Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the Fiscal Year Ended March 31, 1999
[ ] 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)
Registrant's telephone number, including area code: (650) 628-1500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
(Title of class)
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 ___
Indicated by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Registrant's common stock, $.01 par value,
held by non-affiliates of the Registrant on June 1, 1999 was $2,069,031,141.
As of June 1, 1999, there were 61,588,965 shares of Registrant's common stock,
$.01 par value, outstanding.
Documents Incorporated by Reference
Portions of Registrant's definitive proxy statement (the "Proxy Statement") for
its 1999 Annual Meeting of Stockholders are incorporated by reference into Part
III hereof.
This report consists of 57 sequentially numbered pages. The Exhibit Index is
located at sequentially numbered page 57.
Page 1 of 57
ELECTRONIC ARTS INC.
1999 FORM 10-K ANNUAL REPORT
Table of Contents
PAGE
----
PART I
Item 1. Business 3
Item 2. Properties 11
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 4A. Executive Officers of the Registrant 13
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 15
Item 6. Selected Financial Data 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 27
Item 8. Financial Statements and Supplementary Data 29
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosures 48
PART III
Item 10. Directors and Executive Officers of the Registrant 49
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners and Management 49
Item 13. Certain Relationships and Related Transactions 49
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K 50
Signatures 55
Exhibit Index 57
2
PART I
This Annual Report on Form 10-K, including Item 1 ("Business") and Item 7
("Management's Discussion and Analysis of Financial Condition and Results of
Operations"), contains forward looking statements regarding future events or our
future financial performance that involve certain risks and uncertainties
including those discussed in "Risk Factors" below at pages 25 to 26. Actual
events or actual future results may differ materially from any forward looking
statements due to such risks and uncertainties.
Item 1: BUSINESS
Overview
Electronic Arts was initially incorporated in California in 1982. In
September 1991, we were reincorporated under the laws of Delaware. Our principal
executive offices are located at 209 Redwood Shores Parkway, Redwood City,
California 94065 and our telephone number is (650) 628-1500.
We create, market and distribute interactive entertainment software for
a variety of hardware platforms. As of March 31, 1999, we marketed approximately
111 titles developed and/or published under one of our brand names in North
America, including older titles marketed as "Classics" or "Publisher's Choice."
Additionally, we distribute localized versions of these products in the rest of
the world. We also distributed approximately 21 additional titles developed by
other software publishers ("Affiliated Labels") in North America and over 1,000
Affiliated Label titles in the rest of the world. Since our inception, we have
developed products for 38 different computer hardware platforms, including the
following: IBM PC-CD and compatibles, 16-bit Sega Genesis video game system,
16-bit Super Nintendo Entertainment System, PlayStation, Nintendo 64 and
PlayStation II. Our fiscal 1999 product releases were for PC-CD, PlayStation and
Nintendo N64 cartridge products. As of March 31, 1999, we were developing
products for five different hardware platforms.
Our product development methods and organization are modeled on those
used in the entertainment industry. We also market our products with techniques
borrowed from other entertainment companies such as record producers, magazine
publishers and video distributors. Our employees called "producers", who are
each responsible for the development of one or more products, oversee product
development and direct teams comprised of both our employees and outside
contractors. Our designers regularly work with celebrities and organizations in
sports, entertainment and other areas to develop products that provide gaming
experiences that are as realistic and interactive as possible. Celebrities and
organizations with whom we have had contracts include: FIFA, NASCAR, John
Madden, the National Basketball Association, the PGA TOUR, Tiger Woods, the
National Hockey League, World Championship Wrestling Inc., Football Association
Premier League, Formula One, and Sammy Sosa. We maintain development studios in
California, Canada, United Kingdom, Florida, Texas, Japan, Washington, Maryland
and Nevada.
We invest in the creation of state-of-the-art software tools and
utilities that are then used in product development. These tools allow for more
cost-effective product development and the ability to more efficiently convert
products from one hardware platform to another. We have also made investments in
facilities and equipment to facilitate the creation and editing of digital forms
of video and audio recordings and product development efforts for new hardware
platforms.
We distribute our products and those of our Affiliated Labels primarily
by direct sales to retail chains and outlets in the United States and Europe. In
Japan and the Asia Pacific region, we distribute products both directly to
retailers and through third party distributors. Our products are available in
over 58,000 retail
3
locations worldwide. In fiscal 1999, approximately 42% of our net revenues were
generated by international operations, compared to 43% in fiscal 1998 and 45% in
fiscal 1997.
Investments and Joint Ventures
Acquisitions
Westwood Studios
In September 1998, we completed the acquisition of Westwood Studios,
Inc. and certain assets of the Irvine, California-based Virgin Studios
(collectively "Westwood") for approximately $122,688,000 in cash, including
transaction expenses. The transaction was accounted for under the purchase
method. Westwood has produced 13 titles in the past two years and is best known
for its successful PC-CD franchises, Command and Conquer and Lands of Lore. See
note 11 of the Notes to the Consolidated Financial Statements, included in item
8 hereof.
ABC Software
In July 1998, we acquired ABC Software AG, in Switzerland, and ABC
Software GmbH, in Austria (collectively "ABC"), independent distributors of
entertainment, edutainment and application software, for approximately
$9,466,000 in cash (net of cash acquired of $5,099,000) and $570,000 in other
consideration. The transaction has been accounted for under the purchase method.
See note 11 of the Notes to the Consolidated Financial Statements, included in
item 8 hereof.
Joint Ventures
In May 1998, Electronic Arts and Square Co., Ltd. ("Square"), a leading
developer and publisher of entertainment software in Japan, completed the
formation of two new joint ventures, in North America and Japan. In North
America, the companies formed Square Electronic Arts, LLC ("Square EA"), which
has exclusive publishing rights in North America for future interactive
entertainment PlayStation titles created by Square. We own a 30% minority
interest in this joint venture while Square owns 70%. Additionally, we have the
exclusive right to distribute in North America products published by this joint
venture.
In Japan, the companies established Electronic Arts Square KK ("EA
Square KK"), which localizes and publishes in Japan our properties originally
created in North America and Europe, as well as develops and publishes original
video games in Japan. We own a 70% majority interest, while Square owns 30%. See
note 11 of the Notes to the Consolidated Financial Statements, included in item
8 hereof.
Investments
We have made investments as part of our overall strategy and currently
hold minority equity interests in several companies, including NovaLogic, Inc.,
Firaxis Software, Inc., Kodiak Inc., Pixel Inc. and The 3DO Company ("3DO").
Market
Historically, no hardware platform or system has achieved long-term
dominance in the interactive entertainment market. Accordingly, we have
developed products at one time or another for 38 different hardware platforms.
In fiscal 1999, Sony's PlayStation was the dominant hardware platform in our
industry. In
4
addition, the installed base of multimedia-enabled home computers, including
those with Internet accessibility, has continued to grow as Personal Computer
("PC") prices have declined and the quality and choices of software have
increased dramatically. We develop and publish products for multiple platforms,
and this diversification continues to be a cornerstone of our strategy.
The following table sets forth the year of release in North America of
each of the hardware platforms for which we have published titles and the
technology on which such platforms are based:
- -----------------------------------------------------------------------------------------------
Date of Introduction in
Manufacturer Platform Name North America Technology
- -----------------------------------------------------------------------------------------------
Sega Genesis 1989 16-bit
Nintendo SNES 1991 16-bit
Matsushita 3DO Interactive Multiplayer 1993 32-bit
Sega Saturn 1995 32-bit
Sony PlayStation 1995 32-bit
Nintendo Nintendo N64 1996 64-bit
- -----------------------------------------------------------------------------------------------
Sega launched DreamcastTM in Japan in December 1998 and it is expected
to be released in North America in late calendar 1999. Sega designed Dreamcast
to combine features from the console and PC platforms.
Sony is scheduled to launch PlayStation II in Japan in March 2000 and
the rest of the world starting in September 2000. PlayStation II specifications
have been announced by Sony to be a 128-bit, Digital Versatile Disk ("DVD")
based system that is Internet and cable ready, and backward compatible with
PlayStation I software.
Nintendo announced its plan for a next generation system to be released
in September 2000. Nintendo's new system will offer a DVD drive and have a modem
for Internet access.
New entrants in the interactive entertainment and multimedia
industries, such as cable television, telephone and diversified media and
entertainment companies, and a proliferation of new technologies, such as online
networks and the Internet have increased the competition in the markets in which
we compete. Our new product releases in fiscal year 2000 will be primarily for
the IBM PC-CD and compatibles, PlayStation and N64. We are also scheduled to
release one or more online network gaming products during fiscal 2000. See Risk
Factors - "New video game platforms create additional technical and business
model uncertainties" at page 25 and "The business models and technology for
e-commerce and online gaming are unproven" at page 25.
The early investment in products for the 32-bit market, including both
Compact Disk personal computer ("PC-CD") and CD-dedicated video game ("CD-video
game") platforms, has been strategically important in positioning us for the
current generation of 32-bit and 64-bit machines. We believe that such
investment continues to be important, and we will continue aggressive
development activities for 32-bit and 64-bit platforms. The PlayStation has
achieved significant market acceptance in all geographical territories, however,
as the PlayStation console market matures, we believe that its growth will not
continue at the present rates. In addition, our revenues and earnings are
dependent on our ability to meet our product release schedule and our failure to
meet those schedules could result in revenues and earnings which fall short of
analysts' expectations in any individual quarter. See Risk Factors - "Product
development schedules are frequently unreliable and make predicting quarterly
results difficult" at page 25.
