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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 (FEE REQUIRED) For the Fiscal Year Ended March 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934 (NO FEE REQUIRED) For the transition period from ___ to ___
Commission File No. 0-17948
ELECTRONIC ARTS INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2838567
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1450 Fashion Island Boulevard
San Mateo, California 94404
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 571-7171
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 2, 1998 was $2,038,644,894.
As of June 2, 1998, there were 60,368,296 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 1998 Annual
Meeting of Stockholders are incorporated by reference into Part III hereof.
This report consists of 58 sequentially numbered pages. The Exhibit Index is located at
sequentially numbered page 58.
Page 1 of 58
ELECTRONIC ARTS INC.
1998 FORM 10-K ANNUAL REPORT
Table of Contents
PAGE
----
PART I
Item 1. Business 3
Item 2. Properties 15
Item 3. Legal Proceedings 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 4A. Executive Officers of the Registrant 17
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 20
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 22
Item 8. Financial Statements and Supplementary Data 31
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosures 49
PART III
Item 10. Directors and Executive Officers of the Registrant 50
Item 11. Executive Compensation 50
Item 12. Security Ownership of Certain Beneficial Owners and
Management 50
Item 13. Certain Relationships and Related Transactions 50
PART IV
Item 14. Exhibits, Financial Statement Schedule, and
Reports on Form 8-K 51
Signatures 56
Exhibit Index 58
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 the
future financial performance of the Company that involve certain risks and
uncertainties discussed in "Factors Affecting Future Performance" below at pages
28 to 30. Actual events or the actual future results of the Company may differ
materially from any forward looking statement due to such risks and
uncertainties.
Item 1: BUSINESS
Overview
Electronic Arts' predecessor was incorporated in California in 1982. In
September 1991, Electronic Arts was reincorporated under the laws of Delaware.
Unless otherwise indicated, the "Company" or "Electronic Arts," refers to
Electronic Arts Inc., a Delaware corporation, its California predecessor and its
wholly-owned and majority-owned subsidiaries. Electronic Arts' principal
executive offices are located at 1450 Fashion Island Boulevard, San Mateo,
California 94404. Its telephone number is (650) 571-7171.
Electronic Arts creates, markets and distributes interactive
entertainment software for a variety of hardware platforms. As of March 31,
1998, the Company marketed approximately 97 titles developed and/or published
under one of its brand names in North America, including older titles marketed
as "Classics" or "Publisher's Choice." Additionally, the Company distributes
localized versions of these products in the rest of the world. The Company also
distributed approximately 22 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 its inception, the Company has
developed products for 37 different computer hardware platforms, including the
following: IBM PC-CD and compatibles, 16-bit Sega Genesis video game system (the
"Genesis"), 16-bit Super Nintendo Entertainment System (the "SNES"), Macintosh
CD, 3DO Interactive Multiplayer, the PlayStation ("PlayStation"), the Sega
Saturn ("Saturn") and the Nintendo 64 ("N64"). The Company's fiscal 1998 product
releases were primarily for PC-CD and 32-bit video game platforms and to a
lesser degree 16-bit and N64 cartridge products. As of March 31, 1998, the
Company was developing products for four different hardware platforms.
3
The Company's product development methods and organization are modeled
on those used in the entertainment industry, and the Company markets its
products with techniques borrowed from other entertainment companies such as
record producers, magazine publishers and video distributors. Company employees
called "producers", who are each responsible for the development of one or more
products, oversee product development and direct teams comprised of both
Electronic Arts employees and outside contractors. Electronic Arts' 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
the Company has had contracts include: FIFA, NASCAR, John Madden, the National
Basketball Association, the PGA TOUR, Tiger Woods, the National Hockey League
and World Championship Wrestling Inc. The Company maintains development studios
in California, Canada, United Kingdom, Florida, Texas, Japan, Washington and
Maryland.
The Company invests 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. The Company has 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.
Additionally, the Company produces film, videotape and audio recordings
to include in its products. Two of the Company's subsidiaries, Electronic Arts
Productions Inc. (d/b/a Crocodile Productions) and Electronic Arts Productions
Ltd., have signed agreements with the Screen Actors Guild ("SAG") and American
Federation of Television and Radio Artists ("AFTRA") in the United States and
with British Actors Equity Association ("Equity") in the United Kingdom,
respectively, giving the Company access to a wide range of talent for use in
Company-produced film and video for inclusion in the Company's products.
Electronic Arts distributes its products and those of its Affiliated
Labels primarily by direct sales to retail chains and outlets in the United
States and Europe. In Japan and the Asia Pacific region, the Company distributes
products both directly to retailers and through third party distributors. The
Company's products are available in over 57,000 retail locations worldwide. In
fiscal 1998, approximately 43% of the Company's net revenues were generated by
international operations, compared to 45% and 40% in fiscal 1997 and fiscal
1996, respectively.
4
Investments and Joint Ventures
Acquisitions
Maxis, Inc.
On July 25, 1997, the Company completed a merger with Maxis, Inc.
("Maxis"), a California-based interactive software developer. Under the
transaction, approximately 4.1 million shares of Electronic Arts' stock were
exchanged for all outstanding Maxis common stock. The transaction was accounted
for as a pooling of interests. The accompanying financial statements, notes and
analyses have been restated for all periods presented to reflect this
transaction. See note 10 of the Notes to the Consolidated Financial Statements,
included in Item 8 hereof.
Electronic Arts Japan
In December 1997, the Company acquired the remaining 35% ownership
interest in Electronic Arts Victor, Inc. ("EAV") from Victor Entertainment
Industries, Inc. ("VEI") for approximately $3,225,000 in cash. As a result of
the acquisition, the joint venture has become a wholly-owned subsidiary of the
Company and has been renamed Electronic Arts, K.K. ("EAJ"). See note 10 of the
Notes to the Consolidated Financial Statements, included in Item 8 hereof.
Tiburon Entertainment, Inc.
On April 1, 1998, the Company acquired Tiburon Entertainment, Inc.
("Tiburon"), an entertainment software developer based in Florida. Prior to the
acquisition, the Company had a minority investment interest in Tiburon.
Joint Ventures
EA Square
In May 1998, the Company and Square Co., Ltd. ("Square"), a third-party
video game console software publisher in Japan, completed the formation of two
new joint ventures, one in North America and one in Japan. In North America, the
companies formed Square Electronic Arts, LLC, which has exclusive publishing
rights in North America for future interactive entertainment titles created by
Square. Additionally, the Company has the exclusive right to distribute in North
America products published by this joint venture. The Company owns a 30%
minority interest in this joint venture while Square owns 70%.
In Japan, the companies established Electronic Arts Square KK, which
will localize and publish in Japan the Company's properties originally created
in North America and Europe, as well as develop and publish original video games
in Japan. The Company owns a 70% majority ownership interest, while Square owns
30%.
5
Investments
The Company has made investments as part of its overall strategy and
currently holds minority equity interests in several companies, including
NovaLogic, Inc., Firaxis Software, Inc., Stormfront Studios, Mpath Interactive,
Accolade, Inc. and The 3DO Company ("3DO"). See Factors Affecting Future
Performance - Investment In Affiliates at page 30.
Divestiture
In December 1997, the Company completed the sale of its 50% ownership
interest in Creative Wonders, LLC (formerly ABC/EA Home Software LLC), a joint
venture company formed with the Walt Disney Company (formerly Capital Cities /
ABC, Inc.). Prior to the sale, the Company distributed children's interactive
titles published and sold by the joint venture into the retail channel. The
investment was accounted for under the equity method prior to the sale. See note
10 of the Notes to the Consolidated Financial Statements, included in Item 8
hereof.
Market
Historically, no hardware platform or system has achieved long-term
dominance in the interactive entertainment market. This phenomenon has resulted
in the Company developing products at one time or another for 37 different
hardware platforms. Today, the competition in the market for hardware platforms
has intensified. In fiscal 1998, the hardware market was characterized by the
growth in the installed base of next generation systems, primarily the
PlayStation and N64. In addition, the installed base of multimedia-enabled home
computers, including those with internet accessibility, has continued to grow as
PC prices have declined and the quality and choices of software have increased
dramatically . The Company develops and publishes products for multiple
platforms, and this diversification continues to be a cornerstone of the
Company's strategy.
The interactive software industry has recently undergone another
significant change due in part to the introduction of new hardware platforms, as
well as remote and electronic delivery systems. The new generation of systems
are based on 32-bit and 64-bit microprocessors that incorporate dedicated
graphics chipsets. Many of these systems utilize CD-ROM drives. The Company
began development of 32-bit software products over six years ago by creating the
original software development system for the first of these advanced products,
the 3DO Interactive Multiplayer ("3DO"), which was introduced in calendar year
1993. Sega and Sony each began distribution of their next generation hardware
systems (named the "Saturn" and "PlayStation," respectively) in Japan during the
quarter ended December 1994. Sega began limited shipment of the Saturn in North
America in May 1995 and Sony began shipping the PlayStation in North America in
September 1995.
6
In June 1996, Nintendo shipped the N64 in Japan and subsequently
introduced the system in North America in September 1996. The N64 is a
cartridge-based video game platform which uses a 64-bit microprocessor.
Additionally, Nintendo is developing the N64DD, a disk drive add on to the N64.
Sega is scheduled to launch Dreamcast(TM) in Japan in November 1998 and
in North America in the fall of 1999. Sega is designing Dreamcast to combine
features from the console and PC platforms.
New entrants in the interactive entertainment and multimedia
industries, such as cable television, telephone and diversified media and
entertainment companies, and a proliferation of new technologies, such as
on-line networks and the internet may increase the competition in the markets in
which the Company competes. The Company's new product releases in its 1999
fiscal year will be primarily for the IBM PC-CD and compatibles, the PlayStation
and the N64. The Company is also scheduled to release one or more on-line
network gaming products during fiscal 1999. See Factors Affecting Future
Performance - The Industry and Competition at page 28.
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 the Company
for the current generation of 32-bit machines. The Company believes that such
investment continues to be important and will continue aggressive development
activities for 32-bit and 64-bit platforms. Although the PlayStation has
achieved significant market acceptance in all geographical territories, there
can be no assurance that its growth will continue at the present rates. The
market acceptance of the N64, particularly in North America and Europe, may
adversely affect the growth rate of the 32-bit CD-platforms. In addition, the
Company's revenues and earnings are dependent on its ability to meet its product
release schedule and its failure to meet those schedules could result in
revenues and earnings which fall short of analysts' expectations for the fiscal
year. See Factors Affecting Future Performance - Development and Platform
Changes, respectively, at page 28.
Competition
See Factors Affecting Future Performance - The Industry and Competition
at page 28.
Relationships with Significant Hardware Platform Companies
Sony
In fiscal 1998, approximately 42% of the Company's net revenues were
derived from sales of software for the PlayStation compared to 28% in fiscal
1997. PlayStation products were first released during the second quarter of
fiscal 1996. During fiscal 1998, the Company released 25 PlayStation games
compared to 14 in fiscal 1997. Among these
7
releases were FIFA: Road to World Cup `98, NBA Live `98, Nascar `98, Madden NFL
`98 and NHL `98. The volume of sales of PlayStation products significantly
increased in fiscal 1998 due to the increase in the installed base of
PlayStation consoles worldwide and the quality and timely release of the
Company's key franchise titles. Although revenues from the sales of PlayStation
products in fiscal 1999 are expected to continue to grow, the Company does not
expect to maintain these growth rates. See Factors Affecting Future Performance
- - Development at page 28.
Under the terms of a licensing agreement entered into with Sony
Computer Entertainment of America in July 1994 (the "Sony Agreement"), as
amended, the Company is authorized to develop and distribute CD-based software
products compatible with the PlayStation. Pursuant to the Sony Agreement, the
Company engages Sony to supply its PlayStation CDs for distribution by the
Company. Accordingly, the Company has limited ability to control its supply of
PlayStation CD products or the timing of their delivery. See Factors Affecting
Future Performance - Hardware Companies at page 29.
In connection with the Company's purchases of Sony products to be
distributed in Japan, Sony of Japan requires cash deposits totaling one-third of
the purchase orders. At March 31, 1998, EAJ had no outstanding deposits to Sony.
EAJ utilizes a line of credit to fund these deposits and other operating needs.
