> - --------------------------------------------------------------------------------------------------------------------- Three Months Ended December 31, 2001 EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - --------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income (loss) before retained interest in EA.com $176,999 $(44,707) $ - $132,292 Net loss related to retained interest in EA.com (38,001) 38,001 - - - --------------------------------------------------------------------------------------------------------------------- Net income (loss) $138,998 $ (6,706) $ - $132,292 ===================================================================================================================== </TABLE> 27
<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 2,761 - 306,797 Group cost of goods sold - 752 (752) (a) - - -------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 304,036 3,513 (752) 306,797 - -------------------------------------------------------------------------------------------------------------------- Gross profit 325,861 7,661 - 333,522 Operating expenses: Marketing and sales 56,690 4,233 4,466 (c) 65,389 General and administrative 25,722 2,758 - 28,480 Research and development 65,081 23,223 21,300 (b) 109,604 Network development and support - 18,640 (18,640) (b) - Customer relationship management - 2,660 (2,660) (b) - Carriage fee - 4,466 (4,466) (c) - Amortization of intangibles 3,184 1,497 - 4,681 - -------------------------------------------------------------------------------------------------------------------- Total operating expenses 150,677 57,477 - 208,154 - -------------------------------------------------------------------------------------------------------------------- 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 ==================================================================================================================== </TABLE> Allocation of retained interest (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 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> 28
<TABLE> <CAPTION> - ---------------------------------------------------------------------------------------------------------------------- Nine Months Ended December 31, 2001 EA Core Adjustments and excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net revenues from unaffiliated customers $1,201,407 $ 53,577 $ - $1,254,984 Group sales 2,927 - (2,927) (a) - - ---------------------------------------------------------------------------------------------------------------------- Total net revenues 1,204,334 53,577 (2,927) 1,254,984 - ---------------------------------------------------------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 598,395 9,247 - 607,642 Group cost of goods sold - 2,927 (2,927) (a) - - ---------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 598,395 12,174 (2,927) 607,642 - ---------------------------------------------------------------------------------------------------------------------- Gross profit 605,939 41,403 - 647,342 Operating expenses: Marketing and sales 150,002 16,299 13,398 (c) 179,699 General and administrative 72,535 7,916 - 80,451 Research and development 185,138 45,232 55,396 (b) 285,766 Network development and support - 46,903 (46,903) (b) - Customer relationship management - 8,493 (8,493) (b) - Carriage fee - 13,398 (13,398) (c) - Amortization of intangibles 9,615 9,694 - 19,309 Restructuring and asset impairment charges - 14,051 - 14,051 - ---------------------------------------------------------------------------------------------------------------------- Total operating expenses 417,290 161,986 - 579,276 - ---------------------------------------------------------------------------------------------------------------------- Operating income (loss) 188,649 (120,583) - 68,066 Interest and other income (expense), net 10,865 (573) - 10,292 - ---------------------------------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 199,514 (121,156) - 78,358 Provision for income taxes 24,291 - - 24,291 - ---------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest 175,223 (121,156) - 54,067 Minority interest in consolidated joint venture 147 - - 147 - ---------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 175,370 $(121,156) $ - $ 54,214 ====================================================================================================================== </TABLE> Allocation of retained interest (in thousands): <TABLE> <CAPTION> - ---------------------------------------------------------------------------------------------------------------------- Nine Months Ended December 31, 2001 EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net income (loss) before retained interest in EA.com $ 175,370 $(121,156) $ - $ 54,214 Net loss related to retained interest in EA.com (102,983) 102,983 - - - ---------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 72,387 $ (18,173) $ - $ 54,214 ====================================================================================================================== </TABLE> 29
<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 8,744 - 505,364 Group cost of goods sold - 1,795 (1,795) (a) - - ---------------------------------------------------------------------------------------------------------------------- Total cost of goods sold 496,620 10,539 (1,795) 505,364 - ---------------------------------------------------------------------------------------------------------------------- Gross profit 490,929 18,725 - 509,654 Operating expenses: Marketing and sales 126,702 7,677 4,466 (c) 138,845 General and administrative 69,611 7,370 - 76,981 Research and development 182,935 55,562 40,443 (b) 278,940 Network development and support - 34,096 (34,096) (b) - Customer relationship management - 6,347 (6,347) (b) - Carriage fee - 4,466 (4,466) (c) - Amortization of intangibles 9,645 4,406 - 14,051 - ---------------------------------------------------------------------------------------------------------------------- Total operating expenses 388,893 119,924 - 508,817 - ---------------------------------------------------------------------------------------------------------------------- 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 ====================================================================================================================== </TABLE> Allocation of retained interest (in thousands): <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 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> (a) Represents elimination of intercompany sales of EA Core packaged goods products to EA.com, and represents elimination of royalties paid to EA Core by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. (c) Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. 30
The following table presents pro-forma results of operations allocating taxes between EA Core and EA.com. This presentation is not consistent with Generally Accepted Accounting Principles ("GAAP") reporting. 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, 2001 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 $236,723 $ (44,707) $ - $192,016 Provision for (benefit from) income taxes 73,384 (13,859) - 59,525 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest 163,339 (30,848) - 132,491 Minority interest in consolidated joint venture (199) - - (199) - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) $163,140 $ (30,848) $ - $132,292 =========================================================================================================================== <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 =========================================================================================================================== <CAPTION> - --------------------------------------------------------------------------------------------------------------------------- Nine Months Ended December 31, 2001 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 $199,514 $(121,156) $ - $ 78,358 Provision for (benefit from) income taxes 61,849 (37,558) - 24,291 - --------------------------------------------------------------------------------------------------------------------------- Income (loss) before minority interest 137,665 (83,598) - 54,067 Minority interest in consolidated joint venture 147 - - 147 - --------------------------------------------------------------------------------------------------------------------------- Net income (loss) $137,812 $ (83,598) $ - $ 54,214 =========================================================================================================================== <CAPTION> - --------------------------------------------------------------------------------------------------------------------------- Nine 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 $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 =========================================================================================================================== </TABLE> 31
Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income - ------------------------------------------------------------------------------- (Loss) for both EA Core and EA.com Segments - ------------------------------------------- Cost of Goods Sold. Cost of goods sold for our packaged goods business consists of actual product costs, royalties expense for celebrities, professional sports and other organizations and independent software developers, manufacturing royalties, expense for defective products and operations expense. Cost of goods sold for our subscription business consists primarily of data center and bandwidth costs associated with hosting our websites, credit card fees and royalties for use of EA and third party properties. Marketing and Sales. Marketing and sales expenses consist of personnel related costs, advertising and marketing and promotional expenses. In addition, marketing and sales includes the amortization of the AOL carriage and revenue share fees ("Carriage Fee"), which began with the launch of EA.com in October 2000. The Carriage Fee is being amortized straight line over the term of the AOL agreement. General and Administrative. General and administrative expenses consist of personnel and related expenses of executive and administrative staff, fees for professional services such as legal and accounting and allowances for bad debts. Research and Development. Research and development expenses consist of personnel related costs, consulting and equipment depreciation, and customer relationship management expenses associated with Electronic Arts' product and online games. EA.com has research and development expenses incurred by Electronic Arts' studios consisting of direct development costs and related overhead costs (facilities, network and development management and supervision) in connection with the development and production of EA.com online games. Network Development and Support. Network development and support costs consist of expenses associated with development of web content, depreciation on server equipment to support online games, network infrastructure direct expenses, software licenses and maintenance, and network and management overhead. Cost of Goods Sold. Cost of goods sold as a percentage of revenues increased slightly for the three months ended December 31, 2001 as compared to the same period last year primarily due to: . Higher cost of goods sold as a percentage of revenue on PlayStation products due to lower average sales price on the platform along with higher royalty rates for Harry Potter and the Sorcerer's Stone. . Higher cost of goods sold as a percentage of revenue on PlayStation 2 products as compared to the prior year due to a higher mix of catalogue sales with lower sales prices. . Revenues in the current year on Nintendo Game Boy Advance and Game Boy Color with higher cost of goods sold as a percentage of revenues. There were no revenues on these platforms last year. These were mainly offset by: . Higher advertising revenues with low cost of goods sold as a percentage of revenues for the three months ended December 31, 2001. 32
. New revenues with low cost of goods sold as percentage of revenues for the Nintendo GameCube and Xbox products. Cost of goods sold as a percentage of revenues decreased for the nine months ended December 31, 2001 as compared to the same period last year primarily due to: . Revenues from the Xbox and Nintendo GameCube with low cost of goods sold as a percentage of revenue. . Higher advertising revenues with low cost of goods sold as a percentage of revenue for the nine months ended December 31, 2001. . Lower revenue on Nintendo 64 products with high cost of goods sold as a percentage of revenue. These were partially offset by: . Higher cost of goods sold as a percentage of revenues on the PlayStation and PlayStation 2 products as compared to the prior year. . Revenues from the Nintendo Game Boy Advance and Game Boy Color with high cost of goods sold as a percentage of revenue. Marketing and Sales. Marketing and sales expenses for the three months ended December 31, 2001 increased in absolute dollars by 44%, and increased 29% for the nine months ended December 31, 2001 primarily attributed to: . Higher marketing and advertising in North America and Europe for programs to support SSX Tricky, Harry Potter and the Sorcerer's Stone, Madden NFL 2002, FIFA Soccer 2002 and James Bond 007...Agent Under Fire. . The amortization of the AOL carriage fee for the nine months ended December 31, 2001 which began with the launch of EA.com in October 2000. The AOL carriage fee amortization expense remained flat for the quarter as compared to the same period last year. General and Administrative. General and administrative expenses increased for the three months ended December 31, 2001 in absolute dollars by 12%, primarily due to: . $1,000,000 contribution to charity organizations providing support for the September 11th tragedy. . Increase in payroll and occupancy costs to support the increased growth in North America. General and administrative expenses increased for the nine months ended December 31, 2001 in absolute dollars by 5%, primarily due to: . $1,000,000 contribution to charity organizations providing support for the September 11th tragedy. . Increase in payroll and occupancy costs to support the increased growth in North America. . Increase in EA.com bad debt expense due to higher product sales. Research and Development (excluding Network Development and Support and Customer Relationship Management). Research and development expenses (excluding network development and support and customer relationship management) decreased in absolute 33
dollars for the three months ended December 31, 2001 by 9% compared to the same period in the prior year due to: . Headcount reductions and office closures for EA.com in October 2001 as part of restructuring of that segment (see Charge for Restructuring and Impairment discussion below). . Partially offset by increased spending on EA.com online projects in development, primarily The Sims Online and Earth and Beyond. Research and development expenses (excluding network development and support and customer relationship management) decreased slightly in absolute dollars for the nine months ended December 31, 2001 by 3% compared to the same period in the prior year due to: . Headcount reductions in EA.com in October 2001 (see Charge for Restructuring and Impairment discussion below). . Offset by increased payroll costs due to higher headcount in Maxis and Westwood. . Offset by increased spending on EA.com online projects in development, primarily The Sims Online and Earth and Beyond. We expect research and development spending to increase in fiscal 2003 due to an increase in development spending for next generation console products including the PlayStation 2, Xbox and Nintendo GameCube, as well as extending our investment in the PC platform. Network Development and Support. Network development and support expenses decreased for the three months ended December 31, 2001 in absolute dollars by 20% primarily for: . Post-launch costs associated with data migration projects upon the launch of the EA.com gamesite in October 2000. . Decrease in payroll costs due to a significant decrease in consultants. Network development and support expenses increased for the nine months ended December 31, 2001 in absolute dollars by 38% primarily due to: . Costs associated with the launch of the EA.com gamesite. . Depreciation related to both hardware and internally developed software that began when the site went live in October 2000. . Increased headcount and network-related costs associated with Pogo. . Higher headcount and capital spending on our network infrastructure to support the growth of our live gamesites and related depreciation during the first six months of the year. Customer Relationship Management. Customer relationship management expenses decreased slightly for the three months ended December 31, 2001 by 3% primarily due to headcount reductions in October 2001 as part of the restructuring plan (see Charge for Restructuring and Impairment discussion below). 34