5
Competition
See Risk Factors - "Our platform licensors are our chief competitors
and frequently control the manufacturing of our video game products" at page 26.
Relationships with Significant Hardware Platform Companies
Sony
In fiscal 1999, approximately 43% of our net revenues were derived from
sales of software for the PlayStation compared to 42% in fiscal 1998. During
fiscal 1999, we released 21 PlayStation games compared to 25 in fiscal 1998.
Among these releases were FIFA 99, World Cup 98 and Madden NFL 99. The volume of
sales of PlayStation products significantly increased in fiscal 1999 due to the
increase in the installed base of PlayStation consoles worldwide and the quality
and timely release of our key franchise titles. Although revenues from the sales
of PlayStation products in fiscal 2000 are expected to continue to grow, we do
not expect to maintain these growth rates. See Risk Factors - "Product
development schedules are frequently unreliable and make predicting quarterly
results difficult" at page 25.
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. Pursuant to the Sony Agreement, we engage Sony
to supply its PlayStation CDs for distribution by us. Accordingly, we have
limited ability to control our supply of PlayStation CD products or the timing
of their delivery. See Risk Factors - "Our platform licensors are our chief
competitors and frequently control the manufacturing of our video game products"
at page 26.
Nintendo
During fiscal 1999, we released nine new titles for the N64 compared to
two titles in fiscal 1998. In fiscal 1999, approximately 12% of our net revenues
were derived from the sale of N64 products compared to 6% in 1998. In March
1997, we signed a licensing agreement with Nintendo (the "N64 Agreement") to
develop, publish and market certain sports and other products for the N64. We do
not expect significant growth in revenues for N64 products in fiscal 2000.
Under the terms of the N64 Agreement, we engage Nintendo to manufacture
our N64 cartridges for distribution by us. Accordingly, we have limited ability
to control our supply of N64 cartridges or the timing of their delivery. A
shortage of microchips or other factors outside our control could impair our
ability to obtain an adequate supply of cartridges.
In connection with our purchases of N64 cartridges for distribution in
North America, Nintendo requires us to provide irrevocable letters of credit
prior to Nintendo's acceptance of purchase orders from us for purchases of these
cartridges. For purchases of N64 cartridges for distribution in Japan and
Europe, Nintendo requires us to make cash deposits. Furthermore, Nintendo
maintains a policy of not accepting returns of N64 cartridges. Because of these
and other factors, the carrying of an inventory of cartridges entails
significant capital and risk. See Risk Factors - "Our platform licensors are our
chief competitors and frequently control the manufacturing of our video game
products" at page 26.
6
Products and Product Development
In fiscal 1999, we generated approximately 65% of our revenues from
products released during the year. See Risk Factors - "Product development
schedules are frequently unreliable and make predicting quarterly results
difficult" at page 25. As of March 31, 1999, we were actively marketing
approximately 111 titles, comprising approximately 193 stock keeping units
("sku's"), that were published by our development divisions and subsidiaries
("EA Studios"). During fiscal 1999, we introduced over 39 EA Studios titles,
representing over 59 sku's, compared to 44 EA Studios titles, comprising over 71
sku's, in fiscal 1998.
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.
For fiscal 1999 and 1998, no title represented revenues greater than
10% of the total fiscal 1999 and 1998 net revenues. For fiscal 1997, we had one
title, Madden Football `97, published on five platforms, which represented
approximately 10% of the total fiscal 1997 net revenues.
We publish products in a number of categories such as sports, action
and interactive movies, strategy, simulations, role playing and adventure, each
of which is becoming increasingly competitive. Our sports-related products,
marketed under the EA Sports brand name, accounted for a significant percentage
of net revenues in fiscal years 1999 and 1998. There can be no assurance that we
will be able to maintain our market share in the sports category.
The front line retail selling prices in North America of our products,
excluding older titles (marketed as "Classics" and "Publisher's Choice"),
typically range from $35.00 to $55.00. "Classics" and "Publisher's Choice"
titles have retail selling prices that range from $10.00 to $30.00. The retail
selling prices of EA titles outside of North America vary based on local market
conditions.
We currently develop or publish products for five different hardware
platforms and have, from time to time, developed and marketed products on 38
different and incompatible platforms in the past. In fiscal 1999, our product
releases were predominantly for PC-CD, 32-bit and 64-bit video game systems. Our
planned product introductions for fiscal 2000 are predominantly for the PC-CD,
PlayStation, N64 as well as for online Internet play. See Risk Factors -
"Product development schedules are frequently unreliable and make predicting
quarterly results difficult" at page 25 and "New video game platforms create
additional technical and business model uncertainties" at page 25.
As compact discs have emerged as the preferred medium for interactive
entertainment, education, and information software, we continued our investment
in the development of CD-ROM tools and technologies in fiscal 1999. The
PlayStation has achieved significant market acceptance in all geographic
territories, however, as the PlayStation console market matures, we believe that
its growth will not continue at the present rates. Most of the CD-video game
products will be convertible for use on multiple advanced hardware systems. We
had research and development expenditures of $202.1 million in fiscal 1999,
$146.2 million in fiscal 1998, and $130.8 million in fiscal 1997. See Risk
Factors - "Product development schedules are frequently unreliable and make
predicting quarterly results difficult" at page 25.
7
Marketing and Distribution
We distribute both EA Studio products and products developed and
published by other software publishers known as "Affiliated Labels."
In most cases, Affiliated Label products are delivered to us as
completed products. As of March 31, 1999, we distributed 21 Affiliated Label
titles in North America and over 1,000 Affiliated Label titles in the rest of
the world. No single Affiliated Label Publisher has accounted for more than 10%
of our net revenue in any of the last three fiscal years.
In May 1998, Electronic Arts and Square Co., Ltd. formed a new joint
venture in North America, creating Square Electronic Arts, LLC ("Square EA") as
discussed in note 11 in the Notes to the Consolidated Financial Statements,
included in Item 8 hereof. In conjunction with the formation of this joint
venture, we will have the exclusive right in North America to distribute
products published by this joint venture. In fiscal 1999, Square EA published
Parasite Eve for the PlayStation, which was a top ten selling title for
Electronic Arts and expects to release Final Fantasy 8 in fiscal 2000.
In February 1998, we announced that we entered into an international
co-publishing agreement with Metro-Goldwyn-Mayer ("MGM") to be the exclusive
distributor of MGM Interactive titles in all territories except North America.
Under this agreement, we will distribute such titles as Tomorrow Never Dies.
We generated approximately 90% of our North American net revenues from
direct sales to retailers through a field sales organization of professionals
and a group of telephone sales representatives. The remaining 10% of our North
American sales were made through a limited number of specialized and regional
distributors and rack jobbers in markets where we believe direct sales would not
be economical. For the fiscal year ended March 31, 1999, we had sales to one
customer, Wal-Mart Stores, Inc., which represented 12% of total net revenues. We
had no sales to any one customer in excess of 10% of total net revenues for the
fiscal years ended March 31, 1998 and 1997.
We are using the Internet to market our products, build brand equity
and increase our understanding of our customers' expectations. We have various
EA websites offering game tips, user bulletin boards and matching service for
head to head competition and tournaments.
The video game and PC businesses have become increasingly "hits"
driven, requiring significantly greater expenditures for marketing and
advertising, particularly for television advertising. There can be no assurance
that we will continue to produce "hit" titles, or that advertising for any
product will increase sales sufficiently to recoup those advertising expenses.
We have stock-balancing programs for our personal computer products
that, under certain circumstances and up to a specified amount, allow for the
exchange of personal computer products by resellers. We also typically provide
for price protection for our personal computer and video game system products
that, under certain conditions, allows the reseller a price reduction from us
for unsold products. We maintain a policy of exchanging products or giving
credits, but do not give cash refunds. Moreover, the risk of product returns may
increase as new hardware platforms become more popular or market factors force
us to make changes in our distribution system. We monitor and manage the volume
of our sales to retailers and distributors and their inventories as substantial
overstocking in the distribution channel can result in high returns or the
requirement for substantial price protection in subsequent periods. We believe
that we provide adequate reserves for returns and price protection which are
based on estimated future returns of products, taking into account promotional
8
activities, the timing of new product introductions, distributor and retailer
inventories of our products and other factors, and that our current reserves
will be sufficient to meet return and price protection requirements for current
in-channel inventory. However, there can be no assurance that actual returns or
price protection will not exceed our reserves.
We also have a fulfillment group that sells product directly to
consumers through a toll-free number and through our websites listed in
advertising by us and our Affiliated Labels. This group is also responsible for
targeted direct mail marketing and sells product backups and accessories to
registered customers.
The distribution channels through which consumer software products are
sold have been characterized by change, including consolidations and financial
difficulties of certain distributors and retailers and the emergence of new
retailers such as general mass merchandisers. The development of remote and
electronic delivery systems will create further changes. The bankruptcy or other
business difficulties of a distributor or retailer could render our accounts
receivable from such entity uncollectible, which could have an adverse effect on
our operating results and financial condition. In addition, an increasing number
of companies are competing for access to these channels. Our arrangements with
our distributors and retailers may be terminated by either party at any time
without cause. Distributors and retailers often carry products that compete with
ours. Retailers of our products typically have a limited amount of shelf space
and promotional resources for which there is intense competition. There can be
no assurance that distributors and retailers will continue to purchase our
products or provide our products with adequate levels of shelf space and
promotional support.