At March 31, 1998, EAJ had lines of credit of approximately $6,138,000 of which
$4,604,000 was outstanding.
Nintendo
During fiscal 1998, the Company released two new titles for the N64,
Madden 64 and FIFA: Road to World Cup 98. In fiscal 1998, approximately 6% of
the Company's net revenues were derived from the sale of N64 products compared
to 3% in 1997. In March 1997, the Company signed a licensing agreement with
Nintendo (the "N64 Agreement") to develop, publish and market certain sports and
other products for the N64. Sales of N64 products are expected to grow in fiscal
1999, but as revenues for these products increase, they may not grow at the
current rate.
Under the terms of the N64 Agreement, the Company engages Nintendo to
manufacture its N64 cartridges for distribution by the Company. Accordingly, the
Company has limited ability to control its supply of N64 cartridges or the
timing of their delivery. A shortage of microchips or other factors outside the
control of the Company could impair the Company's ability to obtain an adequate
supply of cartridges.
As the 16-bit videogame market has made the transition to next
generation 32-bit and 64-bit systems, the Company does not expect to release any
new SNES titles in fiscal 1999 and revenues from the sale of SNES products in
fiscal 1999 are not expected to be significant.
8
In connection with the Company's purchases of N64 cartridges for
distribution in North America, Nintendo requires the Company to provide
irrevocable letters of credit prior to Nintendo's acceptance of purchase orders
from the company for purchases of these cartridges. For purchases of N64
cartridges for distribution in Japan and Europe, Nintendo requires the Company
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 Factors
Affecting Future Performance - Hardware Companies at page 29.
Sega
In the fiscal year ended March 31, 1998, approximately 2% of the
Company's net revenue came from sales of Saturn products compared to 6% in
fiscal 1997. During fiscal 1998, the Company released eight Saturn products
compared with 12 in fiscal 1997. As the installed base of Saturn consoles has
not achieved the growth rates of PlayStation consoles, the Company's revenues
from sales of Saturn products have declined and are expected to decline
significantly in future years. The Company plans no new releases of Saturn
products in fiscal 1999.
Additionally, as the 16-bit videogame market has made the transition to
next generation 32-bit and 64-bit systems, the Company does not expect to
release any new titles for the Genesis in fiscal 1999 and, accordingly, revenues
from the sale of Genesis products in fiscal 1999 is not expected to be
significant.
Products and Product Development
In fiscal 1998, the Company generated approximately 70% of its revenues
from products released during the year. See Factors Affecting Future Performance
- - Products at page 28. As of March 31, 1998, the Company was actively marketing
approximately 97 titles, comprising approximately 189 stock keeping units
("sku's"), that were published by the Company's development divisions and
subsidiaries ("EA Studios"). During fiscal 1998, the Company introduced over 44
EA Studios titles, representing over 71 sku's, compared to 36 EA Studio titles,
comprising over 68 sku's, in fiscal 1997.
The products published by EA Studios are designed and created by its
in-house designers and artists and by independent software developers
("independent artists"). The Company typically pays the independent artists
royalties based on the sales of the specific products, as defined in the related
independent artist agreements.
For fiscal 1998, no title represented revenues greater than 10% of the
total fiscal 1998 net revenues. For fiscal 1997, the Company had one title,
Madden Football `97, published on five platforms, which represented
approximately 10% of the total fiscal 1997 net revenues. For fiscal 1996, the
Company had one title, FIFA Soccer '96,
9
published on six platforms, which represented approximately 10% of the total
fiscal 1996 net revenues.
The Company publishes 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. The Company's
sports-related products, marketed under the EA Sports brand name, accounted for
a significant percentage of net revenues in fiscal years 1998 and 1997. There
can be no assurance that the Company will be able to maintain its market share
in the sports category. See Factors Affecting Future Performance -The Industry
and Competition at page 28.
The front line retail selling prices in North America of the Company's
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 $15.00. The
retail selling prices of EA titles outside of North America vary based on local
market conditions.
The Company currently develops or publishes products for four different
hardware platforms and has from time to time developed and marketed products on
37 different and incompatible platforms in the past. In fiscal 1998, the Company
product releases were predominantly for PC-CD, 32-bit video game platforms and
to a lesser degree 16-bit and 64-bit video game systems. The Company's planned
product introductions for fiscal 1999 are predominantly for the PC-CD, the
PlayStation, the N64 as well as for online internet play in fiscal 1999. See
Factors Affecting Future Performance - Development and Platform Changes,
respectively, at page 28.
As compact discs have emerged as the preferred medium for interactive
entertainment, education, and information software, the Company continued its
investment in the development of CD-ROM tools and technologies in fiscal 1998
and currently has more than 27 products in development for CD-video game
platforms, including the PC-CD and PlayStation platforms. Although the
PlayStation has achieved significant market acceptance in all geographic
territories, there can be no assurance that its growth will continue at the
present rates. The market acceptance of the N64, particularly in North America
and Europe, may adversely affect the growth rate of the 32-bit CD-platforms.
Most of the CD-video game products will be convertible for use on multiple
advanced hardware systems. During the fiscal years 1998, 1997 and 1996, the
Company had research and development expenditures of $146.2 million, $130.8
million, and $108.0 million, respectively. See Factors Affecting Future
Performance - Development at page 28.
Marketing and Distribution
The Company distributes both EA Studio products and products developed
and published by other software publishers known as "Affiliated Labels."
10
In most cases, Affiliated Label products are delivered to the Company
as completed products. As of March 31, 1998, the Company distributed 22
Affiliated Label titles in North America and over 1,000 Affiliated Label titles
in the rest of the world. No single Affiliated Label has accounted for more than
10% of the Company's net revenue in any of the last three fiscal years.
In May 1998, the Company and Square Co., Ltd. formed a new joint
venture in North America, creating Square Electronic Arts, LLC as discussed in
note 15 in the Notes to the Consolidated Financial Statements, included in Item
8 hereof. In conjunction with the formation of this joint venture, the Company
will have the exclusive right in North America to distribute products published
by this joint venture.
In February 1998, the Company announced that it 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.
During fiscal 1997, the Company entered into a one year agreement with
Twentieth Century Fox Home Entertainment outside of North America and multi-year
agreements with Accolade, Inc. and DreamWorks Interactive in Europe and certain
Asian territories.
The Company generated approximately 90% of its North American net
revenues from direct sales through a field sales organization of professionals
and a group of telephone sales representatives. The remaining 10% of its North
American sales were made through a limited number of specialized and regional
distributors and rack jobbers in markets where the Company believes direct sales
would not be economical. The Company had no customers accounting for more than
10% of total net revenues for the years ended March 31, 1998, 1997 and 1996.
As discussed above, (See Market above) 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 the Company will continue to produce
"hit" titles, or that advertising for any product will increase sales
sufficiently to recoup those advertising expenses.
The Company has stock-balancing programs for its personal computer
products that, under certain circumstances and up to a specified amount, allow
for the exchange of personal computer products by resellers. The Company also
typically provides for price protection for its personal computer and video game
system products that, under certain conditions, allows the reseller a price
reduction from the Company for unsold products. The Company maintains a policy
of exchanging products or giving credits, but does not give cash refunds.
Moreover, the risk of product returns may increase as new hardware platforms
become more popular or market factors force the Company to make changes in its
distribution system. The Company monitors and manages the volume of its sales to
11
retailers and distributors and their inventories as substantial overstocking in
the distribution channel can result in high returns or the requirement for
substantial price protection in subsequent periods. The Company believes that it
provides adequate reserves for returns and price protection which are based on
estimated future returns of products, taking into account promotional
activities, the timing of new product introductions, distributor and retailer
inventories of the Company's products and other factors, and that its current
reserves will be sufficient to meet return and price protection requirements for
current in-channel inventory. However, there can be no assurance that actual
returns or price protection will not exceed the Company's reserves. See Factors
Affecting Future Performance - Revenue and Expenses at page 29.
The Company also has a fulfillment group that sells product directly to
consumers through a toll-free number listed in advertising by the Company and
its Affiliated Labels. This group is also responsible for targeted direct mail
marketing and sells product upgrades, 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 Electronic Arts'
accounts receivable from such entity uncollectible, which could have an adverse
effect on the operating results and financial condition of the Company. In the
quarter ended September 1996, the Company recorded $3,331,000 in bad debt
expenses related to uncollectible receivables from a customer who filed for
bankruptcy. In addition, an increasing number of companies are competing for
access to these channels. Electronic Arts' arrangements with its distributors
and retailers may be terminated by either party at any time without cause.
Distributors and retailers often carry products that compete with those of the
Company. Retailers of Electronic Arts' products typically have a limited amount
of shelf space and promotional resources for which there is intense competition.
There can be no assurance that distributors and retailers will continue to
purchase Electronic Arts' products or provide Electronic Arts' products with
adequate levels of shelf space and promotional support.
International Operations
The Company has wholly owned subsidiaries throughout the world,
including offices in the United Kingdom, France, Spain, Germany, Australia,
Canada, South Africa, Singapore, Sweden, Puerto Rico, Japan, Malaysia, Brazil
and Holland. The amounts of net revenues, operating profit and identifiable
assets attributable to each of the Company's geographic regions for each of the
last three fiscal years are set forth in Note 14 of the Notes to the
Consolidated Financial Statements included in Item 8 hereof. 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
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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 EA products.
In fiscal 1998, the Company continued its strategy to expand into emerging world
markets by opening offices in Austria, Switzerland, Brazil and Portugal.
Though international revenues are expected to grow in fiscal 1999,
international revenues may not grow at as high a rate as in prior years.
Manufacturing
In fiscal 1998 and prior years, a portion of the Company's personal
computer CD-ROM products were manufactured in Puerto Rico. The Company intends
to phase out its Puerto Rico operations and will contract out with third parties
to produce the Company's CD-ROM products.
In many instances, the Company is able to acquire materials on a
volume-discount basis. The Company has multiple potential sources of supply for
most materials. Except with respect to its PlayStation and N64 products, the
Company also has alternate sources for the manufacture and assembly of most of
its products. To date, the Company has not experienced any material difficulties
or delays in production of its software and related documentation and packaging.
However, a shortage of components or other factors beyond the control of the
Company could impair the Company's ability to manufacture, or have manufactured,
its products. See Factors Affecting Future Performance - Hardware Companies at
page 29.
Backlog
The Company normally ships product 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. The Company
does not consider backlog to be an indicator of future performance.
Seasonality
The Company's business is highly seasonal. The Company typically
experiences its highest revenues and profits in the calendar year-end holiday
season and a seasonal low in revenues and profits in the quarter ending in June.
13
Employees
As of March 31, 1998, the Company employed approximately 2,100 people,
of whom over 1,100 were outside the United States. The Company believes that its
ability to attract and retain qualified employees is an important factor in its
growth and development and that its future success will depend, in large
measure, on its ability to continue to attract and retain qualified employees.
To date, the Company has been successful in recruiting and retaining sufficient
numbers of qualified personnel to conduct its business successfully. See Factors
Affecting Future Performance - Employees at page 29.
14
ITEM 2: PROPERTIES
The Company's principal administrative, sales and marketing, research
and development, and support facility is located in four modern buildings in San
Mateo, California, 15 miles south of San Francisco. The Company presently
occupies approximately 196,000 sq. ft. in these buildings, under leases that
expire at various times between August 1998 and April 1999.
In February 1995, the Company entered into a master operating lease for
land and buildings to be constructed in Redwood City, California. The facility
is to be used as a corporate headquarters for EA. The above mentioned rental
space EA currently occupies in San Mateo, California is expected to be vacated
upon the completion of the new corporate headquarters. The square footage of the
new facilities is expected to be approximately 350,000. The Company expects
completion of these facilities in fiscal 1999.
The Company's 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. The Company also
occupies sales offices in the metropolitan areas of Toronto, Chicago, Dallas and
New York. The Company also has a manufacturing facility in San Juan, Puerto
Rico.
In addition to the Company's San Mateo development studio, the
Company's North American research and development activities are supported by a
106,000 sq. ft. development facility in Burnaby, British Columbia, Canada and a
33,000 sq. ft. facility in Seattle, Washington. The Company also owns a 180,000
sq. ft. development facility in Austin, Texas and leases a 42,400 sq. ft.
development facility in Walnut Creek, California. The Company is constructing a
new facility to include administrative, sales and development functions in
Burnaby, British Columbia, Canada. The square footage of the new facility is
expected to be approximately 206,000. The Company expects completion of this
facility in fiscal 1999.