Customer relationship management expenses increased by 34% for the nine months ended December 31, 2001 primarily due to increased headcount in the first six months of fiscal 2002 (prior to the reduction noted above) to support the growth in the Ultima Online subscriber base, launch of Majestic and Motor City Online, and the increase in the number of free games and subscription offerings. Amortization of Intangibles. The amortization of intangibles results primarily from the acquisitions of Westwood, Pogo, Kesmai, DreamWorks Interactive, ABC Software and other acquisitions. The increase for the three and nine months ended December 31, 2001 for EA.com, compared to the same periods in the prior year, was due to the acquisition of Pogo in February 2001. With the implementation of new accounting pronouncements (see Impact of Recently Issued Accounting Standards on page 42) as of April 2002, we will no longer amortize goodwill. We are in the process of determining the impact on our amortization of other intangibles. Charge for Restructuring and Impairment. During the quarter ended December 31, 2001, we announced a restructuring plan for EA.com to reduce EA.com's workforce and consolidate facilities. These restructuring and resulting asset impairment charges were necessary in order to focus on key online priorities and reduce EA.com's operating cost structure. We recorded total charges of $14,051,000, consisting of $3,763,000 for workforce reductions, $3,785,000 for consolidation of facilities and other administrative charges and $6,503,000 for the write-off of non-current assets. The restructuring plan resulted in the termination of approximately 240 personnel, or one-third of EA.com's workforce, which affected all departments across the organization. The estimated costs for consolidation of facilities is comprised of contractual rental commitments under real estate leases for unutilized office space offset by estimated future sub-lease income. Included in these costs are estimated costs to close offices or consolidate facilities in various locations and costs to write off a portion of the assets from these facilities. In addition, the restructuring efforts required an evaluation of asset impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", to write these depreciable assets and certain intangibles to their fair value. We will continue to evaluate the effectiveness of products, departments, technology and processes and look for ways to consolidate and streamline EA.com operations in an effort to further reduce operating expenses. Interest and Other Income, Net. Interest and other income, net, for the three months ended December 31, 2001 increased by 31% in absolute dollars compared to the same period in the prior year primarily due to an increase in our equity share in Square EA in the current year, partially offset by foreign currency losses. For the nine months ended December 31, 2001, interest and other income, net, decreased slightly by 3% compared to the same period in the prior year. Income Taxes. Our effective tax rate was 31% for the three and nine months ended December 31, 2001 and 2000. 35
Net Income. In absolute dollars, reported net income for the three and nine months ended December 31, 2001 increased primarily related to higher revenues and gross profits as compared to the same periods last year. This was partially offset by an increase in marketing and sales expenses to support programs for key titles shipping in the current year and restructuring charges incurred in the current quarter of fiscal 2002. We consider pro forma net income and operating profit, which excludes the items noted in the table below, to be the most relevant benchmarks of our operating performance. Pro forma net income, excluding the items noted in the table below, was $147,140,000 for the three months ended December 31, 2001 and $91,457,000 for the three months ended December 31, 2000. Pro forma net income, excluding the items noted in the table below, was $78,794,000 for the nine months ended December 31, 2001 and $17,826,000 for the nine months ended December 31, 2000. The increase in pro forma net income for the three and nine months ended December 31, 2001 was due to higher revenues and gross profits as compared to the same periods last year. This was partially offset by an increase in marketing and sales expenses to support programs for key titles shipped in the current year. With the implementation of new accounting pronouncements relating to goodwill and intangible assets (see Impact of Recently Issued Accounting Standards on page 42) as of April 2002, we will no longer amortize goodwill. We are in the process of determining the impact on our amortization of other intangibles. 36
(in thousands): - -------------------------------------------------------------------------------- Reconciliation of GAAP to Pro Forma net income (loss) <TABLE> <CAPTION> Three Months Ended ------------------------------------------------------------------------------------ December 31, 2001 December 31, 2000 ----------------------------------------- ------------------------------------------ EA Core Electronic EA Core Electronic (excl. EA.com) EA.com Arts (excl. EA.com) EA.com Arts ----------------------------------------- ------------------------------------------ <S> <C> <C> <C> <C> <C> <C> Net income (loss) - GAAP $ 138,998 $ (6,706) $132,292 $ 95,416 $ (7,438) $ 87,978 Net loss related to retained interest in EA.com (note 1) 38,001 (38,001) - 42,144 (42,144) - Pro forma allocation of income taxes (note 2) (13,859) 13,859 - (15,370) 15,370 - ----------------------------------------- ------------------------------------------ Pro forma net income (loss) 163,140 (30,848) 132,292 122,190 (34,212) 87,978 Amortization of intangibles 3,205 3,154 6,359 3,184 1,497 4,681 Restructuring and asset impairment charges - 14,051 14,051 - - - Non-cash stock compensation for non-employees (note 3) 882 227 1,109 291 70 361 Income taxes effect on the above items (1,267) (5,404) (6,671) (1,077) (486) (1,563) ----------------------------------------- ------------------------------------------ Pro forma net income (loss) excluding the items above $ 165,960 $ (18,820) $147,140 $124,588 $(33,131) $ 91,457 ========================================= ========================================== </TABLE> 1) EA Core maintains approximately 85% retained interest in EA.com and is reflected in the Net income - GAAP for EA Core. The pro forma statements exclude the retained interest allocation. 2) The provision for income taxes was allocated between EA Core and EA.com at the worldwide effective tax rate (31%) based on each segment's pro rata share of income or loss. The sum of tax provision for EA Core and EA.com is the same as consolidated tax provision. 3) Total non-cash stock compensation charges are included in Research and Development in GAAP financials, and excluded in the pro forma. 37