International Operations
We have wholly owned subsidiaries throughout the world, including
offices in the United Kingdom, France, Spain, Germany, Australia, Canada, South
Africa, Singapore, Sweden, Japan, Malaysia, Brazil and Holland. The amounts of
net revenues, operating profit and identifiable assets attributable to each of
our geographic regions for each of the last three fiscal years are set forth in
Note 16 of the Notes to the Consolidated Financial Statements included in Item 8
hereof. International net revenues increased by 33% to $516,865,000, or 42% of
consolidated fiscal 1999 net revenues, compared to $389,429,000, or 43% of
consolidated fiscal 1998 net revenues. Europe's net revenues increased by
$117,999,000 primarily due to an increase in sales of PlayStation and AL
products. Japan's net revenues increased by $11,371,000 primarily due to the
sales of FIFA: Road to World Cup 98. Asia Pacific net revenues decreased by
$1,934,000 due to the weaknesses in Asian currencies. In local currency, in
spite of weak economies, net revenues for Asia Pacific increased compared to the
prior year.
Though international revenues are expected to grow in fiscal 2000,
international revenues may not grow at as high a rate as in prior years. See
Risk Factors - "Our business, our products, and our distribution are subject to
increasing regulation in key territories" at page 25 and "Foreign Sales and
Currency Fluctuations" at page 26.
Manufacturing
In many instances, we are able to acquire materials on a
volume-discount basis. We have multiple potential sources of supply for most
materials. Except with respect to our PlayStation and N64 products, we also have
alternate sources for the manufacture and assembly of most of our products. To
date, we have not experienced any material difficulties or delays in production
of our software and related documentation and packaging. However, a shortage of
components or other factors beyond our control could impair our ability to
manufacture, or have manufactured, our products. See Risk Factors - "Our
platform licensors are our chief competitors and frequently control the
manufacturing of our video game products" at page 26.
9
Backlog
We normally ship products within a few days after receipt of an order.
However, a backlog may occur for EA Studio and Affiliated Label products that
have been announced for release but not yet shipped. We do not consider backlog
to be an indicator of future performance.
Seasonality
Our business is highly seasonal. We typically experience our highest
revenues and profits in the calendar year-end holiday season and a seasonal low
in revenues and profits in the quarter ending in June. In the June quarter of
our fiscal year 2000, we expect these seasonal trends to be magnified due to the
lack of significant product releases during the quarter. Additionally, we had
exceptional results for the same period in fiscal 1999 due to the shipment and
success of World Cup 98.
Employees
As of March 31, 1999, we employed approximately 2,500 people, of whom
over 1,200 were outside the United States. We believe that our ability to
attract and retain qualified employees is an important factor in our growth and
development and that our future success will depend, in large measure, on our
ability to continue to attract and retain qualified employees. To date, we have
been successful in recruiting and retaining sufficient numbers of qualified
personnel to conduct our business successfully. See Risk Factors - "We face
intense competition for talent from highly valued Internet companies" at page
26.
10
ITEM 2: PROPERTIES
Our principal administrative, sales and marketing, research and
development, and support facility is located in two modern buildings in Redwood
City, California, 20 miles south of San Francisco. We moved into this facility
in October 1998. We presently occupy approximately 350,000 sq. ft. in these
buildings under an operating lease for the buildings and certain adjoining land
that will expire on December 1, 2001. Monthly lease payments vary based upon the
London InterBank Offered Rate. We have the option to purchase the property for
the unamortized financed balance at any time after the non-cancelable lease
term, or we may terminate the lease at any time after the non-cancelable term by
arranging a third party sale or by making a termination payment. In April 1999,
we exercised our option to purchase a parcel of land under the lease and sold it
to a third party. The proceeds will mitigate a portion of the occupancy costs
for this facility. Should we elect to terminate the lease, we will guarantee a
residual value of up to 85% of the unamortized value of the property. As part of
the agreement, we must also comply with certain financial covenants.
Our North American distribution is supported by a 54,000 sq. ft. leased
facility used as an office and warehouse in Hayward, California, and an 84,000
sq. ft. warehouse facility in Louisville, Kentucky. Effective April 1999, we
entered into a lease agreement that increases the Kentucky warehouse facility's
square footage to 250,000 sq. ft. We also occupy sales offices in the
metropolitan areas of Toronto, Chicago, Dallas and New York.
In addition to our Redwood City development studio, we own a 206,000
sq. ft. development facility in Burnaby, British Columbia, Canada and rent a
33,000 sq. ft. facility in Seattle, Washington. The move to the new Canadian
offices was completed in June 1999. We also own a 180,000 sq. ft. development
facility in Austin, Texas and lease a 42,400 sq. ft. development facility in
Walnut Creek, California.
Our United Kingdom subsidiary occupies administrative and sales
facilities in Langley, England, under a lease for a total of 44,000 sq. ft. and
a 22,000 sq. ft. development facility in Surrey, England. In Europe, we also
lease a distribution hub in Heerlen, Holland and two administrative and sales
facilities in Germany, as well as sales and distribution facilities in: Madrid,
Spain; Lyon, France; Johannesberg, South Africa; Neudorf, Austria and Zurich,
Switzerland. Additionally, we have sales offices throughout Europe.
In Asia and the South Pacific, we maintain a 5,500 sq. ft. sales and
distribution facility in Brisbane, Australia. We also have sales and
distribution facilities in Singapore, Malaysia and Taiwan, and representative
offices in Beijing, Hong Kong and Shanghai, China. We also maintain a 27,000 sq.
ft. sales and development office in Tokyo, Japan. See Notes 3 and 9 of the Notes
to the Consolidated Financial Statements included in Item 8 hereof.
We believe that these facilities are adequate for our current needs. We
believe that suitable additional or substitute space will be available as needed
to accommodate our future needs.
11
ITEM 3: LEGAL PROCEEDINGS
We are subject to pending claims and litigation. Management, after
review and consultation with counsel, considers that any liability from the
disposition of such lawsuits would not have a material adverse effect upon our
consolidated financial condition or results of operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the quarter ended March 31, 1999.
12
ITEM 4A: EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the executive
officers of Electronic Arts, who are chosen by and serve at the discretion of
the Board of Directors:
Name Age Position
---- --- --------
Lawrence F. Probst III 49 Chairman and Chief Executive Officer
Don A. Mattrick 35 President, Worldwide Studios
John S. Riccitiello 39 President and Chief Operating Officer
William Bingham Gordon 49 Executive Vice President and Chief
Creative Officer
E. Stanton McKee, Jr. 54 Executive Vice President and Chief
Financial and Administrative Officer
Nancy L. Smith 46 Executive Vice President and General
Manager, North American Publishing
Ruth A. Kennedy 44 Senior Vice President, General Counsel
and Secretary
J. Russell Rueff, Jr. 37 Senior Vice President, Human Resources
David L. Carbone 48 Vice President, Finance
Mr. Probst has been a director of Electronic Arts since January 1991
and currently serves as Chairman and Chief Executive Officer. He was elected as
Chairman in July 1994. Mr. Probst has previously served as President of
Electronic Arts; as Senior Vice President of EA Distribution, Electronic Arts'
distribution division, from January 1987 to January 1991; and from September
1984, when he joined Electronic Arts, until December 1986, served as Vice
President of Sales. Mr. Probst holds a B.S. degree from the University of
Delaware.
Mr. Mattrick has served as President of Worldwide Studios since
September 1997. Prior to this, he served as Executive Vice President, North
American Studios, since October 1996. From July 1991 to October 1996, he served
as Senior Vice President, North American Studios, Vice President of Electronic
Arts and Executive Vice President/General Manager for EA Canada. Mr. Mattrick
was founder and former chairman of Distinctive Software Inc. from 1982 until it
was acquired by us in 1991.
Mr. Riccitiello has served as President and Chief Operating Officer
since October 1997. Prior to joining Electronic Arts, Mr. Riccitiello served as
President and Chief Executive Officer of the worldwide bakery division at Sara
Lee Corporation. Before joining Sara Lee, he served as President and CEO of
Wilson Sporting Goods Co. and has also held executive management positions at
Haagen-Dazs, PepsiCo, Inc. and The Clorox Company. Mr. Riccitiello holds a
degree in Economics and Marketing from the University of California, Berkeley.
Mr. Gordon has served as Executive Vice President and Chief Creative
Officer since March 1998. Prior to this, he served as Executive Vice President,
Marketing since October 1995. From August 1993 to October
13
1995, he served as Executive Vice President of EA Studios and as Senior Vice
President of Entertainment Production since February 1992. He also served as
Senior Vice President of Marketing, as General Manager of EA Studios, as Vice
President of Marketing, as Director of Advertising and as Vice President of our
former entertainment division while employed by us. Mr. Gordon holds a B.A.
degree from Yale University and an M.B.A. degree from Stanford University.