The Company's United Kingdom subsidiary occupies administrative, sales
and distribution 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, the Company also leases two administrative, sales and distribution
facilities in Germany, as well as sales and distribution facilities in: Madrid,
Spain; Lyon, France; Johannesberg, South Africa; Neudorf, Austria and Zurich,
Switzerland. Additionally, the Company has sales offices throughout Europe.
In Asia and the South Pacific, the Company maintains a 5,500 sq. ft.
sales and distribution facility in Brisbane, Australia. The Company also has
sales and distribution facilities in Singapore, Malaysia, Thailand, Taiwan and
New Zealand, and representative offices in Beijing, Hong Kong and Shanghai,
China. The Company also maintains a
15
27,000 sq. ft. sales and development office in Tokyo, Japan. See Notes 3 and 8
of the Notes to the Consolidated Financial Statements included in Item 8 hereof.
The Company believes that these facilities are adequate for its current
needs. The Company believes that suitable additional or substitute space will be
available as needed to accommodate the Company's future needs.
ITEM 3: LEGAL PROCEEDINGS
The Company is subject to pending claims and litigation. Management,
after review and consultation with counsel, considers that any liability from
the disposition of such lawsuits would not have a material adverse effect upon
the consolidated financial condition of the Company.
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, 1998.
16
ITEM 4A: EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, who are chosen by and serve at
the discretion of the Board of Directors, are as follows:
Name Age Position
---- --- --------
Lawrence F. Probst III 48 Chairman and Chief
Executive Officer
Don A. Mattrick 34 President, Worldwide Studios
John S. Riccitiello 38 President and Chief
Operating Officer
William Bingham Gordon 48 Executive Vice President and
Chief Creative Officer
Mark S. Lewis 48 Executive Vice President,
Worldwide Publishing
E. Stanton McKee, Jr. 53 Executive Vice President and
Chief Financial and
Administrative Officer
Nancy L. Smith 45 Executive Vice President and
General Manager, North
American Publishing
Ruth A. Kennedy 43 Senior Vice President,
General Counsel and
Secretary
David L. Carbone 47 Vice President, Finance
Mr. Probst has been a director of the Company 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, the Company's
distribution division, from January 1987 to January 1991; and from September
1984, when he joined the Company, 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 the Company in 1991.
17
Mr. Riccitiello has served as President and Chief Operating Officer
since October 1997. Prior to joining the Company, 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 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 the Company's
former entertainment division while employed by the Company. Mr. Gordon holds a
B.A. degree from Yale University and an M.B.A. degree from Stanford University.
Mr. Lewis has served as Executive Vice President, Worldwide Publishing
since June 1998. Prior to this, he served as Executive Vice President,
International since October 1996 and as Senior Vice President, International
from July 1993 to October 1996. From August 1991 to July 1993, he served as
President of Electronic Arts, Ltd., a wholly owned subsidiary of the Company
which serves the European market from its base in Langley, England. He has also
served as Managing Director of Electronic Arts, Ltd., Director of European
Publishing, and as a Producer and Manager of Product Support and Acquisitions
during his tenure with the Company. He has been employed by the Company since
1984. Mr. Lewis is a graduate of Yale University.
Mr. McKee joined the Company 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 the Company in 1984. Ms. Smith holds
a B.S. degree in management and organizational behavior from the University of
San Francisco.
18
Ms. Kennedy has been employed by the Company 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. Carbone has been with the Company 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.
19
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's 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 the Company's Common Stock from April 1, 1996 through March 31, 1998.
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, 1997:
First Quarter $34.50 $25.25
Second Quarter 39.13 24.75
Third Quarter 37.63 27.88
Fourth Quarter 36.13 26.25
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
There were approximately 2,000 holders of record of the Company's Common Stock
as of June 2, 1998. The Company believes that a significant number of beneficial
owners of its Common Stock hold their shares in street names.
Dividend Policy
The Company has not paid any cash dividends and does not anticipate
paying cash dividends in the foreseeable future.
20
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 1998 1997 1996 1995 1994
- ------------------------------------------------------ --------- --------- --------- --------- ---------
Net revenues $ 908,852 $ 673,028 $ 587,299 $ 531,493 $ 441,621
Cost of goods sold 480,766 328,943 291,491 277,543 232,973
--------- --------- --------- --------- ---------
Gross profit 428,086 344,085 295,808 253,950 208,648
Operating expenses:
Marketing and sales 128,308 102,072 85,771 70,764 52,254
General and administrative 57,838 48,489 37,711 33,492 26,992
Research and development 146,199 130,755 108,043 79,910 65,869
Charge for acquired in-process technology 1,500 -- 2,232 -- --
Merger costs 10,792 -- -- -- --
--------- --------- --------- --------- ---------
Total operating expenses 344,637 281,316 233,757 184,166 145,115
--------- --------- --------- --------- ---------
Operating income 83,449 62,769 62,051 69,784 63,533
Interest and other income, net 24,811 13,279 7,514 13,476 3,896
--------- --------- --------- --------- ---------
Income before provision for income taxes
and minority interest 108,260 76,048 69,565 83,260 67,429
Provision for income taxes 35,726 26,003 22,584 26,859 20,471
--------- --------- --------- --------- ---------
Income before minority interest 72,534 50,045 46,981 56,401 46,958
Minority interest in consolidated joint venture 28 1,282 (304) 2,620 (94)
--------- --------- --------- --------- ---------
Income from continuing operations 72,562 51,327 46,677 59,021 46,864
Discontinued operations:
Loss from discontinued operations (net of income tax
benefit of $251 in fiscal 1994) -- -- -- -- (376)
Gain on disposal of discontinued operations (net of
income tax expense of $173 in fiscal 1995) -- -- -- 303 --
--------- --------- --------- --------- ---------
Net income $ 72,562 $ 51,327 $ 46,677 $ 59,324 $ 46,488
--------- --------- --------- --------- ---------
Per share amounts:
Income from continuing operations:
Basic $ 1.23 $ 0.89 $ 0.84 $ 1.13 $ 0.91
Diluted $ 1.19 $ 0.86 $ 0.80 $ 1.06 $ 0.85
Net income:
Basic $ 1.23 $ 0.89 $ 0.84 $ 1.13 $ 0.91
Diluted $ 1.19 $ 0.86 $ 0.80 $ 1.07 $ 0.84
Number of shares used in computation:
Basic 58,867 57,544 55,685 52,446 51,223
Diluted 60,958 59,557 58,190 55,546 55,427
- ------------------------------------------------------- --------- --------- --------- --------- ---------
BALANCE SHEET DATA AT FISCAL YEAR END
- ------------------------------------------------------- --------- --------- --------- --------- ---------
Cash and short-term investments $374,560 $268,141 $190,873 $182,776 $135,250
Marketable securities 3,721 5,548 37,869 10,725 11,931
Working capital 408,098 284,863 247,001 180,714 144,428
Long-term investments 24,200 34,478 30,319 14,200 --
Total assets 745,681 584,041 489,496 359,866 287,723
Total liabilities 181,713 136,237 108,668 107,894 102,450
Minority interest -- 28 1,277 1,148 3,485
Redeemable preferred stock -- -- -- 11,363 10,849
Total stockholders' equity 563,968 447,776 379,551 239,461 170,939
21
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 Electronic
Arts' ("the Company" or "EA") future performance that involve certain risks and
uncertainties including those discussed in "Factors Affecting Future
Performance" at pages 28 to 30 of this Annual Report on Form 10-K. Actual events
or the actual future results of the Company may differ materially from any
forward looking statements due to such risks and uncertainties.
RESULTS OF OPERATIONS
Comparison of Fiscal 1998 to 1997
1998 1997 % change
- -------------------------------------------------------------------
Net revenues $908,852,000 $673,028,000 35.0
- -------------------------------------------------------------------
The Company derives revenues primarily from shipments of entertainment software,
which includes EA Studio Compact Disk ("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 EA. The Company
also derives revenues from licensing of EA Studio products and AL products
to hardware companies ("OEMs") and online subscription revenues.
Total net revenues increased compared to the prior year due to increased sales
of PlayStation ("PlayStation") products, increased worldwide distribution of AL
products, sales of Nintendo 64-bit ("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 the Sega Saturn(R) ("Saturn").
Sales of PlayStation products in fiscal 1998 increased to $380,299,000, or 42%
of total net revenue, compared to $187,531,000, or 28% of total net revenue in
fiscal 1997. The Company released 25 new PlayStation titles in fiscal 1998
compared to 14 in fiscal 1997. The Company expects revenues from PlayStation
products to continue to grow in fiscal 1999, but as revenues for these products
increase, the Company does not expect to maintain these growth rates.
Net revenues derived for other 32-bit products, primarily for Saturn, were
$17,507,000 in fiscal 1998 compared to $38,344,000 in fiscal 1997. As the
installed base of Saturn consoles has not achieved the growth rates of
PlayStation game consoles, the Company's revenues from sales of Saturn products
have declined and are expected to decline significantly in future years. The
Company released eight new Saturn titles in fiscal 1998 compared to 12 in fiscal
1997. The Company does not expect to release any new Saturn titles in fiscal
1999.
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 new worldwide exclusive distribution agreement with
Dreamworks Interactive, including The Lost World: Jurassic Park and due to
continued distribution of products from Accolade, Inc. for which the Company
began distribution in the fourth quarter of fiscal 1997. AL revenues also
increased related to sales of products under exclusive distribution agreements
with Twentieth Century Fox Home Entertainment outside North America. The Company
expects revenues from AL products to continue to grow in fiscal 1999, but as
revenues for these products increase, the Company does not expect to maintain
these growth rates.
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. The Company
released two titles in fiscal 1998 compared to one title in fiscal 1997. In
March 1997, the Company signed a licensing agreement with Nintendo to develop,
publish and market certain sports products for the N64. Sales of N64 products
are expected to grow in fiscal 1999, but as revenues for these products
increase, they may not grow at the current rate.
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. The Company 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 the Company's 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 1998, compared to $89,160,000, or
13% of net revenues in fiscal 1997. As the 16-bit video game market has made the
transition to next generation 32-bit and 64-bit systems, the
22
Company does not expect to release any new titles in fiscal 1999 and revenues
from the sales of 16-bit products in fiscal 1999 is not expected to be
significant.
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 EA products in Europe and
Maxis 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 EA 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 reflects 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 the Company's 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.
Increases in marketing and sales as well as general and administrative expenses
were partially offset by savings attributable to the integration of Maxis, Inc.
("Maxis") in the second quarter of fiscal 1998.
Increases in research and development expenses were 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.
The Company released a total of 71 new products in fiscal 1998 compared to 68 in
fiscal 1997. Total CD-based new products released for fiscal 1998 were 63
compared to 58 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 Electronic Arts Victor, Inc. ("EAV") in December 1997, the Company
incurred a charge of $1,500,000 for acquired in-process technology. This charge
was made after the Company 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.
23
On July 25, 1997, the Company completed a merger with Maxis. In conjunction with
the merger, the Company recorded costs of $10,792,000 which included direct
transaction fees and costs associated with integrating the operations of the two
companies.
===============================================================
%
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 last year and the sale of
the Company's 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%
- ---------------------------------------------------------------
The Company's 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, the Company acquired the remaining minority ownership
interest in EAV in December 1997. Prior to the acquisition, EAV was sixty-five
percent owned by the Company and thirty-five percent owned by Victor
Entertainment Industries, Inc. ("VEI"). Minority interest for the year reflects
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.
RESULTS OF OPERATIONS
Comparison of Fiscal 1997 to 1996
1997 1996 % change
- ---------------------------------------------------------------
Net revenues $673,028,000 $587,299,000 14.6
- ---------------------------------------------------------------
Total net revenues increased compared to the prior year due to an increase in
net revenues derived from a higher volume of CD-based products (CD-video games
and PC-CD), Affiliated Label products and a 64-bit video game cartridge product.
This was partially offset by a decrease in sales of 16-bit video game
cartridges.