(in thousands): - -------------------------------------------------------------------------------- Reconciliation of GAAP to Pro Forma net income (loss) <TABLE> <CAPTION> Nine Months Ended ------------------------------------------------------------------------------------------- December 31, 2001 December 31, 2000 --------------------------------------------- --------------------------------------------- EA Core Electronic EA Core Electronic (excl. EA.com) EA.com Arts (excl. EA.com) EA.com Arts ------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Net income (loss) - GAAP $ 72,387 $ (18,173) $ 54,214 $ 21,942 $ (15,144) $ 6,798 Net loss related to retained interest in EA.com (note 1) 102,983 (102,983) - 85,814 (85,814) - Pro forma allocation of income taxes (note 2) (37,558) 37,558 - (31,297) 31,297 - --------------------------------------------- --------------------------------------------- Pro forma net income (loss) 137,812 (83,598) 54,214 76,459 (69,661) 6,798 Amortization of intangibles 9,615 9,694 19,309 9,645 4,406 14,051 Restructuring and asset impairment charges - 14,051 14,051 - - - Non-cash stock compensation for non-employees (note 3) 1,923 340 2,263 1,804 128 1,932 Income taxes effect on the above items (3,577) (7,466) (11,043) (3,549) (1,406) (4,955) --------------------------------------------- --------------------------------------------- Pro forma net income (loss) excluding the items above $ 145,773 $ (66,979) $ 78,794 $ 84,359 $ (66,533) $ 17,826 ============================================= ============================================= </TABLE> 1) EA Core maintains approximately 85% retained interest in EA.com and is reflected in the Net income - GAAP for EA Core. The pro forma statements exclude the retained interest allocation. 2) The provision for income taxes was allocated between EA Core and EA.com at the worldwide effective tax rate (31%) based on each segment's pro rata share of income or loss. The sum of tax provision for EA Core and EA.com is the same as consolidated tax provision. 3) Total non-cash stock compensation charges are included in Research and Development in GAAP financials, and excluded in the pro forma. 38
LIQUIDITY AND CAPITAL RESOURCES - -------------------------------------------------------------------------------- EA Core and EA.com As of December 31, 2001, our working capital was $647,853,000 compared to $478,701,000 at March 31, 2001. Cash, cash equivalents and short-term investments increased by $20,350,000 during the nine months ended December 31, 2001. We used $10,606,000 of cash from operations, $64,624,000 for short-term investments, $40,056,000 of cash for capital expenditures, offset by $75,819,000 of cash generated through the sale of equity securities under our stock plans during the nine months ended December 31, 2001. Reserves for bad debts and sales returns increased from $89,833,000 at March 31, 2001 to $139,898,000 at December 31, 2001. Reserves have been charged for returns of product and price protection credits issued for products sold in prior periods. Management believes these reserves are adequate based on historical experience and its current estimate of potential returns and allowances. Our principal source of liquidity is $486,842,000 in cash, cash equivalents and short-term investments and $7,282,000 in marketable securities. Management believes the existing cash, cash equivalents, short-term investments, marketable securities and cash generated from operations will be sufficient to meet cash and investment requirements on both a short-term and long-term basis. EA.com Included in the amounts above is the following for the EA.com business: . With the exception of the proceeds from the sale of stock and warrant to AOL in fiscal 2000 in the amount of $20,000,000, to date, EA.com has been funded solely by Electronic Arts. This funding has been accounted for as capital contributions from Electronic Arts. Excess cash generated from operations is transferred to Electronic Arts, and has been accounted for as a return of capital. We anticipate these funding procedures will continue in the near-term. However, Electronic Arts may, at its discretion, provide funds to EA.com under a debt arrangement, instead of treating such funding as a capital contribution. . During the nine months ended December 31, 2001, EA.com used $88,700,000 of cash in operations, $12,447,000 in capital expenditures for computer equipment, network infrastructure, internal use software and related third party software, offset by $107,571,000 provided through the capital contributions from Electronic Arts. As a result of the net operating loss generated, we realized a tax benefit of approximately $37,558,000. . 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 contributions from Electronic Arts. As a result of the net operating loss generated, we realized a tax benefit of approximately $31,297,000. 39
Under the AOL agreement entered into in November 1999, EA.com is required to pay $50,000,000 to AOL as a carriage fee and $31,000,000 as a minimum guaranteed revenue share for revenues generated by subscriptions and other certain commercial transactions on the EA.com site. Of these amounts, $25,000,000 in carriage fee and $11,000,000 in revenue share were paid upon signing the agreement with the remainder of the respective items due in four equal annual installments beginning with the first anniversary of the initial payments. EA.com paid AOL an annual carriage payment of $6,250,000 and an annual revenue share payment of $5,000,000 in both fiscal 2001 and 2002. Future liquidity needs of EA.com will be met by Electronic Arts as Electronic Arts intends to continue to fund the cash requirements of EA.com for the foreseeable future. Other Commitments Advertising Commitments We made a commitment to spend $15,000,000 in offline media advertisements promoting our online games, including those on the AOL service, prior to March 31, 2005. As of December 31, 2001, we have spent $2,500,000 against this commitment. On February 7, 2000, we acquired Kesmai Corporation (now referred to as "Kesmai") from News America Corporation ("News Corp") in exchange for $22,500,000 in cash and approximately 206,000 shares of our existing common stock valued at $8,650,000. We agreed to spend $12,500,000 through the period ended June 1, 2002 in advertising with News Corp or any of its affiliates. In addition, if certain conditions are met, including that a qualified public offering of Class B common stock does not occur within twenty-four months of News Corp's purchase of such shares and all of the Class B outstanding shares have been converted to Class A common stock, then (1) News Corp has the right to (i) exchange Class B common stock for approximately 206,000 shares of Class A common stock, and (ii) receive cash from Electronic Arts in the amount of $9,650,000, and (2) we will agree to spend an additional $11,675,000 in advertising with News Corp and its affiliates. Lease Commitments We lease certain of our current facilities and certain equipment under non-cancelable capital and operating lease agreements. We are required to pay property taxes, insurance and normal maintenance costs for certain of our facilities and will be required to pay any increases over the base year of these expenses on the remainder of our facilities. In February of 1995, we entered into an operating lease on our headquarter's facility in Redwood City, California, which as extended in July of 2001 runs through July of 2006. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. We have an option to purchase the property (land and facilities) for $145,000,000 or, at the end of the lease, to arrange for (1) an additional extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000 if the sales price is less than this amount, subject to certain provisions of the lease. 40