Mr. McKee joined Electronic Arts in March 1989 and is currently
Executive Vice President and Chief Financial and Administrative Officer. Prior
to October 1996, he served as Senior Vice President and Chief Financial and
Administrative Officer. Mr. McKee holds B.A. and M.B.A. degrees from Stanford
University and is also a Certified Public Accountant.
Ms. Smith has served as Executive Vice President and General Manager,
North American Publishing since March 1998. Prior to this, she served as
Executive Vice President, North American Sales since October 1996. She
previously held the position of Senior Vice President of North American Sales
and Distribution from July 1993 to October 1996 and as Vice President of Sales
from 1988 to 1993. Ms. Smith has also served as Western Regional Sales Manager
and National Sales Manager since she joined Electronic Arts in 1984. Ms. Smith
holds a B.S. degree in management and organizational behavior from the
University of San Francisco.
Ms. Kennedy has been employed by Electronic Arts since February 1990.
She served as Corporate Counsel until March 1991 and is currently Senior Vice
President, General Counsel and Secretary. Prior to October 1996, she served as
Vice President, General Counsel and Secretary. Ms. Kennedy was elected Secretary
in September 1994. Ms. Kennedy is a member of the State Bars of California and
New York and received her B.A. degree from William Smith College and her Juris
Doctor from the State University of New York.
Mr. Rueff has served as Senior Vice President of Human Resources since
October of 1998. Prior to joining Electronic Arts, Mr. Rueff held various
positions with the PepsiCo companies for over 10 years, including: Vice
President, International Human Resources; Vice President, Staffing and
Resourcing at Pepsi-Cola International; Vice President, Restaurant Human
Resources for Pizza Hut; and also various other management positions within the
Frito-Lay Company. Mr. Rueff holds a M.S. degree in Counseling and a B.A. degree
in Radio and Television from Purdue University in Indiana.
Mr. Carbone has been with Electronic Arts since February 1991 as Vice
President, Finance. He was elected Assistant Secretary of the Company in March
1991. Mr. Carbone holds a B.S. degree in accounting from King's College and is a
Certified Public Accountant.
14
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is traded on the National Market under the symbol "ERTS". The
following table sets forth the quarterly high and low closing sales prices of
our Common Stock from April 1, 1997 through March 31, 1999. Such prices
represent prices between dealers and does not include retail mark-ups,
mark-downs or commissions and may not represent actual transactions.
Closing Sales Prices
-----------------------------
High Low
---- ---
Fiscal Year Ended March 31, 1998:
First Quarter $35.38 $20.13
Second Quarter 37.50 30.75
Third Quarter 39.56 29.94
Fourth Quarter 46.94 34.94
Fiscal Year Ended March 31, 1999:
First Quarter $54.81 $41.63
Second Quarter 55.56 38.13
Third Quarter 56.00 33.88
Fourth Quarter 52.19 38.25
There were approximately 1,900 holders of record of our Common Stock as of June
1, 1999. We believe that a significant number of beneficial owners of our Common
Stock hold their shares in street names.
Dividend Policy
We have not paid any cash dividends and do not anticipate paying cash
dividends in the foreseeable future.
15
ITEM 6: SELECTED FINANCIAL DATA
ELECTRONIC ARTS AND SUBSIDIARIES
SELECTED FIVE-YEAR FINANCIAL DATA
Years Ended March 31 (In thousands, except per share data)
INCOME STATEMENT DATA 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 1,221,863 $ 908,852 $ 673,028 $ 587,299 $ 531,493
Cost of goods sold 625,547 480,766 328,943 291,491 277,543
------------------------------------------------------------------------
Gross profit 596,316 428,086 344,085 295,808 253,950
Operating expenses:
Marketing and sales 163,407 128,308 102,072 85,771 70,764
General and administrative 75,556 57,838 48,489 37,711 33,492
Research and development 202,080 146,199 130,755 108,043 79,910
Charge for acquired in-process technology 44,115 1,500 -- 2,232 --
Merger costs -- 10,792 -- -- --
Amortization of intangibles 5,880 -- -- -- --
------------------------------------------------------------------------
Total operating expenses 491,038 344,637 281,316 233,757 184,166
------------------------------------------------------------------------
Operating income 105,278 83,449 62,769 62,051 69,784
Interest and other income, net 13,180 24,811 13,279 7,514 13,476
------------------------------------------------------------------------
Income before provision for income taxes and minority
interest 118,458 108,260 76,048 69,565 83,260
Provision for income taxes 45,414 35,726 26,003 22,584 26,859
------------------------------------------------------------------------
Income before minority interest 73,044 72,534 50,045 46,981 56,401
Minority interest in consolidated joint venture (172) 28 1,282 (304) 2,620
------------------------------------------------------------------------
Income from continuing operations 72,872 72,562 51,327 46,677 59,021
Discontinued operations:
Gain on disposal of discontinued operations (net of
income tax expense of $173 in fiscal 1995) -- -- -- -- 303
------------------------------------------------------------------------
Net income $ 72,872 $ 72,562 $ 51,327 $ 46,677 $ 59,324
------------------------------------------------------------------------
Per share amounts:
Income from continuing operations:
Basic $ 1.20 $ 1.23 $ 0.89 $ 0.84 $ 1.13
Diluted $ 1.15 $ 1.19 $ 0.86 $ 0.80 $ 1.06
Net income:
Basic $ 1.20 $ 1.23 $ 0.89 $ 0.84 $ 1.13
Diluted $ 1.15 $ 1.19 $ 0.86 $ 0.80 $ 1.07
Number of shares used in computation:
Basic 60,748 58,867 57,544 55,685 52,446
Diluted 63,272 60,958 59,557 58,190 55,546
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA AT FISCAL YEAR END
- ------------------------------------------------------------------------------------------------------------------------------------
Cash, cash equivalents and short-term investments $ 312,822 $ 374,560 $ 268,141 $ 190,873 $ 182,776
Marketable securities 4,884 3,721 5,548 37,869 10,725
Working capital 333,256 408,098 284,863 247,001 180,714
Long-term investments 18,400 24,200 34,478 30,319 14,200
Total assets 901,873 745,681 584,041 489,496 359,866
Total liabilities 236,209 181,713 136,237 108,668 107,894
Minority interest 2,733 -- 28 1,277 1,148
Redeemable preferred stock -- -- -- -- 11,363
Total stockholders' equity 662,931 563,968 447,776 379,551 239,461
16
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following "Management's Discussion and Analysis of Financial Condition and
Results of Operations", contains forward looking statements regarding future
events or our future financial performance that involve certain risks and
uncertainties including those discussed in "Risk Factors" at pages 25 to 26 of
this Annual Report on Form 10-K. Actual events or actual future results may
differ materially from any forward looking statements due to such risks and
uncertainties.
RESULTS OF OPERATIONS
Comparison of Fiscal 1999 to 1998
1999 1998 % change
- --------------------------------------------------------------------------------
Net revenues $1,221,863,000 $ 908,852,000 34.4
- --------------------------------------------------------------------------------
We derive revenues primarily from shipments of entertainment software, which
includes EA Studio CD products for dedicated entertainment systems ("CD-video
games"), EA Studio CD personal computer products ("PC-CD"), EA Studio cartridge
products and Affiliated Label ("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 ("OEMs") and online
subscription revenues.
Our total net revenues increased compared to the prior year due to increased
sales of products on PlayStation , Nintendo N64 , PC-CD and increased worldwide
distribution of AL products. This increase was partially offset by a decrease in
sales of Sega Saturn(R) products and 16-bit video game products.
Sales of PlayStation products in fiscal 1999 increased to $519,830,000, or 43%
of total revenue, compared to $380,299,000, or 42% of total revenue in fiscal
1998. We released 21 new PlayStation titles in fiscal 1999 compared to 25 in
fiscal 1998. The increase in sales was attributable to the greater installed
base of PlayStation game consoles and the releases of key titles for this
platform including FIFA 99, World Cup 98 and Madden NFL 99. We expect revenues
from PlayStation products to continue to grow in fiscal 2000, but as revenues
for these products increase, we do not expect to maintain these growth rates.
Net revenues derived from other 32-bit products, primarily for Saturn, were
$749,000 in fiscal 1999 compared to $17,507,000 in fiscal 1998. We released no
new Saturn titles in fiscal 1999 compared to eight in fiscal 1998. We do not
expect to release any new Saturn titles in fiscal 2000 and revenues from the
sales of Saturn products are not expected to be significant in future years.
Net revenues from PC-CD products increased to $270,793,000 in fiscal 1999,
representing 22% of total net revenues, from $231,034,000, or 25% of total net
revenues in fiscal 1998. We released 29 PC-CD titles in fiscal 1999 compared to
30 PC-CD titles in fiscal 1998. The worldwide increase in sales of PC-CD
products was primarily attributable to an increase in sales in Europe and North
America due to the related releases of key titles for this platform including
Sim City 3000.
Net revenues derived from N64 video game cartridge products were $152,349,000,
or 12% of total net revenues, compared to $56,677,000, or 6%, in fiscal 1998.
The increase in N64 revenues was primarily due to more title releases for this
platform compared to last year and a larger N64 market. We released nine titles
in fiscal 1999, including NASCAR 99,compared to two titles in fiscal 1998. We do
not expect significant growth in revenues for N64 products in fiscal 2000.