Net revenues from 32-bit CD-video game products, including the PlayStation and
Saturn, were $225,875,000 in fiscal 1997, representing 34% of the total net
revenues compared to $78,003,000, or 13% of total net revenues in fiscal 1996.
The increase in sales of PlayStation and Saturn products was attributable to the
greater installed base of these 32-bit CD-video game consoles and more titles
published for these consoles by the Company.
Sales of PlayStation products in fiscal 1997 increased to $187,531,000, or 28%
of total revenue, compared to $51,971,000, or 9% of total revenue in fiscal
1996. The Company released 14 new PlayStation titles in both fiscal 1997 and
fiscal 1996.
Net revenues derived from the sales of other 32-bit products were $38,344,000,
primarily from Saturn products in fiscal 1997, compared to $26,032,000, which
included both 3DO Interactive Multiplayer(R) ("3DO") and Saturn products in
fiscal 1996. The Company released 12 new Saturn titles in fiscal 1997 compared
to eight 3DO titles and five Saturn titles in fiscal 1996. The Company produced
no new games for 3DO in fiscal 1997.
24
Net revenues from PC-CD products increased to $216,338,000 in fiscal 1997,
representing 32% of total net revenues, from $183,976,000, or 31% of total net
revenues in fiscal 1996. The Company released 32 PC-CD titles in fiscal 1997
compared to 45 titles in fiscal 1996. Included in these totals were Maxis'
releases of five titles in fiscal 1997, and 23 in fiscal 1996. The increase in
sales of PC-CD products was attributable to the growth in the PC market
worldwide, growth in the sports category and the expansion of the Company's
direct distribution worldwide. The increase in fiscal 1997 was partially offset
by a decrease in sales for Maxis due to the late releases for the holiday buying
season as well as a delay in the release of the follow-on product to SimCity
2000(TM).
Net revenues generated by 16-bit video game cartridge-based products were
$89,160,000, or 13% of total revenues in fiscal 1997, compared to $202,599,000,
or 35% of net revenues in fiscal 1996. Sales of 16-bit video game hardware and
related software have significantly declined due to the transition to next
generation 32-bit and 64-bit video game consoles. During fiscal 1997, the
Company released fewer titles for the 16-bit platforms as compared to fiscal
1996.
Sales of EA Studio Sega(R) Genesis(TM) ("Genesis") cartridge products in fiscal
1997 declined to $62,005,000, or 9% of total revenue, compared to $138,643,000,
or 24% of total revenue in fiscal 1996. The Company released six new Genesis
titles in fiscal 1997, compared to 10 in fiscal 1996.
Net revenues derived from cartridge products for the Super Nintendo
Entertainment System(R) ("Super NES(R)") were $27,155,000, or 4% of total
revenue, in fiscal 1997 compared to $63,956,000, or 11% of total revenue in
fiscal 1996. The Company released three new titles for the Super NES in fiscal
1997 compared to five in fiscal 1996.
Licensing of EA Studio products generated $26,749,000 in fiscal 1997, compared
to $32,221,000 in fiscal 1996. The decrease primarily resulted from lower volume
of distribution of the Company's products through OEMs in North America and
Japan and Maxis products in Europe.
Net revenues derived from sales of N64 video game cartridge products were
$17,804,000 in fiscal 1997. The Company released its first N64 title during the
fourth quarter of fiscal 1997.
Net revenues from shipments of AL products in fiscal 1997 increased to
$96,696,000 from $81,649,000 in fiscal 1996. The increase was due to higher
sales of AL products in Europe and Asia Pacific related to an exclusive
international distribution agreement with Twentieth Century Fox Home
Entertainment and other affiliates. This was partially offset by a decrease in
AL net revenues in North America and Japan. The decrease in North America was
attributable to lower volume of revenue from two exclusive distribution
arrangements for certain PC entertainment and 3DO products to key accounts on
behalf of other third party publishers which began in fiscal 1996 and the loss
of a significant affiliate at the end of the second quarter of fiscal 1997. The
decrease in Japan was due to lower volume of sales from existing affiliates.
The Company's revenues from floppy disk products, hand-held cartridge products
and products from the Sega 32X platform decreased to $406,000 in fiscal 1997
from $8,851,000 in fiscal 1996. Results reflect the now completed market shift
away from these products to CD-based products. The Company produced no new games
for these platforms in fiscal 1997.
North American net revenues increased by 5% to $372,616,000 in fiscal 1997 as
compared to $354,630,000 in fiscal 1996. The increase was mainly attributable to
strong growth in 32-bit CD-video game and PC-CD systems partially offset by the
decline in 16-bit sales. Net revenues from sales of CD-video game and PC-CD
products increased $102,074,000 while sales of 16-bit cartridge products
decreased $83,917,000 in comparison to the prior year.
International net revenues increased by 29% to $300,412,000, or 45% of
consolidated 1997 net revenues, compared to $232,669,000, or 40% of the 1996
total. The increase in international revenues was due to higher worldwide sales
of 32-bit CD-video game products and increased sales of PC-CD and AL products in
Europe and Asia Pacific. This was partially offset by a decrease in 16-bit video
game cartridge products.
=================================================================
1997 1996 % change
- -----------------------------------------------------------------
Cost of goods sold $328,943,000 $291,491,000 12.8
As a percentage of
net revenues 48.9% 49.6%
- -----------------------------------------------------------------
Cost of goods sold as a percentage of revenues in fiscal 1997 reflects lower
product costs associated with CD-based products offset by higher professional,
celebrity and manufacturing royalties, higher distribution and manufacturing
expenses for the operations in Europe and North America and growth in the lower
margin distribution business.
=================================================================
%
Operating Expenses 1997 1996 change
- -----------------------------------------------------------------
Marketing and sales As $102,072,000 $85,771,000 19.0
a percentage of
net revenues 15.2% 14.6%
- -----------------------------------------------------------------
General and
Administrative $48,489,000 $37,711,000 28.6
As a percentage of
net revenues 7.2% 6.4%
- -----------------------------------------------------------------
Research and
Development $130,755,000 $108,043,000 21.0
As a percentage of
net revenues 19.4% 18.4%
- -----------------------------------------------------------------
25
The increase in marketing and sales expense was due to higher television
advertising expenses and higher co-operative advertising expenses associated
with higher revenues. Additionally, marketing and sales expenses, along with
general and administrative expenses, increased due to additional headcount and
higher facility expenses related to the opening of new sales offices in
international markets. Increases in general and administrative expenses were
also due to implementation related costs for new management information systems
in North America and Europe. The increase in research and development expenses
was primarily due to higher average development costs for CD-based products than
for cartridge products and higher depreciation expense. The Company released a
total of 68 new products in fiscal 1997 compared to 89 in fiscal 1996. Total
CD-based new products released for fiscal 1997 were 58 compared to 72 in fiscal
1996.
==============================================================
Other Operating 1997 1996 % change
Expenses
- --------------------------------------------------------------
Charge for acquired $- $2,232,000 N/M
in-process technology
As a percentage
of net revenues N/A 0.4%
- --------------------------------------------------------------
In March 1996, Maxis acquired for cash Cinematronics LLC, an independent
developer of entertainment software based in Austin, Texas. In connection with
this acquisition, the Company incurred a charge of $2,232,000 for acquired
in-process technology. This charge was made after the Company 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.
==============================================================
1997 1996 % change
- --------------------------------------------------------------
Operating income $62,769,000 $62,051,000 1.2
As a percentage
of net revenues 9.3% 10.6%
- --------------------------------------------------------------
The increase in operating income was primarily due to higher net revenues and
increased gross profit margins, partially offset by higher operating expenses.
==============================================================
1997 1996 % change
- --------------------------------------------------------------
Interest and other
income, net $13,279,000 $7,514,000 76.7
As a percentage
of net revenues 2.0% 1.3%
- --------------------------------------------------------------
The increase in other income was due to gains on sales of marketable securities
and higher interest income related to higher average cash balances. The fiscal
1996 balance also included write-offs of certain investments in affiliates.
==============================================================
1997 1996 % change
- --------------------------------------------------------------
Income taxes $26,003,000 $22,584,000 15.1
Effective tax rate 34.2% 32.5%
- --------------------------------------------------------------
The effective tax rate for fiscal 1997 increased over the prior year primarily
as a result of reported losses in Japan for which no tax benefit could be
currently realized.
==============================================================
%
1997 1996 change
- --------------------------------------------------------------
Minority interest in
consolidated joint
venture $1,282,000 $(304,000) N/M
As a percentage
of net revenues 0.2% (0.1%)
- --------------------------------------------------------------
The fiscal 1997 minority interest represents VEI's pro rata share of EAV's net
loss for that period. Conversely, minority interest for fiscal 1996 represents
VEI's pro rata share of net income from EAV's operations.
==============================================================
1997 1996 % change
- --------------------------------------------------------------
Net income $51,327,000 $46,677,000 10.0
As a percentage
of net revenues 7.6% 7.9%
- --------------------------------------------------------------
The increase in net income was due to higher revenue and gross profit margins
higher other income partially offset by higher operating expenses.
26
================================================================================
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Company's working capital was $408,098,000 compared to
$284,863,000 at March 31, 1997. Cash and short-term investments increased by
approximately $106,419,000 in fiscal 1998. The Company generated $78,993,000 of
cash from operations in fiscal 1998. In addition, $37,748,000 was provided
through the sale of equity securities under the Company's employee stock plans.
Reserves for bad debts and sales returns increased from $43,268,000 at March
31, 1997 to $51,575,000 at March 31, 1998. 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 1998 the Company invested approximately $45,000,000, primarily
in computer hardware and software purchases required to support the Company's
development efforts, management information systems and expenditures related to
new facilities in Europe and Canada.
In connection with the Company's purchases of Sony products to be distributed
in Japan, Sony of Japan requires cash deposits totaling one-third of purchase
orders. Additionally, Nintendo of Japan requires cash deposits on all orders of
N64 cartridge products. Electronic Arts, K.K. ("EAJ") utilizes lines of credit
to fund these deposits for purchases of Sony and Nintendo products and for other
operating requirements. At March 31, 1998, EAJ had lines of credit of
approximately $6,138,000 of which $4,604,000 was outstanding.
The Company's principal source of liquidity is $374,560,000 in cash and
short-term investments. Management believes the existing cash, cash equivalents,
short-term investments, marketable securities and cash generated from operations
will be sufficient to meet cash and investment requirements for the next twelve
months and the foreseeable future.
================================================================================
YEAR 2000
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "Year 2000" problem
is complex and pervasive as many computer systems will be affected in some way
by the rollover of the two-digit year value to 00. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail. The Year 2000 issue creates risk for the Company from unforeseen problems
in its own computer systems and from third parties with which the Company deals
on financial transactions worldwide. Failures of the Company's and/or third
parties' computer systems could have a material adverse impact on the Company's
ability to conduct business. For example, a significant percentage of purchase
orders received from the Company's customers are computer generated and
electronically transmitted. A failure of the computer systems of the Company's
customers to be Year 2000 compliant could significantly impact the orders
received by the Company from such customer.
The Company's financial information systems include an Oracle system in the
United States and Europe, which the Company believes to be Year 2000 compliant.
The Company is analyzing its remaining computer systems to identify any
potential Year 2000 issues and will take appropriate corrective action based on
the results of such analysis. Management has not yet determined the cost related
to achieving Year 2000 compliance.
In addition, the Year 2000 could affect the ability of consumers to use the PC
based products sold by the Company. If the computer systems on which the
consumers use the Company's products are not Year 2000 compliant, such
noncompliance could affect the consumers ability to use such products.
27
================================================================================
FACTORS AFFECTING FUTURE PERFORMANCE
Future operating results of the Company depend upon many factors and are subject
to various risks and uncertainties. Some of those important risks and
uncertainties which may cause the Company's operating results to vary or which
may materially and adversely affect the Company's operating results are as
follows:
The Industry and Competition. The interactive software business has historically
been a volatile and highly dynamic industry affected by changing technology,
limited hardware platform life cycles, hit products, competition, component
supplies, seasonality, consumer spending and other economic trends. The business
is also intensely competitive. A variety of companies offer products that
compete directly with one or more of the Company's products. These direct
competitors vary in size from very small companies to companies with financial,
managerial and technical resources comparable to or greater than those of the
Company. Typically, the Company's chief competitor on dedicated game platforms
is the hardware manufacturer/licensor itself, to which the Company must pay
royalties, and in the case of Sony and Nintendo, manufacturing charges. For
example, Sony has aggressively launched sports product lines that directly
compete with the Company's sports products on the PlayStation. In addition,
competition for creative talent has intensified, and the attraction and
retention of key personnel by the Company is increasingly difficult.