In December 2000, we entered into a second operating lease for a five year term from December 2000 to expand our headquarter's facilities and develop adjacent property adding approximately 310,000 square feet to our campus. We expect to complete construction in June of 2002. The facilities will provide space for marketing, sales and research and development. We have an option to purchase the property for $130,000,000 or, at the end of the lease, to arrange for (1) an extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118,800,000 if the sales price is less than this amount, subject to certain provisions of the lease. Lease rates are based upon the Commercial Paper Rate and the London Interbank Offered Rate. The two lease agreements described above require us to maintain certain financial covenants, all of which we were in compliance with as of December 31, 2001. Letters of Credit In connection with our purchases of N64 cartridges and Nintendo GameCube optical disks 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 and optical disks. For purchases of N64 cartridges and Nintendo GameCube optical disks for distribution in Japan and Europe, Nintendo requires us to make cash deposits. Development, Celebrity, League and Content Licenses: Payments and Commitments The products published by EA Studios are designed and created by our in-house designers and artists and by independent software developers ("independent artists"). We typically pay the independent artists royalties based on the sales of the specific products, as defined in the related independent artist agreements. Advance payments on these royalties are paid to independent artists upon meeting deliverables as detailed in the contractual agreement. In addition, certain celebrity, league and content license contracts contain minimum guarantee payments and marketing commitments that are not dependent on any deliverables. Celebrities and organizations with whom we have contracts include: FIFA, NASCAR, John Madden, the National Basketball Association, the PGA TOUR, Tiger Woods, the National Hockey League, Formula One, Warner Bros. (Harry Potter) and MGM / Danjag (James Bond). These minimum guarantee payments and marketing commitments are included in the table below. Summary of minimum commitments as of March 31, 2001 (in thousands): <TABLE> <CAPTION> ============================================================================================================ Fiscal Year Ended Minimum Letters of March 31, Leases Advertising Guarantees Credit AOL Marketing ------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> 2003 $16,045 $17,000 $26,572 $4,269 $11,250 $ 6,340 2004 12,699 3,500 20,642 - 11,250 6,615 2005 10,437 4,500 15,832 - - 2,010 2006 10,031 - 16,172 - - 1,000 2007 7,985 - 6,822 - - - Thereafter 10,076 - 2,500 - - - ------------------------------------------------------------------------------------------------------------ $67,273 $25,000 $88,540 $4,269 $22,500 $15,965 ------------------------------------------------------------------------------------------------------------ </TABLE> 41
Impact of Recently Issued Accounting Standards In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133 "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - an Amendment of FASB Statement No. 133" and SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133", which establishes accounting and reporting standards for derivative instruments and hedging activities. The terms of SFAS 133 and SFAS 138 are effective as of the beginning of the first quarter of the fiscal year beginning after June 15, 2000. SFAS 133, as amended, requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. We utilize fair value foreign exchange contracts to hedge foreign currency exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies. We adopted SFAS 133 on April 1, 2001. The adoption of SFAS 133 did not have a material impact on our consolidated financial position or results of operations. In April 2001, the Emerging Issues Task Force issued No. 00-25 ("EITF 00-25"), "Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products", which states that consideration from a vendor to a reseller of the vendor's products is presumed to be a reduction of the selling prices of the vendor's products and, therefore, should be characterized as a reduction of revenue when recognized in the vendor's income statement. That presumption is overcome and the consideration can be categorized as a cost incurred if, and to the extent that, a benefit is or will be received from the recipient of the consideration. That benefit must meet certain conditions described in EITF 00-25. The consensus should be applied no later than in annual or interim financial statements for periods beginning after December 15, 2001. We believe the adoption of EITF 00-25 will not have a material impact on our consolidated financial position or results of operations. In June 2001, the FASB issued SFAS 141, "Business Combinations", which addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Board Opinion No. 16 ("APB 16"), "Business Combinations", and SFAS 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises". All business combinations in the scope of SFAS 141 are to be accounted for using one method, the purchase method. This Statement requires that intangible assets be recognized as assets apart from goodwill if they meet one of two criteria--the contractual-legal criterion or the separability criterion. SFAS 141 also requires disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption. This Statement does not change many of the provisions of APB 16 and SFAS 38 related to the application of the purchase method. Also, SFAS 141 does not change the requirement to write off certain research and development assets acquired in a business combination as required by FASB Interpretation No. 4, "Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method". The provisions of SFAS 141 apply to all business combinations initiated after June 30, 2001 and 42
applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001, or later. We had no acquisitions subsequent to June 30, 2001, therefore SFAS 141 has had no impact on our consolidated financial position or results of operations. In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets", which supersedes APB 17, "Intangible Assets". SFAS 142 addresses the accounting treatment for goodwill and other intangible assets acquired individually or with a group of other assets upon their acquisition, but not acquired in a business combination. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. With the adoption of SFAS 142, goodwill is no longer subject to amortization over its estimated useful life; rather, goodwill will be subject to at least an annual assessment for impairment by applying a fair-value-based test. Also, if the benefit of an intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented or exchanged, an acquired intangible asset should be separately recognized. The terms of SFAS 142 are effective as of the beginning of the first quarter of the fiscal year beginning after December 15, 2001. Certain provisions of SFAS 142 shall be applied to goodwill and other acquired intangible assets for which the acquisition date is after June 30, 2001. With the implementation of SFAS 142 as of April 2002, we will no longer amortize goodwill. We are in the process of determining the impact on our amortization of other intangibles. In June 2001, the FASB issued SFAS 143 "Accounting for Asset Retirement Obligations". SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. SFAS 143 is effective for fiscal years beginning after June 15, 2002. We do not expect the adoption of SFAS 143 to have a material impact on our financial position or results of operations. In October 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. We are in the process of determining the impact of this new accounting standard. In November 2001, Emerging Issues Task Force issued No. 01-09 ("EITF 01-09"), "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products", which codifies and reconciles the Task Force consensuses on all or specific aspects of EITF 00-14, "Accounting for Certain Sales Incentives", EITF 00-22, "Accounting for `Points' and Certain Other Time-Based or Volume-Based Sales Incentives Offers, and Offers for Free Products or Services to be Delivered in the Future" and EITF 00-25, "Vendor Income Statement 43
Characterization of Consideration Paid to a Reseller of the Vendor's Products", and identifies other related interpretive issues that have not yet been addressed by the Task Force. The transition guidance for the codification of EITF 00-14, 00-22 and 00-25 is governed by the original consensuses on those Issues. For entities that have adopted EITF 00-14, 00-22 (Issue 3), and/or 00-25, the above guidance should be applied to transactions entered into after November 15, 2001. We believe the adoption of EITF 01-09 will not have a material impact in our consolidated financial position or results of operations. 44