Net revenues from shipments of AL products in fiscal 1999 increased to
$248,105,000, or 20% of total revenue, compared to $185,865,000, or 20% of total
revenue in fiscal 1998. The increase was due to higher sales of AL products in
North America and Europe. This increase was primarily attributable to the
distribution of products published by Square EA in North America and the
acquisition of ABC Software in Switzerland. We expect revenues from AL products
to continue to grow in fiscal 2000, but as revenues for these products increase,
we do not expect to maintain these growth rates.
Net revenues generated by 16-bit video game cartridge-based products were
$635,000 in fiscal 1999, compared to $17,314,000, or 2% of net revenues in
fiscal 1998. As the 16-bit video game market has been replaced by 32-bit and
64-bit systems, we did not release any new titles in fiscal 1999. We do not
expect to release any new titles in fiscal 2000 and revenues from the sales of
16-bit products are not expected to be significant.
Licensing of EA Studio products generated $17,788,000 in fiscal 1999, compared
to $15,431,000 in fiscal 1998. The increase was primarily the result of an
increase in the revenues generated by the licensing of our products in Europe.
North America net revenues increased by 36% to $704,998,000 in fiscal 1999 as
compared to $519,423,000 in fiscal 1998. The increase was mainly attributable to
strong growth in N64 and PlayStation systems, the distribution of AL titles and
growth in PC-CD sales. Net revenues from PlayStation and N64 revenues increased
$148,181,000 due to a larger market and greater installed base for these
platforms as well as more title releases for N64 in comparison to the prior
year. North America AL sales increased by
17
$39,813,000, compared to the prior year primarily due to the distribution of
products published by Square EA. PC-CD revenues increased by $13,439,000 due to
key title releases during the year.
International net revenues increased by 33% to $516,865,000, or 42% of
consolidated fiscal 1999 net revenues, compared to $389,429,000, or 43% of the
fiscal 1998 total. Europe's net revenues increased by $117,999,000 primarily due
to an increase in sales of PlayStation and AL products. Japan's net revenues
increased by $11,371,000 primarily due to the sales of FIFA: Road to World Cup
98. Asia Pacific net revenues decreased by $1,934,000 due to the weakness in
Asian currencies. In local currency, in spite of weak economies, net revenues
for Asia Pacific increased compared to the prior year.
================================================================================
1999 1998 % change
- --------------------------------------------------------------------------------
Cost of goods sold $625,547,000 $480,766,000 30.1
As a percentage of net
revenues 51.2% 52.9%
- --------------------------------------------------------------------------------
Cost of goods sold as a percentage of revenues decreased in fiscal 1999
primarily due to lower artist royalties, including savings related to an
acquisition of a software development company during fiscal 1999, partially
offset by higher sales of lower margin N64 products.
================================================================================
Operating %
Expenses 1999 1998 change
- -------------------------------------------------------------------------------
Marketing and sales $163,407,000 $ 128,308,000 27.4
As a percentage of
net revenues 13.4% 14.1%
- -------------------------------------------------------------------------------
General and
administrative $ 75,556,000 $ 57,838,000 30.6
As a percentage of
net revenues 6.2% 6.4%
- -------------------------------------------------------------------------------
Research and
development $202,080,000 $ 146,199,000 38.2
As a percentage of
net revenues 16.5% 16.1%
- -------------------------------------------------------------------------------
The increase in marketing and sales expenses was primarily attributable to
increased print, Internet and television advertising to support new releases and
increased cooperative advertising associated with higher revenues in North
America and Europe as compared to the prior year. Increases in marketing and
sales expenses were also due to additional headcount related to the continued
expansion of our worldwide distribution business and the acquisitions of ABC
Software and Westwood Studios.
The increase in general and administrative expenses was primarily due to an
increase in headcount and occupancy costs to support the increase in growth in
North America and Europe operations, including the opening of additional
international offices in Europe and the acquisition of ABC Software.
The increase in research and development expenses was due to additional
headcount-related expenses attributable to the acquisition of Westwood Studios,
Inc. and certain assets of the Irvine, California-based Virgin Studio
(collectively "Westwood") in September 1998 and Tiburon Entertainment, Inc. in
April 1998, higher development costs per title, as products are including more
content and are more complex and time consuming to develop, and an increase in
development costs for Ultima Online.
We released a total of 59 new products in fiscal 1999 compared to 71 in fiscal
1998.
================================================================================
Other Operating %
Expenses 1999 1998 change
- --------------------------------------------------------------------------------
Amortization of
intangibles $ 5,880,000 $ -- N/M
As a percentage of
net revenues 0.5% N/A
- --------------------------------------------------------------------------------
Charge for acquired
in-process technology $ 44,115,000 $ 1,500,000 N/M
As a percentage of
net revenues 3.6% 0.2%
- --------------------------------------------------------------------------------
Merger costs $ -- $ 10,792,000 (100.0)
As a percentage of
net revenues N/A 1.2%
- --------------------------------------------------------------------------------
Amortization of intangibles results from the acquisitions of Westwood and ABC
Software in the second quarter of fiscal 1999.
In connection with the purchase of Westwood in September 1998, we allocated and
expensed $41,836,000 of the $122,688,000 purchase price to in-process research
and development projects. This allocation represents the estimated fair value
based on risk-adjusted cash flows related to the incomplete research and
development projects. At the date of acquisition, this amount was expensed as a
non-recurring charge as the in-process technology had not yet reached
technological feasibility and had no alternative future uses. Westwood had three
major PC-CD projects in progress at the time of the acquisition including two in
the best-selling franchise Command and Conquer and one in the critically
acclaimed Lands of Lore series. As of the acquisition date, costs to complete
the Westwood projects acquired were expected to be approximately $9.1 million in
fiscal 1999, $10.6 million in fiscal 2000 and $1.0 million in fiscal 2001. We
believe there have been no significant changes to these estimates as of March
31, 1999. We currently expect to complete the development of these projects at
various dates
18
through fiscal 2001 and to publish the products upon completion.
The nature of the efforts required to develop the acquired in-process technology
into commercially viable products principally relate to the completion of all
planning, designing and testing activities necessary to establish that the
product can be produced to meet our design requirements including functions,
features and technical performance requirements. Though we currently expect that
the acquired in-process technology will be successfully developed, there can be
no assurance that commercial or technical viability of these products will be
achieved. Furthermore, future developments in the entertainment software
industry, changes in computer or video game console technology, changes in other
product offerings or other developments may cause us to alter or abandon these
plans.
The value assigned to purchased in-process technology was determined by
estimating the completion percentage of research and development efforts at the
acquisition date, forecasting risk adjusted revenues considering the completion
percentage, estimating the resulting net cash flows from the projects and
discounting the net cash flows to their present values. The completion
percentages were estimated based on cost incurred to date, importance of the
completed development tasks and the elapsed portion of the total project time.
The revenue projection used to value the in-process research and development is
based on unit sales forecasts for worldwide sales territories and adjusted to
consider only the revenue related to development achievements completed at the
acquisition date. Net cash flow estimates include cost of goods sold and sales,
marketing and general and administrative expenses and taxes forecasted based on
historical operating characteristics. In addition, net cash flow estimates were
adjusted to allow for fair return on working capital and fixed assets, charges
for franchise and technology leverage and return on other intangibles.
Appropriate risk adjusted discount rates ranging from 20% to 22.5% were used to
discount the net cash flows back to their present value. The remaining
identified intangibles will be amortized on a straight-line basis over two to
twelve years based on expected useful lives of franchise tradenames, existing
products and technologies, retention of workforce, and other intangible assets.
If these projects are not successfully developed, we may not realize the value
assigned to the in-process research and development projects. In addition, the
value of other acquired intangible assets may also become impaired.
In conjunction with the merger of Westwood, we accrued approximately $1,500,000
related to direct transaction costs and other related accruals. At March 31,
1999, there were $725,000 in accruals remaining related to these items.
Additionally, for fiscal 1999, the charge for in-process research and
development also included write-offs of $2,279,000 associated with the
acquisition of two software development companies in the first quarter.
For fiscal 1998, we incurred a charge of $1,500,000 for acquired in-process
technology in connection with the acquisition of the remaining 35% minority
ownership interest in Electronic Arts Victor, Inc. in December 1997. This charge
was made after we concluded that the in-process technology had no alternative
future use after taking into consideration the potential for usage of the
software in different products and resale of the software.
On July 25, 1997, we completed a merger with Maxis, Inc. ("Maxis"). In
conjunction with the merger, we recorded costs of $10,792,000 which included
direct transaction fees and costs associated with integrating the operations of
the two companies. At March 31, 1999, there were no accruals remaining related
to these merger costs.
================================================================================
1999 1998 % change
- --------------------------------------------------------------------------------
Operating income $105,278,000 $83,449,000 26.2
As a percentage of
net revenues 8.6% 9.2%
- --------------------------------------------------------------------------------
Operating income increased due to higher net revenues and related gross profit
partially offset by increased operating expenses including the charges for
acquired in-process technology of $44,115,000 in the current fiscal year
partially offset by merger costs of $10,792,000 and a charge for acquired
in-process technology of $1,500,000 related to the acquisitions in the prior
fiscal year.