Products. Interactive entertainment software products typically have life spans
of only 3 to 12 months. In addition, the packaged goods market is crowded with a
large number of titles competing for limited retail shelf space. The Company's
future success will depend in large part on its ability to develop and introduce
new competitive products on a timely basis and, in the packaged goods market, to
get those products distributed widely at retail. To compete successfully, new
products must adapt to new hardware platforms and emerging industry standards,
provide additional content and functionality and be successfully distributed in
numerous changing worldwide markets. If the Company were unable, due to resource
constraints or technological or other reasons, to successfully develop and
distribute such products in a timely manner, this inability would have a
material adverse effect on its operating results and financial condition.
Development. Product development schedules, particularly for new hardware
platforms and high-end multimedia 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. CD-ROM products frequently include more content and are
more complex, time-consuming and costly to develop and, accordingly, cause
additional development and scheduling risk than earlier generation products. For
example, Dungeon Keeper, originally scheduled to ship in the quarter ended June
1996, shipped during the summer of 1997. In addition Populous 3 for PC-CD and
PlayStation were scheduled for shipment in the fiscal year ended March 31, 1998
and are now expected to ship in the fiscal year ending March 31, 1999. Also,
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, it is anticipated that this product will ship during the first half of
the fiscal year ending March 31, 1999. 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. The Company's revenues and earnings
are dependent on its ability to meet its product release schedule. Its 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.
Platform Changes. A large portion of the Company's revenues are derived from the
sale of products designed to be played on proprietary video game platforms such
as the PlayStation and the N64. The interdependent nature of the Company's
business and that of its hardware licensors brings significant risks to the
Company's business. The success of the Company's products is significantly
affected by market acceptance of the new video game hardware systems and the
life span of older hardware platforms, and the Company's ability to accurately
predict these factors with respect to each platform. In many cases, the Company
will have expended a large amount of development and marketing resources on
products designed for new video game systems (such as the new 32-bit and 64-bit
systems) that have not yet achieved large installed bases or will have continued
product development for older hardware platforms that may have shorter life
cycles than the Company expected. Conversely, if the Company does not choose to
develop for a platform that achieves significant market acceptance, or
discontinues development for a platform that has a longer life cycle than
expected, the Company's revenue growth may be adversely affected. For example,
the Company has only released three products for the N64 through March 1998
since the introduction of this platform in September 1996. Additionally, the
Company is developing a line of EA SPORTS and other N64 products for release in
fiscal 1999.
The Company believes that investment in products for the 32-bit market,
including both PC-CD and CD-video game platforms (particularly the PlayStation)
was strategically important in positioning the Company for the now completed
transition to 32-bit machines. The Company continues to believe that such
investment is important and will continue its aggressive development activities
for 32-bit platforms. Although the PlayStation has achieved significant market
acceptance in all geographic territories, there can be no assurance that its
growth will continue at the present rates. The market acceptance of the N64,
particularly in North
28
America and Europe, may adversely affect the growth rate of the 32-bit
CD-platforms.
Multiplayer Online Gaming. While the Company does not currently derive
significant revenues from online games, the Company believes that multiplayer
online gaming will become a more significant factor in the Company's business
and in the interactive gaming business generally in the future. Online gaming,
and particularly multiplayer online gaming such as the Company's Ultima Online
product, has at least four general areas of risk not currently associated with
most packaged good sales. First, the speed and reliability of the internet and
the performance of the players' internet service provider are not controlled by
the Company but impact game performance. Second, 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. The Company's ability to effectively
proctor such games is uncertain. Third, 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. The Company has little experience in
pricing strategies for online games or in predicting usage patterns of its
customers. Finally, the legal standards that may apply to online products are
uncertain; the Company has recently been sued in a class action lawsuit alleging
defects in Ultima Online, regulation of the internet and the content it carries
is regularly proposed by various legislators, and piracy of online games is
difficult to prosecute under existing intellectual property laws. The viability
of this segment, generally, and the Company's ability to compete in the segment
will depend significantly on these and other factors outside the Company's
control.
Hardware Companies. The Company's contracts with hardware licensors, which are
also some of the Company's chief competitors, often grant significant control to
the licensor over the manufacturing of the Company's products. This fact could,
in certain circumstances, leave the Company unable to get its products
manufactured and shipped to customers. In most events, control of the
manufacturing process by hardware companies increases both the manufacturing
lead times and the expense to the Company as compared to the lead times and
costs that the Company can achieve independently. For example, the Company, in
prior years, experienced delays in the manufacturing of PlayStation products
which caused delays in shipping those products. The results of future periods
may be affected by similar delays. Finally, the Company's contracts with its
hardware licensors often require the Company to take significant risks in
holding or prepaying for its inventory of products. In particular, the Company's
agreement with Nintendo for N64 products requires prepayment of costly
cartridge-based inventory, minimum orders and no rights of return.
Revenue and Expenses. A substantial majority of the revenue of the Company in
any quarter typically results from orders received and products introduced in
that quarter. The Company's expenses are based, in part, on development of
products to be released in the future. Certain overhead and product development
expenses do not vary directly in relation to revenues. This trend is increasing
as the Company increases the proportion of products developed internally. As a
result, the Company's quarterly results of operations are difficult to predict,
and small delays in product deliveries may cause quarterly revenues, operating
results and net income to fall significantly below anticipated levels. The
Company typically receives orders shortly before shipments, making backlog an
unreliable indicator of quarterly results. A shortfall in shipments at the end
of any particular quarter may cause the results of that quarter to fall
significantly short of anticipated levels.
Gross Margins. Gross margins for the Company's products as a whole decreased
over the last year. The Company expects that margins may be consistent with or
decline from fiscal 1998 levels for several reasons. First, the mix in sales of
the Company's products has a significant effect on gross margins. If the
proportion of AL revenues continues to increase in relation to other revenues,
margins may continue to decline. Similarly, as the Company releases more N64
products, which carry significantly lower margins due to high cost of goods,
overall gross margins may continue to decline. Further, gross margins continue
to be affected by increases in professional and celebrity license fees and
royalties. Also, while the costs of development of new products for 32-bit and
64-bit systems have increased, overall costs of goods are not declining
significantly. For products on platforms for which the Company is required to
purchase its goods from the hardware companies, the Company is unable to achieve
cost reductions through manufacturing efficiencies, and in addition, pays
manufacturing royalties to hardware companies. Additionally, retailers continue
to require significant price protection for products. With an increasing number
of titles available for advanced platforms, such requirements for price
protection may increase. The Company also anticipates that retail and wholesale
prices for interactive entertainment products may decrease and gross margins may
be further adversely affected.
Marketing and Distribution. Both the video game and PC businesses have become
increasingly "hits" driven. Additional marketing and advertising funds are
required to drive and support "hit" products, particularly expenditures for
television advertising. There can be no assurance that the Company will continue
to produce "hit" titles, or that advertising for any product will increase sales
sufficiently to recoup those advertising expenses.
Employees. Competition for employees in the interactive software business
continues to be intense. Large software and media companies frequently offer
significantly larger cash compensation than does the Company, placing pressure
on the
29
Company's base salary and cash bonus compensation. Small start-up
companies such as those proliferating in the online business areas offer
significant potential equity gains which are difficult for more mature companies
like the Company to match without significant stockholder dilution. While
executive turnover has decreased in fiscal 1998 as compared to prior years, many
key executives continue to experience intense recruiting pressure. There can be
no assurance that the Company will be able to continue to attract and retain
enough qualified employees in the future.
Foreign Sales and Currency Fluctuations. For the 1998 fiscal year, international
net revenues comprised 43% of total consolidated net revenues. The Company
expects foreign sales to continue to account for a significant and growing
portion of the Company's 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, the Company is subject to additional
foreign currency risk. Though the Company does not currently derive a
significant portion of revenues and operating profits from sales in Asia and
other developing countries, the Company's foreign currency exposure may increase
as the Company's operations in these countries grow and if current economic
trends in Asia continue. There can be no assurance that these or other factors
will not have an adverse effect on the Company's future operating results.
Investments in Affiliates. The Company has a number of equity investments in
affiliates, including small developers, such as Firaxis; other publishers, such
as Accolade, Inc. and NovaLogic, Inc.; and new ventures such as Mpath
Interactive. Additionally, the Company has an equity investment in The 3DO
Company. These companies are generally small and may not have significant
financial resources. Financial difficulties for any of these companies could
cause a reduction in the value of the Company's investment.
Fluctuations in Stock Price. Due to analysts' expectations of continued growth
and other factors, any shortfall in earnings could have an immediate and
significant adverse effect on the trading price of the Company's common stock in
any given period. As a result of the factors discussed in this annual report and
other factors that may arise in the future, the market price of the Company's
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 the Company, to changes in analysts' earnings
estimates, or to factors affecting the computer, software, entertainment, media
or electronics industries or the securities markets in general. For example,
during the fiscal years 1998 and 1997 the price per share of the Company's
common stock ranged from $20.13 to $46.94 and from $24.75 to $39.13,
respectively.
Seasonality. The Company's business is highly seasonal. The Company typically
experiences its highest revenues and profits in the calendar year-end holiday
season and a seasonal low in revenues and profits in the quarter ending in June.
Because of the foregoing factors, as well as other factors affecting the
Company's operating results and financial condition, past financial performance
should not be considered a reliable indicator of future performance, and
investors should not use historical trends to anticipate results or trends in
future periods.
30
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 31 through 48.
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, 1998 and 1997, 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, 1998. 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 10 to
the consolidated financial statements, which statements reflect total assets
constituting 12 percent as of March 31, 1997, and total revenues constituting 7
percent and 9 percent for the years ended March 31, 1997 and 1996, respectively,
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 and the report of the other auditors 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, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended March
31, 1998, in conformity with generally accepted accounting principles.
Mountain View, California KPMG Peat Marwick LLP
May 1, 1998
31
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
As of March 31, 1998 1997
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and short-term investments $374,560 $268,141
Marketable securities 3,721 5,548
Receivables, less allowances of $51,575 and $43,268, respectively 139,374 103,244
Inventories 19,626 17,873
Prepaid royalties 20,470 10,311
Deferred income taxes 17,792 5,259
Other current assets 14,268 10,724
------------------------------
Total current assets 589,811 421,100
Property and equipment, net 105,095 89,762
Prepaid royalties 2,289 9,351
Long-term investments 24,200 34,478
Investment in affiliates 20,541 25,657
Other assets 3,745 3,693
------------------------------
$745,681 $584,041
==============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $56,233 $43,450
Accrued liabilities 125,480 92,787
------------------------------
Total current liabilities 181,713 136,237
Minority interest in consolidated joint venture - 28
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 1,000,000 shares - -
Common stock, $0.01 par value. Authorized 104,000,000 shares;
issued and outstanding 60,159,601 and 58,263,058, respectively 602 583
Paid-in capital 234,294 188,547
Retained earnings 330,540 257,978
Unrealized appreciation of investments 1,730 2,593
Translation adjustment (3,198) (1,925)
------------------------------
Total stockholders' equity 563,968 447,776
------------------------------
$745,681 $584,041
==============================
See accompanying notes to consolidated financial statements.
32
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Years Ended March 31,
1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
Net revenues $908,852 $673,028 $587,299
Cost of goods sold 480,766 328,943 291,491
--------------------------------------------------
Gross profit 428,086 344,085 295,808
Operating expenses:
Marketing and sales 128,308 102,072 85,771
General and administrative 57,838 48,489 37,711
Research and development 146,199 130,755 108,043
Charge for acquired in-process technology 1,500 - 2,232
Merger costs 10,792 - -
--------------------------------------------------
Total operating expenses 344,637 281,316 233,757
--------------------------------------------------
Operating income 83,449 62,769 62,051
Interest and other income, net 24,811 13,279 7,514
--------------------------------------------------
Income before provision for income taxes and minority interest 108,260 76,048 69,565
Provision for income taxes 35,726 26,003 22,584
--------------------------------------------------
Income before minority interest 72,534 50,045 46,981
Minority interest in consolidated joint venture 28 1,282 (304)
--------------------------------------------------
Net income $72,562 $51,327 $46,677
==================================================
Net income per share:
Basic $1.23 $0.89 $0.84
Diluted $1.19 $0.86 $0.80
Number of shares used in computation:
Basic 58,867 57,544 55,685
Diluted 60,958 59,557 58,190
See accompanying notes to consolidated financial statements.