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 console in Japan, North America and Europe in calendar year 2000. Nintendo launched its new console system, Nintendo GameCube, in Japan in September 2001 and in North America in November 2001, and announced its plans to launch in Europe in May 2002. Microsoft launched its new console system, Xbox, in November 2001 in North America, and announced its plans to launch in Japan in February 2002 and in Europe in March 2002. Delays in the launch or shortages of these platforms could also adversely affect our sales of products for these platforms. Current sales of our products for the existing PlayStation and Nintendo 64 platforms have been adversely affected (by the introduction of the PlayStation 2 and other new platforms). We expect this trend to continue until one or more of these new consoles achieve a wide installed base of consumers. New Video Game Platforms Create Additional Technical and Business Model Uncertainties Large portions of our revenues are derived from the sale of products for play on proprietary video game platforms such as the Sony PlayStation. The success of our products is significantly affected by acceptance of the new video game hardware systems and the life span of older hardware platforms and our ability to accurately predict which platforms will be most successful. Sometimes we will spend development and marketing resources on products designed for new video game systems that have not yet achieved large installed bases or will continue product development for older hardware platforms that may have shorter life cycles than we expected. Conversely, if we do not develop for a platform that achieves significant market acceptance, or discontinue development for a platform that has a longer life cycle than expected, our revenue growth may be adversely affected. For example, the Sega Dreamcast console launched in Japan in early 1999 and in the United States in September of 1999. We have developed no products for this platform. Had this platform achieved wide market acceptance, our revenue growth would have been adversely affected. Similarly, we are developing products for the Xbox and Nintendo GameCube. If these platforms do not achieve wide commercial acceptance, our revenue growth will be adversely impacted. 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 45
with development for new technologies. For example, EMPEROR: Battle for Dune for the PC, which was expected to ship in fiscal 2001 was not released until the first quarter of fiscal 2002 due to development delays. Also, James Bond 007...Agent Under Fire for the PS2, which was expected to ship in fiscal 2001, released in October of fiscal 2002 due to development delays. Additionally, development risks for CD-ROM and DVD products can cause particular difficulties in predicting quarterly results because brief manufacturing lead times allow finalizing products and projected release dates late in a quarter. Our revenues and earnings are dependent on our ability to meet our product release schedules, and our failure to meet those schedules could result in revenues and earnings which fall short of analysts' expectations for any individual quarter and the fiscal year. Our Business Is Both Seasonal and Cyclical Our business is highly seasonal with a significant percentage of our revenues occurring in the December quarter. In fiscal 2002, we expect these seasonal trends to be magnified by general industry factors, including the current platform transition, the fall launches of the Xbox and Nintendo GameCube in North America and the economic slowdown in the United States and other territories. In addition, we are continuing to invest significantly in our online operation, EA.com. Our business is also cyclical; video game platforms have historically had a life cycle of four to six years, and decline as more advanced platforms are being introduced. As one group of platforms is reaching the end of its cycle and new platforms are emerging, buying patterns may change. Purchases of products for older platforms may slow at a faster rate than sales of new platforms. We are currently in such a platform transition. Sony shipped its PlayStation 2 console in Japan, North America and Europe in calendar year 2000. Nintendo launched its new console system, Nintendo GameCube, in Japan in September 2001 and in North America in November 2001, and announced its plans to launch in Europe in May 2002. Microsoft launched its new console system, Xbox, in November 2001 in North America and announced its plans to launch in Japan in February 2002 and in Europe in March 2002. Sales of our products for the N64 and Sony PlayStation platforms have already been adversely affected, and we expect this trend to continue. The Impact of e-Commerce and Online Games on Our Business Is Not Known While we do not currently derive significant revenues from online sales of our packaged products, we believe that such form of distribution will become a more significant factor in our business in the future. E-Commerce is becoming an increasingly popular method for conducting business with consumers. How that form of distribution will affect the more traditional retail distribution, at which we have historically had success, and over what time period, is uncertain. In addition, we expect the number and popularity of online games to increase and become a significant factor in the interactive games business generally. We do not know how that increase generally, or the emerging business of EA.com specifically, will affect the sales of packaged goods. Our Business, Our Products, and Our Distribution Are Subject to Increasing Regulation in Key Territories Legislation is increasingly introduced which may affect the content of our products and their distribution. For example, privacy rules in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory while of course the Internet recognizes no geographical boundaries. Other countries such as Germany have adopted laws regulating content transmitted over 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. 46
Our Platform Licensors Are Our Chief Competitors and Frequently Control the Manufacturing of Our Video Game Products Our agreements with hardware licensors, which are also our chief competitors, typically give significant control to the licensor over the approval and manufacturing of our products. This fact could, in certain circumstances, leave us unable to get our products approved, manufactured and shipped to customers. In most events, control of the approval and manufacturing process by the platform licensors increases both our manufacturing lead times and costs as compared to those we can achieve independently. For example, in prior years, we experienced delays in obtaining approvals for and manufacturing of PlayStation products which caused delays in shipping those products. The potential for additional delay or refusal to approve or manufacture our products continues with our platform licensors. Such occurrences would harm our business and adversely affect our financial performance. Additionally, we have not negotiated a final publishing agreement with Nintendo for the Nintendo GameCube platform and we do not know whether the final terms of this agreement will be favorable. Proliferation and Assertion of Patents Poses Serious Risks to our Business Many patents have been issued that may apply to widely used game technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of existing games. Several such patents have been asserted against us. Such claims can harm our business. We will incur substantial expenses in evaluating and defending against such claims, regardless of the merits of the claims. In the event that there is a determination that we have infringed a third party patent, we could incur significant monetary liability and be prevented from using the rights in the future. Risk Factors Relating to Our Online Business Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate its Business and Prospects EA.com's business is still in the developing stages, so evaluating its business and prospects will be more difficult than would be the case for a more mature business. We will continue to encounter the risks and difficulties faced in launching a new business, and we may not achieve our goals or may be compelled to change the manner in which we seek to develop the business. These uncertainties as to the future operations of EA.com will increase the difficulty we face in completing and pursuing the essential plans for the development of the business and will also make it more difficult for our stockholders and securities analysts to predict the operating results of this business. EA.com Has a History of Losses and Expects To Continue To Incur Losses and May Never Achieve Profitability EA.com has incurred substantial losses to date, including the first three quarters of fiscal year 2002. We expect EA.com to continue to incur losses as it develops its business. EA.com will be required to maintain the significant support, service and product enhancement demands of online users, and we cannot be certain that EA.com will produce sufficient revenues from its operations to support these costs. Even if profitability is achieved, EA.com may not be able to sustain it over a period of time. 47