================================================================================
1999 1998 % change
- --------------------------------------------------------------------------------
Interest and other
income, net $13,180,000 $24,811,000 (46.9)
As a percentage of
net revenues 1.1% 2.7%
- --------------------------------------------------------------------------------
The decrease in interest and other income, net, was primarily attributable to
the sale of our 50% ownership interest in Creative Wonders, LLC in December
1997. The sale resulted in a gain in the prior year of $12,625,000.
================================================================================
1999 1998 % change
- --------------------------------------------------------------------------------
Income taxes $45,414,000 $35,726,000 27.1
Effective tax rate 38.3% 33.0%
- --------------------------------------------------------------------------------
Our effective tax rate for fiscal 1999 was negatively affected as there was no
tax benefit recorded for a portion of the charges related to the acquired
in-process technology. Excluding the effect of these charges, the effective tax
rate for the current fiscal year would have been 32.0% as compared to a 33.0%
tax rate in the corresponding prior year periods. The lower rate of 32.0%
results primarily from a higher portion of international income subject to a
lower foreign tax rate as
19
compared to the prior year and an increase in the federal research and
experimental credit.
================================================================================
1999 1998 % change
- --------------------------------------------------------------------------------
Minority interest in
consolidated joint venture $(172,000) $28,000 N/M
As a percentage of
net revenues 0.0% 0.0%
- --------------------------------------------------------------------------------
In the first quarter of fiscal 1999, we formed EA Square KK which is seventy
percent owned by us and thirty percent owned by Square Co. Ltd. ("Square"), a
leading developer and publisher of entertainment software in Japan. Minority
interest for fiscal 1999 represents Square's 30% interest in the net income of
EA Square KK.
For fiscal 1998, the minority interest represented the 35% interest in
Electronic Arts Victor, Inc. ("EAV") owned by Victor Entertainment Industries,
Inc. ("VEI"). We acquired the remaining 35% minority ownership interest in EAV
held by VEI in December 1997.
================================================================================
1999 1998 % change
- --------------------------------------------------------------------------------
Net income $72,872,000 $72,562,000 0.4
As a percentage of
net revenues 6.0% 8.0%
- --------------------------------------------------------------------------------
Reported net income was flat due to the one-time charges related to acquisitions
offsetting significantly higher operating income. The increase in net income,
excluding one-time charges, was due to higher revenues and gross profits, offset
by higher operating expenses. For fiscal 1998, net income included a one-time
gain on sale of Creative Wonders, LLC in the amount of $8,459,000, net of taxes,
offset by Maxis merger costs and a charge for acquired in-process developments
of $8,236,000, net of taxes. For fiscal 1999, net income included one-time
charges for acquired in-process technology of $37,506,000, net of taxes.
Excluding one-time items in both years, as noted above, net income increased to
$110,378,000 from $72,339,000, or 53% over the prior year.
RESULTS OF OPERATIONS
Comparison of Fiscal 1998 to 1997
1998 1997 % change
- --------------------------------------------------------------------------------
Net revenues $908,852,000 $673,028,000 35.0
- --------------------------------------------------------------------------------
Our total net revenues increased compared to the prior year due to increased
sales of PlayStation products, increased worldwide distribution of AL products,
sales of N64 video game cartridge products and sales of PC-CD products. This
increase was partially offset by a decrease in sales of 16-bit video game
cartridges and License/OEM revenues.
Net revenues from 32-bit CD-video game products, primarily for the PlayStation,
were $397,806,000 in fiscal 1998, representing 44% of the total net revenues
compared to $225,875,000, or 34% of total net revenues in fiscal 1997. The
increase in sales of 32-bit video game products was attributable to the greater
installed base of PlayStation game consoles and related releases of key titles
for this platform during the year offset by a decline in revenues from sales of
products for Saturn.
Sales of PlayStation products in fiscal 1998 increased to $380,299,000, or 42%
of total revenue, compared to $187,531,000, or 28% of total revenue in fiscal
1997. We released 25 new PlayStation titles in fiscal 1998 compared to 14 in
fiscal 1997.
Net revenues derived from the sales of other 32-bit products, primarily from
Saturn, were $17,507,000 in fiscal 1998 compared to $38,344,000 in fiscal 1997.
As the installed base of Saturn consoles did not achieve the growth rates of
PlayStation consoles, our revenues from sales of Saturn products declined. We
released eight new Saturn titles in fiscal 1998 compared to 12 in fiscal 1997.
Net revenues from shipments of AL products in fiscal 1998 increased to
$185,865,000, or 20% of total revenue, compared to $96,696,000, or 14% of total
revenue in fiscal 1997. This increase was due to higher sales of AL products in
North America, Europe and Asia Pacific. This increase was attributable to the
product releases under a worldwide exclusive distribution agreement with
DreamWorks Interactive, including The Lost World: Jurassic Park, and due to
continued distribution of products from Accolade, Inc. which began in the fourth
quarter of fiscal 1997. AL revenues also increased as a result of our exclusive
distribution agreement with Twentieth Century Fox Home Entertainment outside
North America.
Net revenues derived from N64 video game cartridge products were $56,677,000, or
6% of total net revenues, compared to $17,804,000 in fiscal 1997. We released
two titles in fiscal 1998 compared to one title in fiscal 1997.
Net revenues from PC-CD products increased to $231,034,000 in fiscal 1998,
representing 25% of total net revenues, from $216,338,000, or 32% of total net
revenues in fiscal 1997. We released 30 PC-CD titles in fiscal 1998 compared to
32 PC-CD titles in fiscal 1997. The increase in sales of PC-CD products was
attributable to the worldwide growth in the PC market and the expansion of our
direct distribution worldwide. PC-CD sales growth for fiscal 1998 was partially
offset by a decline in titles published by Maxis. Maxis' PC-CD revenues for
fiscal 1998 decreased by $17,010,000 or 45% compared to fiscal 1997.
Net revenues generated by 16-bit video game cartridge-based products were
$17,314,000, or 2% of total revenues in fiscal
20
1998, compared to $89,160,000, or 13% of net revenues in fiscal 1997.
Licensing of EA Studio products generated $15,431,000 in fiscal 1998, compared
to $26,749,000 in fiscal 1997. The decrease was primarily the result of a
decrease in the revenues generated by the licensing of our products in Europe
and Japan.
North America net revenues increased by 39% to $519,423,000 in fiscal 1998 as
compared to $372,616,000 in fiscal 1997. The increase was mainly attributable to
strong growth in PlayStation and N64 systems as well as AL product revenues
partially offset by the decline in 16-bit cartridge and Saturn product sales.
Net revenues from PlayStation and N64 products increased $172,496,000 while
sales of 16-bit cartridge and Saturn products decreased $62,671,000 in
comparison to the prior year. North America AL sales increased $34,355,000,
compared to the prior year.
International net revenues increased by 30% to $389,429,000, or 43% of
consolidated fiscal 1998 net revenues, compared to $300,412,000, or 45% of the
fiscal 1997 total. The increase in international revenues was due to higher
worldwide sales of PlayStation products and increased sales of PC-CD, N64 and AL
products in Europe and Asia Pacific. This was partially offset by a decrease in
32-bit product sales in Japan, international 16-bit video game cartridge
revenues and licensing of our products.
================================================================================
1998 1997 % change
- --------------------------------------------------------------------------------
Cost of goods sold $480,766,000 $328,943,000 46.2
As a percentage of net
revenues 52.9% 48.9%
- --------------------------------------------------------------------------------
Cost of goods sold as a percentage of revenues in fiscal 1998 reflected
increased product costs associated with increased sales of lower margin
affiliated label and N64 titles, a decrease in higher margin PC-CD sales as a
proportion of total net revenues and higher professional and celebrity royalties
on CD-video game and PC-CD titles as well as higher manufacturing royalties on
CD-video game titles.
================================================================================
%
Operating Expenses 1998 1997 change
- --------------------------------------------------------------------------------
Marketing and sales $128,308,000 $102,072,000 25.7
As a percentage of
net revenues 14.1% 15.2%
- --------------------------------------------------------------------------------
General and
administrative $ 57,838,000 $ 48,489,000 19.3
As a percentage of
net revenues 6.4% 7.2%
- --------------------------------------------------------------------------------
Research and
development $146,199,000 $130,755,000 11.8
As a percentage of
net revenues 16.1% 19.4%
- --------------------------------------------------------------------------------
The increase in marketing and sales expenses was primarily attributable to
increased television and print advertising to support new releases and increased
cooperative advertising associated with higher revenues as compared to the prior
year. Increases in marketing and sales expenses were also due to additional
headcount related to the continued expansion of our worldwide distribution
business.
The increase in general and administrative expenses was primarily due to an
increase in payroll and occupancy costs due to the opening of additional
international offices and additional depreciation related to the installation of
new management information systems worldwide. This increase was partially offset
by lower spending in Japan.
The increase in marketing and sales as well as general and administrative
expenses were partially offset by savings attributable to the integration of
Maxis in the second quarter of fiscal 1998.
The increase in research and development expenses was due to additional
headcount related expenses in North America and Europe attributable to increased
in-house development capacity, higher development costs per title and additional
depreciation of computer equipment.
We released a total of 71 new products in fiscal 1998 compared to 68 in fiscal
1997.