33
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended March 31, 1998, 1997 and 1996
(In thousands)
Common Stock Unrealized
------------------ Paid-In Retained Appreciation Translation
Shares Amount Capital Earnings of Investments Adjustment Total
- ---------------------------------------------------------------------------------------------------------------------------
Balances at March 31, 1995 53,227 $532 $78,482 $162,539 $(1,206) $(886) $239,461
Conversion of Maxis preferred stock into
common stock 763 8 11,441 11,449
Issuance of Maxis common stock in initial
public offering, net of issuance costs 893 9 35,499 35,508
Proceeds from sales of shares through
employee stock plans and other plans 1,864 17 22,055 22,072
Tax benefit related to stock options 10,067 10,067
Adjustment effect of immaterial pooling 1 103 (177) (73)
Adjustment for change in Manley &
Associates fiscal year end (2,301) (2,301)
Repayment of notes receivable 146 146
Amortization of deferred compensation 351 351
Unrealized gain on investments, net 17,472 17,472
Accretion of Maxis preferred stock (87) (87)
Translation adjustment (1,191) (1,191)
Net income 46,677 46,677
--------------------------------------------------------------------------------
Balances at March 31, 1996 56,747 567 158,144 206,651 16,266 (2,077) 379,551
Proceeds from sales of shares through
employee stock plans and other plans 1,516 16 20,985 21,001
Tax benefit related to stock options 9,210 9,210
Repayment of notes receivable 101 101
Amortization of deferred compensation 107 107
Unrealized loss on investments, net (13,673) (13,673)
Translation adjustment 152 152
Net income 51,327 51,327
--------------------------------------------------------------------------------
Balances at March 31, 1997 58,263 583 188,547 257,978 2,593 (1,925) 447,776
Proceeds from sales of shares through
employee stock plans and other plans 1,897 19 37,729 37,748
Tax benefit related to stock options 7,931 7,931
Repayment of notes receivable 87 87
Unrealized loss on investments, net (863) (863)
Translation adjustment (1,273) (1,273)
Net income 72,562 72,562
--------------------------------------------------------------------------------
Balances at March 31, 1998 60,160 $602 $234,294 $330,540 $1,730 $(3,198) $563,968
================================================================================
See accompanying notes to consolidated financial statements.
34
ELECTRONIC ARTS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended March 31,
(In thousands) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES: $72,562 $ 51,327 $ 46,677
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Minority interest in consolidated joint venture (28) (1,282) 304
Equity in net loss of affiliates 1,162 1,566 1,746
Gain on sale of affiliate (12,625) - -
Depreciation and amortization 26,907 22,986 16,850
Loss (gain) on sale of fixed assets 1,813 164 (2,044)
Loss on disposition of assets related to merger 5,607 - -
Gain on sale of marketable securities (4,098) (8,393) (4,879)
Provision for doubtful accounts 4,302 4,840 3,010
Charge for acquired in-process technology 1,500 - 2,232
Adjustment for change in fiscal year end for pooled subsidiaries - - (2,301)
Change in:
Receivables (40,432) (28,018) (22,914)
Inventories (1,753) (1,626) (2,198)
Prepaid royalties (3,097) 5,887 (10,598)
Other assets (2,563) 2,255 (4,948)
Accounts payable 12,783 4,824 2,961
Accrued liabilities 29,217 24,307 (8,386)
Deferred income taxes (12,264) 1,165 1,269
-------------------------------------------------
Net cash provided by operating activities 78,993 80,002 16,781
-------------------------------------------------
INVESTING ACTIVITIES:
Proceeds from sale of furniture and equipment 25 171 4,221
Proceeds from sales of marketable securities 7,276 21,152 5,273
Purchase of marketable securities (2,762) - -
Capital expenditures (45,238) (39,124) (59,184)
Acquisition of minority interest in EA Japan (3,225) - -
Investment in affiliates, net 16,579 (11,271) (6,387)
Purchase of held-to-maturity securities (1,008) (23,627) (34,989)
Proceeds from maturity of securities 13,047 20,598 5,183
Change in short-term investments, net (34,504) (62,132) (14,711)
Acquisition of subsidiaries - - (2,842)
Other 291 - (73)
-------------------------------------------------
Net cash used in investing activities (49,519) (94,233) (103,509)
-------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from sales of shares through employee stock plans and other plans 37,748 21,001 22,072
Issuance of Maxis common stock in initial public offering, net of issuance - - 35,508
costs
Repayment of notes receivable 87 101 146
Tax benefit from exercise of stock options 7,931 9,210 10,067
-------------------------------------------------
Net cash provided by financing activities 45,766 30,312 67,793
-------------------------------------------------
Translation adjustment (1,273) 152 (1,191)
Minority interest on translation adjustment - 33 (175)
-------------------------------------------------
Increase (decrease) in cash and cash equivalents 73,967 16,266 (20,301)
Beginning cash and cash equivalents 141,996 125,730 146,031
-------------------------------------------------
Ending cash and cash equivalents 215,963 141,996 125,730
Short-term investments 158,597 126,145 65,143
-------------------------------------------------
Ending cash and short-term investments $374,560 $ 268,141 $ 190,873
=================================================
Supplemental cash flow information:
Cash paid during the year for income taxes $ 32,888 $ 15,323 $ 14,802
=================================================
Non-cash investing activities:
Change in unrealized appreciation of investments $(1,411) $(19,562) $ 24,952
Conversion of Maxis preferred stock to common stock - - 11,449
=================================================
See accompanying notes to consolidated financial statements.
35
ELECTRONIC ARTS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1998, 1997 and 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The accompanying consolidated financial statements include the accounts of
Electronic Arts Inc. and its wholly-owned and majority-owned subsidiaries (the
"Company"). All significant intercompany balances and transactions have been
eliminated in consolidation.
A summary of the significant accounting policies applied in the preparation
of the accompanying consolidated financial statements of the Company follows:
(a) Fiscal Year
The Company's fiscal year is reported on a 52/53-week period that ends on the
Saturday nearest to March 31 in each year. The results of operations for fiscal
1998 and 1997 contain 52 weeks and fiscal 1996 contains 53 weeks. Since the
results of an additional week are not material, and for clarity of presentation,
all fiscal periods are treated as ending on a calendar month.
(b) Revenue Recognition
Product Sales: Revenue is recognized when the product is shipped. Subject to
certain limitations, the Company permits customers to obtain exchanges within
certain specified periods and provides price protection on certain unsold
merchandise. Revenue is recognized net of allowances for returns and price
protection.
Software Licenses: For those agreements which provide the customers the right to
produce multiple copies in exchange for guaranteed minimum royalty amounts,
revenue is recognized at delivery of the product master or the first copy. Per
copy royalties on sales that exceed the guarantee are recognized as earned.
Revenue from the licensing of software was $15,431,000, $26,749,000, and
$32,221,000 for the fiscal years ended March 31, 1998, 1997 and 1996,
respectively.
(c) Cash and Investments
Cash equivalents consist of highly liquid investments with insignificant rate
risk and with maturities of three months or less at the date of purchase.
Short-term investments include securities with maturities greater than three
months and less than one year, except for certain investments with stated
maturities greater than one year. Long-term investments consist of securities
with maturities greater than one year.
The Company accounts for investments under Statement of Financial Accounting
Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities, ("SFAS 115"). The Company's policy is to protect the value of its
investment portfolio and to minimize principal risk by earning returns based on
current interest rates. Management determines the appropriate classification of
its debt and equity securities at the time of purchase and reevaluates such
designation as of each balance sheet date. Debt securities are classified as
held-to-maturity when the Company has the positive intent and ability to hold
the securities to maturity. Securities classified as held-to-maturity are
carried at amortized cost, which is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is included in interest
income. Debt securities not classified as held-to-maturity are classified as
available for sale and are stated at fair value which approximates cost.
Securities sold is based on the specific identification method.
(d) Prepaid Royalties
Prepaid royalties consist primarily of prepayments for manufacturing royalties,
original equipment manufacturer (OEM) fees and license fees paid to celebrities
and professional sports organizations for use of their trade name. Also included
in prepaid royalties are prepayments made to independent software developers
under development arrangements that have alternative future uses. Prepaid
royalties are expensed at the contractual royalty rate as cost of goods sold
based on actual net product sales. Management evaluates the future realization
of prepaid royalties quarterly and charges to income any amounts that management
deems unlikely to be realized through product sales. Royalty advances are
classified as current and non-current assets based upon estimated net product
sales for the following year.
(e) Software Development Costs
Research and development costs, which consist primarily of software development
costs, are expensed as incurred. Statement of Financial Accounting Standards No.
86 provides for the capitalization of certain software development costs
incurred after technological feasibility of the software is established or
development costs that have alternative future uses. Under the Company's current
practice of developing new products, the technological feasibility of the
underlying software is not established until substantially all product
development is complete, which generally includes the development of a working
model. The software development costs that have been capitalized to date have
been insignificant.
36
(f) Inventories
Inventories are stated at the lower of cost or market. Inventories at March 31,
1998 and 1997 consisted of:
==============================================================
1998 1997
- --------------------------------------------------------------
(in thousands)
Raw materials and work in process $ 2,392 $ 4,714
Finished goods 17,234 13,159
- --------------------------------------------------------------
$19,626 $17,873
- --------------------------------------------------------------
(g) Outside Production Costs
The Company defers the outside production costs of the film content of its
products. Such costs are expensed as cost of goods sold based on actual net
product sales. Film costs deferred as of March 31, 1998 and 1997 were $757,000
and $926,000, respectively.
(h) Advertising costs
The Company generally expenses advertising costs as incurred, except for
production costs associated with media campaigns which are deferred and charged
to expense at the first run of the ad. Cooperative advertising with distributors
and retailers is accrued when revenue is recognized. Cooperative advertising
credits are reimbursed when qualifying claims are submitted. For the fiscal
years ended March 31, 1998, 1997 and 1996, advertising expenses totaled
approximately $55,090,000, $36,159,000 and $31,160,000, respectively.
(i) Property and Equipment
Property and equipment are stated at cost. Depreciation of furniture and
equipment is computed using the declining balance method over the estimated
useful lives of the respective assets, which range from three to seven years.
Depreciation on new management information systems is computed using the
straight-line method over the estimated useful lives of the respective assets,
which range from four to seven years. Buildings are being depreciated using the
straight line method over 20 years. Amortization of leasehold improvements is
computed using the declining balance method over the lesser of the lease terms
or the estimated useful lives of the improvements.
(j) Intangible Assets
Intangible assets net of amortization at March 31, 1998 and 1997 of $2,148,000,
and $1,115,000, respectively, are included in other current and noncurrent
assets and include goodwill, costs of obtaining product technology and
noncompete covenants which are amortized using the straight line method over the
lesser of their estimated useful lives or the agreement terms, typically no more
than seven years. Amortization expense for fiscal years ended March 31, 1998,
1997 and 1996 was $692,000, $654,000, and $740,000, respectively.
(k) Income Taxes
Income tax expense is based on reported earnings before income taxes. Deferred
income taxes reflect the impact of temporary differences between assets and
liabilities recognized for financial reporting purposes and such amounts
recognized for tax purposes.
(l) Foreign Currency Translation
For each of the Company's foreign subsidiaries the functional currency is its
local currency. Assets and liabilities of foreign operations are translated into
U.S. dollars using current exchange rates, and revenues and expenses are
translated into U.S. dollars using average exchange rates. The effects of
foreign currency translation adjustments are deferred and included as a
component of stockholders' equity.