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. For example, our product Majestic and our Sports package, each of which launched with a monthly subscription pricing model , have obtained only limited commercial success to date. Accordingly, we have discontinued our Sports package and have announced that we will discontinue Majestic on May 1, 2002. Similarly, we are inexperienced in predicting usage patterns for our games. Because of our inexperience in this area, we may not be effective in achieving success that may otherwise be attainable from offering our games online. Online Games Have Risks That Are Not Associated with Our Traditional Business Online games, particularly multiplayer games, pose risks to player enjoyment that do not generally apply to packaged game sales. Players frequently would not be acquainted with other players, which may adversely affect the playing experience. Social issues raised by a player's conduct may impact the experience for other players. We have not determined whether or how we might monitor or proctor player behavior that impairs the game experience. In addition, there are substantial technical challenges to be met both in the introduction of our games online and in maintaining an effective game playing environment over time. Also, hacking and spamming has become a serious problem for online sites, and significant hacking and spamming could seriously interfere with online game play. If these risks are not successfully controlled and technical challenges resolved, potential customers for our games may be unwilling to play in sufficient volume to allow us to attain or sustain profitability. Proliferation and Assertion of Patents Poses Serious Risks to the Business of EA.com Many patents have been issued that may apply to widely used Internet technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of older technologies. Several such patents have been asserted against us. Such claims can harm our business. 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 continue to receive substantial financing that is required to develop its business. Electronic Arts has agreed to provide a limited amount of funding to 48
EA.com, but this financing alone may not be sufficient for the development of EA.com's business. Any additional funding that is obtained from EA may either be treated as a revolving credit advance or would increase EA's retained interest in EA.com and correspondingly decrease the interest of the holders of outstanding shares of Class B common stock. The attraction of additional equity or debt financing for EA.com from third parties may not be possible or may only be possible on terms that result in significant dilution to Class A and Class B common stockholders or interest or other costs and debt-related restrictions on the operation of the business. To date, nearly all funding (except warrants and cash from revenues) has been provided by EA. If Use of the Internet Does Not Continue To Develop and Reliably Support the Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed EA.com's success depends upon growth in the use of the Internet as a medium for playing games. The use of the Internet for sophisticated games like ours is relatively new. Our business would be seriously harmed if: . use of the Internet does not continue to increase or increases more slowly than expected, . the infrastructure for the Internet does not effectively support online game play, . concerns over the secure transmission of confidential information over public networks inhibit the growth of the Internet as a means of conducting commercial transactions, or . government regulations regarding Internet content, privacy or other conditions impede the effectiveness of the Internet to users. Capacity Restraints May Restrict the Use of the Internet as a Forum for Game Play, Resulting in Decreased Demand for Our Products The Internet infrastructure may not be able to support the demands placed on it by increased usage or the limited capacity of networks to transmit large amounts of data. Other risks associated with commercial use of the Internet could slow its growth, including: . outages and other delays resulting from the inadequate reliability of the network infrastructure, . slow development of enabling technologies and complementary products, and . limited availability of cost-effective, high speed access. Delays in the development or adoption of new equipment standards or protocols required to handle increased levels of Internet activity, or increased governmental regulation, would cause the Internet to fail to gain, or lose, viability as a means of game playing. If these or any other factors cause use of the Internet for commerce to slow or decline, the Internet may not prove viable as a commercial marketplace. This, in turn, would result in decreased demand for EA.com's products and services. To Become and Remain Competitive, EA.com Must Continually Develop and Expand New Content. This Is Inherently Risky and Expensive. EA.com's success depends on our ability to develop products and services for the EA.com site and our ability to continually expand the content on that site. Our agreement with AOL requires us to develop new games under our relationship with AOL. We cannot assure you that products will be developed on time, in a cost effective manner, or that they will be successful. Currently, the release of 49
several products such as The Sims Online and Earth and Beyond for which we expect subscription revenue, have been delayed due to slipping development schedules. Similarly, the online product Majestic achieved only limited commercial success due in part to the difficulties of delivering the product online. Accordingly, we have announced that we will discontinue Majestic on May 1, 2002. We May Not Be Able To Respond to Rapid Technological Change The market for Internet products and services is characterized by rapid technological change and evolving industry standards. Both in completing the design and implementation of our network infrastructure and thereafter, we will be required to continually improve performance, features, reliability and capacity of our network infrastructure. We cannot assure you that we will be successful in responding rapidly or in a cost effective manner to such developments. Increasing Governmental Regulation of the Internet Could Limit the Market for Our Products As Internet commerce continues to evolve, we expect that federal, state and foreign governments will adopt laws and regulations covering issues such as user privacy, taxation of goods and services provided over the Internet, pricing, content and quality of products and services. It is possible that legislation could expose companies involved in electronic commerce to liability, taxation or other increased costs, any of which could limit the growth of electronic commerce generally. Legislation could dampen the growth in Internet usage and decrease its acceptance as a communications and commercial medium. If enacted, these laws and regulations could limit the market for EA.com's products. Our Revenues Have Been Heavily Dependent on a Single Product and Would Be Adversely Affected if That Product's Popularity Were To Decline In the near term, EA.com's subscription revenues to date have consisted primarily of revenues from sales of our online product Ultima Online, and we would be adversely affected if revenues from that product were to decline for any reason and not be replaced. We expect the online game market to become increasingly competitive, and it is possible that other producer's current or future games could cause our revenue from Ultima Online to decline. In addition, popularity of Ultima Online could decline over time simply because of consumer preference for new game experiences. We Invest Very Heavily in Research and Development and Network Technology and Operations for EA.com, and We Cannot Be Assured That We Will Achieve Revenues That Validate This Level of Spending We have invested, and expect to continue to invest, very heavily in research and development and network technology and operations for our website and online games. We will need to expand EA.com's revenues substantially for it to achieve profitability with these levels of expenditure being required, and we may not be able to do so. If we cannot increase revenues to profitable levels, the value of EA.com will be impaired. In order to develop the broad game offerings that we envision for our online operations it will be necessary to engage in significant developmental efforts both to adapt existing EA games to the online format and to create new online games. Our agreements with AOL require us to maintain a substantial commitment to online game development and we cannot be assured that we will realize acceptable returns from this investment. 