================================================================================
Other Operating Expenses
1998 1997 % change
- --------------------------------------------------------------------------------
Charge for acquired
in-process technology $ 1,500,000 $-- N/M
As a percentage of
net revenues 0.2% N/A
- --------------------------------------------------------------------------------
Merger costs $10,792,000 $-- N/M
As a percentage of
net revenues 1.2% N/A
- --------------------------------------------------------------------------------
In connection with the acquisition of the remaining 35% minority ownership
interest in EAV in December 1997, we incurred a charge of $1,500,000 for
acquired in-process technology. This charge was made after we concluded that the
in-process technology had no alternative future use after taking into
consideration the potential for usage of the software in different products and
resale of the software.
On July 25, 1997, we completed a merger with Maxis. In conjunction with the
merger, we recorded costs of $10,792,000 which included direct transaction fees
and costs associated with integrating the operations of the two companies.
21
================================================================================
1998 1997 % change
- --------------------------------------------------------------------------------
Operating income $83,449,000 $62,769,000 32.9
As a percentage of
net revenues 9.2% 9.3%
- --------------------------------------------------------------------------------
Operating income increased due to higher net revenues and related gross profit
partially offset by increased operating expenses including the charge for
acquired in-process technology as well as merger costs related to the
acquisition of Maxis.
================================================================================
1998 1997 % change
- --------------------------------------------------------------------------------
Interest and other
income, net $24,811,000 $13,279,000 86.8
As a percentage of
net revenues 2.7% 2.0%
- --------------------------------------------------------------------------------
The increase in other income is primarily due to higher interest income
attributable to higher cash balances as compared to the previous year and the
sale of our 50% ownership interest in Creative Wonders, LLC in December 1997.
The sale of Creative Wonders resulted in a gain of $12,625,000. This increase
was partially offset by lower gains on sales of marketable securities in the
amount of $4,098,000 compared to $8,393,000 in the prior year.
================================================================================
1998 1997 % change
- --------------------------------------------------------------------------------
Income taxes $35,726,000 $26,003,000 37.4
Effective tax rate 33.0% 34.2%
- --------------------------------------------------------------------------------
Our effective tax rate was lower for the year as a result of a higher proportion
of international income subject to a lower foreign tax rate as compared to the
prior year and the reinstatement of the federal research and development tax
credit for the full fiscal year 1998.
================================================================================
1998 1997 % change
- --------------------------------------------------------------------------------
Minority interest in
consolidated joint venture $28,000 $1,282,000 (97.8)
As a percentage of net
revenues 0.0% 0.2%
- --------------------------------------------------------------------------------
As discussed above, we acquired the remaining minority ownership interest in EAV
in December 1997. Prior to the acquisition, EAV was sixty-five percent owned by
us and thirty-five percent owned by VEI. Minority interest for the year
reflected only a portion of reported losses for EAV as the net equity of EAV
fell below zero in the first quarter of fiscal 1998.
================================================================================
1998 1997 % change
- --------------------------------------------------------------------------------
Net income $72,562,000 $51,327,000 41.4
As a percentage of
net revenues 8.0% 7.6%
- --------------------------------------------------------------------------------
The increase in net income was due to the growth in revenues and gross margins
offset by higher operating expenses. The impact of the gain on sale of Creative
Wonders, LLC was offset by the charge for acquired in-process technology and
merger costs.
22
================================================================================
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1999, our working capital was $333,256,000 compared to
$408,098,000 at March 31, 1998. Cash, cash equivalents and short-term
investments decreased by approximately $61,738,000 in fiscal 1999. We generated
$150,768,000 of cash from operations in fiscal 1999. In addition, $30,577,000
was provided through the sale of equity securities under our stock plans.
Reserves for bad debts and sales returns increased from $51,575,000 at March 31,
1998 to $72,850,000 at March 31, 1999. 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.
During fiscal 1999, we invested $122,688,000 in cash for the acquisition of
Westwood Studios, Inc., $9,466,000 for the acquisition of ABC Software,
approximately $7,800,000 for investment in affiliates and approximately
$8,000,000 in long-term licenses. In addition, we invested approximately
$78,800,000 for new facilities in Europe and Canada and $17,800,000 in computer
equipment worldwide. In addition, we repurchased 222,500 shares of our common
stock for approximately $9,001,000.
Our principal source of liquidity is $312,822,000 in cash, cash equivalents
and short-term investments. Management believes the existing cash, cash
equivalents, short-term investments, marketable securities and cash generated
from operations will be sufficient to meet cash and investment requirements for
the next twelve months and the foreseeable future.
================================================================================
YEAR 2000 READINESS DISCLOSURE
Background of Year 2000 Issues
Many currently installed computer systems and software products are unable to
distinguish between twentieth century dates and twenty-first century dates
because such systems may have been developed using two digits rather than four
to determine the applicable year. For example, computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This error could result in system failures or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced to comply with such "Year
2000" requirements.
State of Readiness
Our business is dependent on the operation of numerous systems that could
potentially be impacted by Year 2000 related problems. Those systems include,
among others: hardware and software systems used to deliver products to our
customers; communications networks such as the Internet and private intranets,
which we depend on to receive orders for products from our customers; the
internal systems of our customers and suppliers; products sold to customers; the
hardware and software systems used internally in the management of our business;
and non-information technology systems and services used in the management of
our business, such as power, telephone systems and building systems.
Based on an analysis of the systems potentially impacted by conducting
business in the twenty-first century, we are applying a phased approach to
making such systems, and accordingly, our operations, ready for the year 2000.
Beyond awareness of the issues and scope of systems involved, the phases of
activities in progress include: an assessment of specific underlying computer
systems, programs and hardware; renovation, replacement or redeployment of Year
2000 non-compliant technology; validation and testing of technologically
compliant Year 2000 solutions; and implementation of the Year 2000 compliant
systems.
As a third party providing software products, we are dependent on the
hardware and software products used to deliver such products and services. If
such products are inoperable due to Year 2000 issues, our business, financial
condition and results of operations could be adversely affected. An inventory of
our internal business systems has been completed and planned software and
hardware upgrades to ensure Year 2000 compliance are in process. The upgrades to
these systems are expected to be completed by June, 1999.
Costs
To date we have not incurred significant costs directly related to Year 2000
issues, even in cases where non-compliant information technology systems were
redeployed or replaced.
We believe that future expenditures to upgrade internal systems and
applications will not have a material adverse effect on our business, financial
condition and results of operations and are primarily included within our
ongoing system development plan. In addition, while the potential costs of
redeploying personnel and of any delays in implementing other projects are not
known, the costs are anticipated to be immaterial.
23
Risks of the Year 2000 Issues
Our financial information systems include an integrated suite of business
applications developed and supported by Oracle Corporation. These applications
systems are in place and currently support daily operations in the United States
and in Europe. Based on representations made by Oracle Corporation and upon our
limited tests, we believe these systems to be Year 2000 compliant.
We believe our software products are Year 2000 compliant; however, success
of our Year 2000 compliance efforts may depend on the success of our customers
dealing with their Year 2000 issues. Customer difficulties with Year 2000 issues
might require us to devote additional resources to resolve underlying problems.
Failures of our and/or third parties' computer systems could have a material
adverse impact on our ability to conduct business. For example, a significant
percentage of purchase orders received from our customers are computer generated
and electronically transmitted. In addition, the Year 2000 could affect the
ability of consumers to use our PC based products. If the computer systems on
which the consumers use our products are not Year 2000 compliant, such
noncompliance could affect the consumers' ability to use such products.
Contingency Plans
We continue to assess certain of our Year 2000 exposure areas in order to
determine what additional steps beyond those identified by our internal review
in the United States are advisable. We are currently developing a contingency
plan for handling Year 2000 problems that are not detected and corrected prior
to their occurrence. We expect this plan will be completed by June 30, 1999. We
believe that the systems, which represent the principal exposures, have been
identified, and to the extent necessary, are in the process of being modified to
become Year 2000 compliant. Additionally, we will be conducting tests of our
principal business systems to verify that those systems are Year 2000 compliant.
Any failure to address any unforeseen Year 2000 issue could adversely affect our
business, financial condition and results of operations.
EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the European
Union established fixed conversion rates between their existing currencies (the
"legacy currency") and the one common legal currency known as the "Euro". From
January 1, 1999 through June 30, 2002 the countries will be able to use their
legacy currencies or the Euro to transact business. By July 1, 2002, at the
latest, the conversion to the Euro will be complete at which time the legacy
currencies will no longer be legal tender. The conversion to the Euro will
eliminate currency exchange rate risk between the member countries.
We do not anticipate any material impact from the Euro conversion on our
financial information systems which currently accommodate multiple currencies.
Computer software changes necessary to comply with the Year 2000 issue are
generally compliant to the Euro conversion issue. Due to numerous uncertainties,
we cannot reasonably estimate the effect that the Euro conversion issue will
have on our pricing or market strategies, and the impact, if any, it will have
on our financial condition and results of operations.
24
- --------------------------------------------------------------------------------
RISK FACTORS
EA's 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:
- - Product development schedules are frequently unreliable and make predicting
quarterly results difficult. Product development schedules, particularly for new
hardware platforms and high-end multimedia PCs are difficult to predict because
they involve creative processes, use of new development tools for new platforms
and the learning process, research and experimentation associated with
development for new technologies. For example, SimCity 3000, the follow on
product to SimCity 2000, was expected to ship in fiscal 1998, at the time of the
merger with Maxis. Due to additional development delays, that product did not
ship until the fourth quarter of fiscal year 1999. Also, Tiberian Sun, which was
expected to ship in fiscal 1999 at the time of the acquisition of Westwood
Studios, is not expected to be released until the second quarter of fiscal 2000
due to development delays. Additionally, development risks for CD-ROM products
can cause particular difficulties in predicting quarterly results because brief
manufacturing lead times allow finalizing products and projected release dates
late in a quarter. Our revenues and earnings are dependent on our ability to
meet our product release schedules, and our failure to meet those schedules
could result in revenues and earnings which fall short of analysts' expectations
for any individual quarter and the fiscal year.