Foreign currency transaction gains and losses are a result of the effect of
exchange rate changes on transactions denominated in currencies other than the
functional currency. Included in interest and other income in the statements of
income are foreign currency transaction gains (losses) of ($517,000),
($1,024,000), and $433,000, for the fiscal years ended March 31, 1998, 1997 and
1996, respectively.
(m) Net Income Per Share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No 128, "Earnings per Share" ("SFAS 128"). SFAS
128 requires dual presentation of basic earnings per share ("EPS") and diluted
EPS for all entities with complex capital structures. Basic EPS is computed as
net earnings divided by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could occur
from common shares issuable through stock-based compensation plans including
stock options, restricted stock awards, warrants and other convertible
securities using the treasury stock method. The following summarizes the
computation of Basic EPS and Diluted EPS (in thousands except for per share
amounts):
==============================================================
Years Ended March 31,
1998 1997 1996
- --------------------------------------------------------------
Net income $72,562 $51,327 $46,677
- --------------------------------------------------------------
Shares:
Weighted average
common shares 58,867 57,544 55,685
Common equivalent shares
attributable to Maxis
redeemable preferred
stock (if-converted
method) - - 127
Dilutive stock options 2,091 2,013 2,378
- --------------------------------------------------------------
Dilutive potential
common shares 60,958 59,557 58,190
- --------------------------------------------------------------
37
Earnings Per Share:
Basic $1.23 $0.89 $0.84
Diluted $1.19 $0.86 $0.80
The number of anti-dilutive shares excluded from the diluted EPS computation was
137,000, 623,000 and 1,081,000 for the fiscal years ended March 31, 1998, 1997
and 1996, respectively.
(n) Employee Benefits
The Company has a 401(k) Plan covering substantially all of its U.S. employees.
The 401(k) Plan permits the Company to make discretionary contributions to
employees' accounts based on the Company's financial performance. The Company
contributed $902,000, $925,000 and $600,000 to the Plan in fiscal 1998, fiscal
1997 and fiscal 1996, respectively.
(o) Stock-based Compensation
The Company accounts for stock-based awards to employees using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25").
(p) Impact of Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income", which establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains and losses) in financial
statements. SFAS 130 requires classification of items of other comprehensive
income in a financial statement and display of other comprehensive income
separately from retained earnings and additional paid-in capital. The Company
will adopt SFAS 130 in its 1999 fiscal year.
In June 1997, FASB also issued Statement of Financial Accounting Standards No.
131 ("SFAS 131"), "Disclosures About Segments of an Enterprise and Related
Information", which establishes standards pertaining to disclosures about
products and services, geographic areas, and major customers in its annual and
interim financial statements. SFAS 131 also requires that public companies
report certain financial and descriptive information about its reportable
operating segments. The Company will adopt SFAS 131 in its 1999 fiscal year.
The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants recently issued Statement of Position ("SOP") 97-2,
"Software Revenue Recognition" effective for transactions entered into in fiscal
years beginning after December 15, 1997. SOP 97-2 supersedes SOP 91-1 and
provides guidance on applying generally accepted accounting principles in
recognizing revenue on software transactions. The Company will adopt SOP 97-2
effective April 1, 1998 and expects adoption will not have a material effect on
the Company's historical revenue recognition practices.
(q) Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. Such
estimates include provisions for doubtful accounts, sales returns and
allowances, warranty provisions, and estimates regarding the recoverability of
prepaid royalty advances and inventory. Actual results could differ from those
estimates.
(r) Reclassifications
Certain amounts have been reclassified to conform to fiscal 1998 presentation.
(2) FINANCIAL INSTRUMENTS
(a) Cash and Investments
==============================================================
March 31,
1998 1997
- --------------------------------------------------------------
(in thousands)
Cash and equivalents:
Cash $88,241 $68,851
Municipal securities 16,272 31,940
Money market funds 111,450 35,105
Money market preferreds - 6,100
- --------------------------------------------------------------
Cash and equivalents 215,963 141,996
- --------------------------------------------------------------
Short-term investments:
Available-for-sale
Commercial paper 15,452 17,315
Municipal securities 24,601 9,163
Money market preferreds 101,438 80,509
Held-to-maturity
Municipal securities 17,106 19,158
- --------------------------------------------------------------
Short-term investments 158,597 126,145
- --------------------------------------------------------------
Cash and short-term investments $374,560 $268,141
- --------------------------------------------------------------
- --------------------------------------------------------------
Long-term investments:
US Treasury securities $24,200 $24,200
Municipal securities - 10,278
- --------------------------------------------------------------
Long-term investments $24,200 $34,478
- --------------------------------------------------------------
Long-term investments include commercial notes with maturities of five to eight
years secured by U.S. Treasury Notes which enable the Company to take advantage
of certain tax incentives in its Puerto Rico operation. Long-term investments
are treated as held-to-maturity for financial reporting purposes. Other
long-term investments have maturities of two years or less.
38
The fair value of held-to-maturity securities at March 31, 1998 was $41,326,000
which included gross unrealized gains of $27,000 and gross unrealized losses of
$7,000. The fair value of held-to-maturity securities at March 31, 1997 was
$53,842,000 which included gross unrealized gains of $206,000.
(b) Marketable Securities
Marketable securities are comprised of equity securities. The Company has
accounted for investments in equity securities as "available-for-sale" and has
stated applicable investments at fair value, with net unrealized appreciation
reported as a separate component of stockholders' equity. Marketable securities
had an aggregate cost of $1,143,000 and $1,559,000 at March 31, 1998 and 1997,
respectively. At March 31, 1998, marketable securities included gross unrealized
gains of $2,771,000 and gross unrealized losses of $193,000. At March 31, 1997
marketable securities included gross unrealized gains of $4,174,000 and gross
unrealized losses of $185,000.
For the fiscal years ended March 31, 1998 and 1997, the fair value of marketable
securities sold was $7,276,000 and $21,152,000, respectively. The gross realized
gains from these sales totaled $4,098,000 and $8,393,000 for fiscal 1998 and
1997, respectively. The gain on sale of investments is based on the specific
identification method.
(c) Foreign Currency Forward Exchange Contracts
The Company utilizes foreign currency forward exchange contracts to hedge
foreign currency market exposures of underlying assets, liabilities and other
obligations, primarily certain intercompany receivables that are denominated in
foreign currencies . The Company does not use forward exchange contracts for
speculative or trading purposes. The Company's accounting policies for these
instruments are based on the Company's designation of such instruments as
hedging transactions. The criteria the Company uses for designating an
instrument as a hedge include the instrument's effectiveness in risk reduction
and one-to-one matching of forward exchange contracts to underlying
transactions. Gains and losses on currency forward contracts that are designated
and effective as hedges of firm commitments are deferred and recognized in
income in the same period that the underlying transactions are settled. Gains
and losses on currency forward contracts that are designated and effective as
hedges of existing transactions are recognized in income in the same period as
losses and gains on the underlying transactions are recognized and generally
offset. Gains and losses on any instruments not meeting the above criteria would
be recognized in income in the current period. The Company transacts business in
various foreign currencies, including European currencies. At March 31, 1998,
the Company had foreign exchange contracts, all with maturities of less than
nine months, to sell approximately $26,000,000 in British Pounds and to purchase
approximately $22,800,000, $11,000,000, $10,600,000 and $4,300,000 in British
Pounds, German Deutschmarks, Italian Liras and other European currencies,
respectively.
The difference between the face value and fair value, based on spot rates, of
these contracts is not significant. The counterparties to these contracts are
substantial and credit worthy multinational commercial banks. The risks of
counterparty nonperformance associated with these contracts are not considered
to be material.
(3) COMMITMENTS
Lease Obligations
The Company leases its current facilities and certain equipment under
non-cancelable operating lease agreements. The Company is required to pay
property taxes, insurance and normal maintenance costs for certain of its
facilities and will be required to pay any increases over the base year of these
expenses on the remainder of the Company's facilities.
In February 1995, the Company entered into a master operating lease, as
subsequently amended, for land and a building to be constructed in Redwood
City, California. The initial term of the lease is for a period of three years
from the earlier of the date of completion of construction or December 1998.
Monthly lease payments are based upon the London Interbank Offered Rate. The
Company has the option to purchase the property for the unamortized financed
balance at any time after the non-cancelable lease term, or it may terminate the
lease at any time after the non-cancelable term by arranging a third party sale
or by making a termination payment. Should the Company elect to terminate the
lease, it will guarantee a residual value of up to 85% of the unamortized value
of the property. As part of the agreement, the Company must also comply with
certain financial covenants.
Total future minimum lease commitments as of March 31, 1998 are:
=======================================================
Year Ended March 31: (in thousands)
1999 $10,722
2000 9,256
2001 8,113
2002 5,554
2003 3,211
Thereafter 13,117
- -------------------------------------------------------
$49,973
- -------------------------------------------------------
Total rent expense for all operating leases was $13,842,000, $11,430,000, and
$8,652,000, for the fiscal years ended March 31, 1998, 1997 and 1996,
respectively.
The current portion of deferred rent of $493,000 and $1,114,000 at March 31,
1998 and 1997, respectively,
39
represents the obligation accrued for rent, calculated on the straight-line
method over the lease term and is included in accrued liabilities.
(4) CONCENTRATION OF CREDIT RISK
The Company extends credit to various companies in the retail and mass
merchandising industry. Collection of trade receivables may be affected by
changes in economic or other industry conditions and may, accordingly, impact
the Company's overall credit risk. Although the Company generally does not
require collateral, the Company performs ongoing credit evaluations of its
customers and reserves for potential credit losses are maintained.
The Company had no sales to any one customer in excess of 10% of total net
revenues for the fiscal years ended March 31, 1998, 1997 and 1996.
Short-term investments are placed with high credit-quality financial
institutions or in short-duration high quality securities. The Company limits
the amount of credit exposure in any one institution or type of investment
instrument.
(5) LITIGATION
The Company is subject to pending claims and litigation. Management, after
review and consultation with counsel, considers that any liability from the
disposition of such lawsuits would not have a material adverse effect upon the
consolidated financial condition of the Company.
(6) PREFERRED STOCK
At March 31, 1998 and 1997, the Company had 1,000,000 shares of Preferred Stock
authorized but unissued. The rights, preferences, and restrictions of the
Preferred Stock may be designated by the Board of Directors without further
action by the Company's stockholders.
(7) STOCK PLANS
(a) Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan program whereby eligible
employees may authorize payroll deductions of up to 10% of their compensation to
purchase shares at 85% of the lower of the fair market value of the Common Stock
on the date of commencement of the offering or on the last day of the six-month
purchase period. The program commenced in September 1991. In fiscal 1998,
199,680 shares were purchased by the Company and distributed to employees at
prices ranging from $26.14 to $26.19. In fiscal 1997, 184,596 shares were
purchased by the Company and distributed to employees at prices ranging from
$21.25 to $25.18. In fiscal 1996, 154,516 shares were purchased by the Company
and distributed to employees at prices ranging from $15.09 to $21.57 per share.
The weighted average fair value of the fiscal 1998, fiscal 1997 and fiscal 1996
awards was $9.43, $10.41 and $8.81, respectively. At March 1998, the Company had
228,958 shares of its Common Stock reserved for future issuance under the Plan.
Prior to the Maxis merger in July 1997, Maxis employees were eligible to
participate in an employee stock purchase plan. In fiscal 1998, 1997 and 1996,
Maxis purchased 7,684, 18,220 and 8,017 shares, respectively, under this plan
which were distributed to participating employees. Shares were purchased at
prices ranging from $27.70 to $27.99 in fiscal 1998, $28.56 to $46.08 in fiscal
1997, and $37.32 in fiscal 1996.
(b) Stock Option Plans
The Company's 1991 Stock Option Plan, 1993 Stock Option Plan, 1995 Stock Option
Plan and Directors' Plan ("Option Plans") provide stock options for employees,
officers and independent contractors, and for directors, respectively. Pursuant
to these Option Plans, the Board of Directors may grant non-qualified and
incentive stock options to employees and officers and non-qualified options to
celebrities, employees of certain companies in which the Company has an equity
investment, and directors, at not less than the fair market value on the date of
grant.
The options generally expire ten years from the date of grant and are generally
exercisable in monthly increments over 50 months.