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, 50
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 such as The Sims Online and Earth and Beyond have experienced 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 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 competitive, although current market conditions have made it less difficult 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 remains relatively high, and has made recruiting from other areas and relocating employees to our headquarters more difficult. If we cannot successfully recruit and retain the employees we need, our ability to develop and manage our businesses will be impaired. Foreign Sales and Currency Fluctuations For the nine months ended December 31, 2001 international net revenues comprised 38% of total consolidated net revenues. For the fiscal year ended March 31, 2001, international net revenues comprised 37% of total consolidated net revenues. We expect foreign sales to continue to account for a significant and growing portion of our revenues. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies which may fluctuate. While we hedge against foreign currency fluctuations, we cannot control translation issues. For example, our Japan and Asia Pacific revenues in the first three quarters of fiscal 2002 were adversely impacted by a devaluation of the Yen and Australian Dollar as compared to the prior year. The devaluation had an adverse effect for the quarter and nine months ended December 31, 2001 on our net revenues 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 fiscal 2001 were adversely affected. Consequently, if Microsoft or Nintendo do not ship the number of units planned for the Xbox and Nintendo GameCube, our sales of these products may be adversely affected in fiscal 2002. 51
We cannot predict the impact of recent actions and comments by the Securities and Exchange Commission (SEC) and FASB Recent actions and comments from the SEC have focused on the integrity of financial reporting. In addition, the FASB and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, some of which represent a significant change from current industry practices. 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. In addition, fluctuations may be due to uncertainties in the securities markets in general. For example, during the fiscal year ended March 31, 2001, the price per share of our Class A common stock ranged from $26.59 to $56.13 and $42.40 to $66.01 during the nine months ended December 31, 2001. World Events The terrorist attacks of September 11, 2001 in the Unites States, the subsequent US military action, and the continuing concerns over potential additional terrorist attacks against US interests and citizens pose serious uncertainties in our business. Consumer spending, consumer preferences in entertainment, and the securities markets generally may be affected on an ongoing and unpredictable basis by these events, all of which may make prediction of our results more difficult. 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. 52
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 Condensed Consolidated Statement of Earnings. At December 31, 2001, we had foreign exchange contracts, all with maturities of less than three months to purchase and sell approximately $393,699,000 in foreign currencies, primarily British Pounds, European Currency Units ("Euros"), Canadian Dollars, Swedish Krona and other currencies. Fair value represents the difference in value of the contracts at the spot rate and the forward rate. The counterparties to these contracts are substantial and creditworthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts are not considered to be material. Notwithstanding our efforts to manage foreign exchange risks, there can be no assurances that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. The following table below provides information about our foreign currency forward exchange contracts at December 31, 2001. The information is provided in U.S. dollar equivalents and presents the notional amount (forward amount), the weighted average contractual foreign currency exchange rates and fair value. <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------- Weighted-Average Contract Amount Contract Rate Fair Value - ----------------------------------------------------------------------------------------------------------- (In thousands) (In thousands) <S> <C> <C> <C> Foreign currency to be sold under contract: British Pound $199,253 1.4502 $ 462 Euro 102,423 0.9000 1,865 Canadian Dollar 21,502 1.5812 183 Swedish Krona 10,327 10.5543 3 Japanese Yen 7,296 116.9100 784 Norwegian Krone 6,707 8.9462 71 Danish Krone 6,384 8.3024 91 Australian Dollar 3,493 0.5137 19 South African Rand 3,179 0.0859 112 Swiss Franc 3,059 1.6346 75 Korean Won 770 1,299.0000 14 - ----------------------------------------------------------------------------------------------------------- Total $364,393 $3,679 - ----------------------------------------------------------------------------------------------------------- Foreign currency to be purchased under contract: British Pound $ 29,306 $ 110 - ----------------------------------------------------------------------------------------------------------- Total $ 29,306 $ 110 - ----------------------------------------------------------------------------------------------------------- Grand total $393,699 $3,789 - ----------------------------------------------------------------------------------------------------------- </TABLE> 53
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, 2001, our cash equivalents, short-term and long-term investments included debt securities of $391,304,000. 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, 2001: - ---------------------------------------------------------------------- Average Interest Rate Cost Fair Value - ---------------------------------------------------------------------- (Dollars in thousands) Cash equivalents Fixed rate 0.00% $ - $ - Variable rate 2.46% $270,600 $270,600 Short-term investments Fixed rate 4.14% $106,344 $107,289 Variable rate 1.60% $ 5,000 $ 5,015 Long-term investments Fixed rate 0.00% $ - $ - Variable rate 6.35% $ 8,400 $ 8,735 - ---------------------------------------------------------------------- Maturity and call dates for short-term investments range from 1 month to 9 months. 54
PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is subject to pending claims and litigation. Management, after review and consultation with counsel, considers that any liability from the disposition of such lawsuits in the aggregate would not have a material adverse effect upon the consolidated financial position or results of operations of the Company. Item 4. Submission of Matters to a Vote of Security Holders None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: None (b) Reports on Form 8-K: None 55
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 14, 2002 Executive Vice President and Chief Financial and Administrative Officer 56