- - New video game platforms create additional technical and business model
uncertainties. A large portion of our revenues are derived from the sale of
products for play on proprietary video game platforms such as the PlayStation
and the N64. 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 continued 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, while the Sega Dreamcast console is scheduled to launch in the
United States in late calendar 1999 and has already launched in Japan, we have
no products under development for this platform. Accordingly, we will not have
products available should this platform achieve wide market acceptance.
Similarly, we intend to launch a variety of products for the new Sony
PlayStation platform, the PlayStation II, expected to be released in the Untied
States in September 2000. Should that platform not achieve wide acceptance by
consumers, we will have spent a disproportionate amount of our resources for
this platform. Additionally, we have not negotiated publishing agreements with
Sony, Sega or Nintendo for their next generation platforms, and we do not know
whether the terms of those agreements will be favorable.
- - The business models and technology for e-commerce and online gaming are
unproven. While we do not currently derive significant revenues from online
sales of our packaged products or from games played online, we believe that both
will become a more significant factor in our business and in the interactive
gaming business generally 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 excelled, and over what time
period, is uncertain. Additionally, technology, staffing and support for sales
direct to consumers differ from that required for sales to resellers.
Online gaming, and particularly multiplayer online gaming such as our Ultima
Online product, has many risks not currently associated with most packaged good
sales including, but not limited to, the following:
In "massively multiplayer" games such as Ultima Online, unanticipated
player conduct significantly affects the performance of the game, and social
issues raised by players' conduct frequently determine player satisfaction. Our
ability to effectively proctor such games is uncertain.
The current business model is as yet experimental and maybe unsustainable;
whether revenues will continue to be sufficient to maintain the significant
support, service and product enhancement demands of online users is uncertain.
We have little experience in pricing strategies for online games or in
predicting usage patterns of our customers.
Additionally, the speed and reliability of the Internet and the performance
of a user's Internet service provider are not controlled by us but impact both
e-commerce and online game performance. Whether the Internet infrastructure will
be adequate to meet increasing demand will affect our ability to grow our
Internet dependent businesses.
- - 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
25
restrictions on our web sites. Those rules vary by territory while of course the
Internet recognizes no geographical boundaries. Other countries such as Germany
have adopted laws regulating content transmitted over the Internet that are
stricter than current United States laws. In the United States, in response to
recent events, the federal and several state governments are considering content
restrictions on products such as those made by us as well as restrictions on
distribution of such products. Any one or more of these factors could harm our
business.
- - Our platform licensors are our chief competitors and frequently control the
manufacturing of our video game products. Our agreements with hardware
licensors, which are also our chief competitors, typically give significant
control to the licensor over the approval and manufacturing of our products.
This fact could, in certain circumstances, leave us unable to get our products
approved, manufactured and shipped to customers. In most events, control of the
approval and manufacturing process by the platform licensors increases both our
manufacturing lead times and costs as compared to those we can achieve
independently. For example, in prior years, we experienced delays in obtaining
approvals for and manufacturing of PlayStation products which caused delays in
shipping those products. The potential for additional delay or refusal to
approve or manufacture our products continues with our platform licensors. Such
occurrences would harm our business and adversely affect our financial
performance.
- - We face intense competition for talent from highly valued Internet companies.
Competition for employees in the interactive software business continues to be
intense. Recently, the most intense competition for recruiting and retaining key
employees is from Internet companies. The high market valuations, large equity
positions for key executives and creative talent and fast stock price
appreciation of these companies make their compensation packages attractive to
those who are already working in more mature companies. This situation creates
difficulty for us to compete for the attraction and retention of executive and
key creative talent.
- - Foreign Sales and Currency Fluctuations. For fiscal 1999, international net
revenues comprised 42% 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. As a result of current economic conditions in
Asia, we are subject to additional foreign currency risk. Though we do not
currently derive a significant portion of revenues and operating profits from
sales in Asia and other developing countries, our foreign currency exposure may
increase as operations in these countries grow and if current economic trends in
Asia continue. Any of these factors may significantly harm our business.
- - 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 may 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, entertainment, media or electronics industries or the
securities markets in general. For example, during the fiscal year 1999, the
price per share of our common stock ranged from $33.88 to $56.00. During the
fiscal year 1998, the price per share of our common stock ranged from $20.13 to
$46.94.
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.
26
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
Market Risk
We are exposed to various market risks, including the changes in foreign
currency exchange rates and interest rates. Market risk is the potential loss
arising from changes in market rates and prices. Foreign exchange contracts used
to hedge foreign currency exposures and short-term investments are subject to
market risk. We do not consider our cash and cash equivalents to be subject to
interest rate risk due to their short maturities. We do not enter into
derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rate Risk
We utilize foreign exchange contracts to hedge foreign currency exposures of
underlying assets and liabilities, primarily certain intercompany receivables
that are denominated in foreign currencies thereby limiting our risk. Gains and
losses on foreign exchange contracts are reflected in the income statement. At
March 31, 1999, we had foreign exchange contracts, all with maturities of less
than nine months to purchase and sell approximately $178,178,000 in foreign
currencies, primarily British Pounds, Canadian Dollars, German Deutschmarks,
Japanese Yen and other European currencies.
Fair value represents the difference in value of the contracts at the spot rate
and the forward rate, plus the unamortized premium or discount. At March 31,
1999, fair value of these contracts is not significant. 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 table below provides information about our foreign currency forward exchange
contracts at March 31, 1999. 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. All
contracts mature within nine months.
- --------------------- ----------------- ------------ -----------------
Weighted-
Average
Contract Contract
Amount Rate Fair Value
- --------------------- ----------------- ------------ -----------------
(in thousands) (in thousands)
Foreign currency to
be sold under
contract:
British Pound $93,044 1.63 $ 331
Canadian Dollar 29,118 1.53 (278)
Japanese Yen 9,862 115.33 408
South African 2,000 7.24 (321)
Rand
Australian 1,554 0.62 (34)
Dollar
Brazilian Real 1,441 1.91 (111)
- --------------------- ----------------- ------------ -----------------
Total $137,019 $ (5)
- --------------------- ----------------- ------------ -----------------
Foreign currency to
be purchased under
contract:
British Pound $41,159 1.61 $1,459
- --------------------- ----------------- ------------ -----------------
Total $41,159 $1,459
- --------------------- ----------------- ------------ -----------------
- --------------------- ----------------- ------------ -----------------
Grand total $178,178 $1,454
- --------------------- ----------------- ------------ -----------------
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 March 31, 1999,
our cash equivalents, short-term and long-term investments included debt
securities of $224,581,000. Notwithstanding our efforts
27
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 March 31, 1999:
- ----------------------- ------------------ ------------ --------------
Average Interest
Rate Cost Fair Value
- ----------------------- ------------------ ------------ --------------
(Dollars in thousands)
Cash equivalents(1)
Fixed rate 0.00% -- --
Variable rate 4.70% $135,567 $135,567
Short-term
investments(1)
Fixed rate 4.64% $ 21,197 $ 21,700
Variable rate 3.94% $ 48,800 $ 48,964
Long-term
investments(1)
Fixed rate 0.00% -- --
Variable rate 5.69% $ 18,400 $ 18,503
- ----------------------- ------------------ ------------ --------------
(1) See definition in note 1 of the Notes to the Consolidated Financial
Statements, included in item 8 hereof.
28
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Report of Independent Auditors, Consolidated Financial Statements and Notes
to Consolidated Financial Statements follow below on pages 29 through 47.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Electronic Arts Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Electronic Arts
Inc. and subsidiaries as of March 31, 1999 and 1998, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the years in the three-year period ended March 31, 1999. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits. We did not audit the financial statements of
Maxis, Inc., a company acquired by Electronic Arts Inc. in a business
combination accounted for as a pooling of interests as described in Note 11 to
the consolidated financial statements, which statements reflect total revenues
constituting 7% for the year ended March 31, 1997, of the related consolidated
totals. Those statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for Maxis, Inc., is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Electronic Arts Inc. and
subsidiaries as of March 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the years in the three-year period ended March
31, 1999, in conformity with generally accepted accounting principles.
Mountain View, California KPMG LLP
April 30, 1999
29
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
As of March 31, 1999 1998
- ----------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 312,822 $ 374,560
Marketable securities 4,884 3,721
Receivables, less allowances of $72,850 and $51,575, respectively 149,468 139,374
Inventories 22,376 19,626
Other current assets 79,915 52,530
-----------------------------
Total current assets 569,465 589,811
Property and equipment, net 181,266 105,095
Long-term investments 18,400 24,200
Investment in affiliates 25,864 20,541
Goodwill and other intangibles 90,682 1,585
Other assets 16,196 4,449
-----------------------------
$ 901,873 $ 745,681
=============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 63,881 $