In connection with the Maxis merger, the Company established the 1993 and 1995
Stock Option Plans ("Maxis Plans") and assumed and transferred all existing
obligations under Maxis' existing stock option plans. The obligations included
immediate vesting of grants to certain employees due to a change in control
provision. Options under the Maxis Plans generally expire ten years from the
date of grant, and vest and become exercisable at a rate of 25% on the first
anniversary of the date of grant and 25% of the shares each year thereafter.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock Based Compensation ("SFAS
123"). Accordingly, no compensation expense has been recognized for options
granted under the Company's employee based stock option plans. Had compensation
expense been determined based on the fair value at the grant dates for awards
under those plans in accordance with the provisions of SFAS 123, the Company's
pro forma net income and net income per share for fiscal 1998, 1997 and 1996
would have been:
(In thousands, except per share data)
=============================================================
1998 1997 1996
- -------------------------------------------------------------
Net Income
As reported $72,562 $51,327 $46,677
Pro forma $52,892 $37,343 $39,705
40
Earnings per Share
As reported - basic $1.23 $0.89 $0.84
Pro forma - basic $0.91 $0.66 $0.72
As reported - diluted $1.19 $0.86 $0.80
Pro forma - diluted $0.88 $0.64 $0.69
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model. The following weighted-average assumptions
used for grants made in 1998, 1997 and 1996 under the stock plans: risk-free
interest rates of 5.31% to 6.42% in 1998; 5.48% to 6.36% in 1997; and 5.12% to
6.25% in 1996; expected volatility of 58% in each of the three years; expected
lives in each of the three years of 2.25 years under the Option Plans and one
year for the Employee Stock Purchase Plan. No dividends are assumed in the
expected term. The Company's calculations are based on a multiple option
valuation approach and forfeitures are recognized when they occur. The above
disclosures include options granted under the former Maxis option plans as if
they were initially granted by the Company.
Because SFAS 123 is applicable only to options granted subsequent to March 31,
1995, the impact of non-vested stock options granted prior to this date has been
excluded from the pro forma calculation. Accordingly, pro forma adjustments are
not indicative of future period pro forma adjustments as the pro forma effect
will not be fully reflected until subsequent years.
41
Additional information regarding options outstanding as of March 31, 1998 is as
follows:
=======================================================================
-----------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------ ----------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Number of Contractual Exercise Number of Exercise
Range of Exercise Prices Shares Life Price Shares Price
- ------------------------------------ ------------- -------------- ------------- -------------- -------------
$0.720 - $4.250 572,633 2.90 $2.98 569,087 $2.98
4.469 - 13.500 906,142 5.33 12.49 824,683 12.39
13.625 - 22.250 1,070,515 5.82 17.00 791,560 16.02
22.300 - 23.500 1,293,389 7.89 23.45 472,069 23.42
23.750 - 24.625 980,094 8.88 24.57 211,289 24.55
24.700 - 29.750 432,499 7.03 27.02 227,301 27.33
29.875 - 30.125 1,278,213 8.45 29.90 417,136 29.90
30.625 - 34.875 1,401,209 8.54 33.64 360,549 32.99
35.000 - 38.438 1,555,671 9.52 35.76 61,335 35.15
38.625 - 45.500 361,765 9.55 42.87 26,550 38.66
- ------------------------------------ ------------- -------------- ------------- -------------- -------------
$0.720 - $45.500 9,852,130 7.68 $25.76 3,961,559 $18.83
- ------------------------------------ ------------- -------------- ------------- -------------- -------------
The following summarizes the activity under the Company's stock option plans
during the fiscal years ended March 31, 1998, 1997 and 1996:
===============================================
Options Outstanding
-----------------------------------------------
Weighted-Average
Shares Exercise Price
--------------------- -------------------------
Balance at March 31, 1995 7,548,128 13.05
Granted 4,411,366 29.27
Canceled (2,330,646) 30.18
Exercised (1,706,689) 11.05
--------------------- -------------------------
Balance at March 31, 1996 (3,301,613 shares were
exercisable at a weighted-average price of $11.84) 7,922,159 17.46
Granted 2,501,965 31.64
Canceled (779,514) 23.57
Exercised (1,321,042) 12.19
--------------------- -------------------------
Balance at March 31, 1997 (3,748,864 shares were
exercisable at a weighted-average price of $15.20) 8,323,568 21.97
Granted 3,833,539 32.92
Canceled (616,275) 37.96
Exercised (1,688,702) 18.92
--------------------- -------------------------
Balance at March 31, 1998 9,852,130 25.76
===============================================
Options available for grant at March 31, 1998 780,860
=====================
42
(8) PROPERTY AND EQUIPMENT
Property and equipment at March 31, 1998 and 1997 consisted of:
================================================================
1998 1997
- ----------------------------------------------------------------
(in thousands)
Computer equipment $105,183 $92,226
Buildings 31,239 21,590
Office equipment, furniture and
fixtures 18,670 17,710
Land 14,885 6,475
Leasehold improvements 12,071 9,900
Warehouse equipment and other 4,414 3,127
- ----------------------------------------------------------------
186,462 151,028
Less accumulated depreciation and
amortization (81,367) (61,266)
- ----------------------------------------------------------------
$105,095 $89,762
- ----------------------------------------------------------------
Depreciation and amortization expenses associated with property and equipment
amounted to $26,215,000, $22,332,000, and $16,110,000, for the fiscal years
ended March 31, 1998, 1997 and 1996, respectively.
(9) ACCRUED LIABILITIES
Accrued liabilities at March 31, 1998 and 1997 consisted of:
================================================================
1998 1997
- ----------------------------------------------------------------
(in thousands)
Accrued royalties $ 36,830 $ 33,592
Accrued expenses 25,872 22,566
Accrued compensation and benefits 29,318 19,750
Accrued income taxes 26,095 12,611
Warranty reserve 3,462 2,226
Deferred income taxes 1,106 1,385
Deferred revenue 2,797 657
- ----------------------------------------------------------------
$125,480 $ 92,787
- ----------------------------------------------------------------
(10) BUSINESS COMBINATIONS AND DIVESTITURE
(a) Maxis, Inc.
On July 25, 1997, the Company completed a merger with Maxis, Inc. ("Maxis"), a
California-based interactive software developer. Under the transaction,
approximately 4.1 million shares of Electronic Arts' stock were exchanged for
all outstanding Maxis common stock. The transaction was accounted for as a
pooling of interests. The accompanying financial statements, notes and analyses
have been restated for all periods presented to reflect this transaction.
In conjunction with the merger of Maxis, the Company recorded costs of
$10,792,000. This charge included direct transaction fees for investment
bankers, attorneys, accountants, and other related costs of approximately
$2,781,000 and costs associated with integrating the operations of the two
companies of approximately $8,011,000. Included in the integration costs were
redundant facility costs, severance payments, equipment abandonment costs and
other asset write downs, contract termination charges and other related
expenses. Of the total merger costs, approximately $5,185,000 related to cash
expenditures while approximately $5,607,000 related to noncash charges. At March
31, 1998, there were no accruals remaining related to these merger related
costs.
Total net revenue and net income (loss) for the individual entities for the
fiscal years ended March 31, 1997 and 1996 are as follows (in thousands):
================================================================
Electronic
Arts Maxis Combined
- ----------------------------------------------------------------
1997
- ----------------------------------------------------------------
Net revenue $624,766 $48,262 $673,028
Net income (loss) 53,002 (1,675) 51,327
- ----------------------------------------------------------------
1996
- ----------------------------------------------------------------
Net revenue $531,887 $55,412 $587,299
Net income 40,489 6,188 46,677
(b) Electronic Arts Victor, Inc.
In December 1997, the Company acquired the remaining 35% ownership interest in
Electronic Arts Victor, Inc. ("EAV") from Victor Entertainment Industries, Inc.
("VEI") for approximately $3,225,000 in cash. As a result of the acquisition,
the joint venture has become a wholly-owned subsidiary of the Company and has
been renamed Electronic Arts, K.K. ("EAJ"). The acquisition was accounted for as
a step acquisition purchase and the excess purchase price over fair value of the
net tangible assets acquired was allocated to purchased in-process technology,
goodwill and other intangible assets. The Company incurred a charge to
operations of $1,500,000 for the acquired in-process technology as of the date
of the acquisition after concluding that the related 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.
The goodwill and other intangible assets of approximately $1,700,000 is being
amortized over 7 years. The results of operations reflect a minority interest
elimination through the date of the acquisition. Prior to the acquisition,
minority interest for the year ended March 31, 1998 reflects only a
43
portion of EAV's losses, as VEI's interest in the net equity of EAV had fallen
below zero.
(c) Creative Wonders, LLC
In December 1997, the Company completed the sale of its 50% ownership interest
Creative Wonders, LLC, a joint venture company formed with the Walt Disney
Company (formerly Capital Cities / ABC, Inc.) for $16,750,000 in cash. The
Company recognized a gain of $12,625,000, which is included in interest and
other income. Prior to the sale, the Company distributed children's interactive
titles published and sold by the joint venture into the retail channel. The
investment was accounted for under the equity method prior to sale.
44
(11) INCOME TAXES
The Company's pretax income from operations for the fiscal years ended March
31, 1998, 1997 and 1996 consisted of the following components:
================================================================
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------
Domestic $ 51,620 $27,614 $24,735
Foreign 56,640 48,434 44,830
- ----------------------------------------------------------------
Total pretax income $108,260 $76,048 $69,565
- ----------------------------------------------------------------
Income tax expense (benefit) for the fiscal years ended March 31, 1998, 1997 and
1996 consisted of:
================================================================
(in thousands) Current Deferred Total
- ----------------------------------------------------------------
1998:
Federal $14,751 $(7,585) $7,166
State 1,361 (727) 634
Foreign 18,561 1,434 19,995
Charge in lieu of taxes
from employee stock
plans 7,931 - 7,931
- ----------------------------------------------------------------
$42,604 $(6,878) $35,726
- ----------------------------------------------------------------
1997:
Federal $3,145 $(3,472) $(327)
State 804 (674) 130
Foreign 16,543 447 16,990
Charge in lieu of taxes
from employee stock
plans 9,210 - 9,210
- ----------------------------------------------------------------
$29,702 $(3,699) $26,003
- ----------------------------------------------------------------
1996:
Federal $(2,798) $554 $(2,244)
State 656 (15) 641
Foreign 14,402 (282) 14,120
Charge in lieu of taxes
from employee stock
plans 10,067 - 10,067
- ----------------------------------------------------------------
$22,327 $257 $22,584
- ----------------------------------------------------------------
The components of the net deferred tax assets as of March 31, 1998 and 1997
consist of:
===================================================================
(in thousands) 1998 1997
- -------------------------------------------------------------------
Deferred tax assets:
Accruals, reserves and other expenses 50,096 $32,249
Maxis Federal and State loss
carryforwards 2,088 486
Foreign loss and credit carryforwards 11,514 11,766
- -------------------------------------------------------------------
Total gross deferred tax assets 63,698 44,501
Less: valuation allowance (11,514) (11,766)
- -------------------------------------------------------------------
Net deferred tax assets 52,184 32,735
- -------------------------------------------------------------------
Deferred tax liabilities:
Undistributed earnings of DISC (2,081) (2,081)
Prepaid royalty expenses (32,422) (25,385)
Unremitted earnings of foreign
subsidiaries (147) -
Unrealized gains on marketable
securities (848) (1,396)
- -------------------------------------------------------------------
Total gross deferred tax (35,498) (28,862)
liabilities
- -------------------------------------------------------------------
Net deferred tax asset $16,686 $3,873
- ------------------------------------------- ----------- -----------
The valuation allowance relates solely to the foreign loss and foreign credit
carryforwards, for which the utilization is uncertain in future periods.
At March 31, 1998, the Company had federal net operating loss carryforwards in
the amount of $6,000,000.
The differences between the statutory income tax rate and the Company's
effective tax rate, expressed as a percentage of income before provision for
income taxes, for the years ended March 31, 1998, 1997 and 1996 were as follows:
==================================================================
1998 1997 1996
- ------------------------------------------------------------------
Statutory Federal tax rate 35.0% 35.0% 35.0%
State taxes, net of Federal benefit 1.0 0.8 1.3
Differences between statutory rate
and foreign effective tax rate (2.2) (1.0) (2.6)
Foreign loss without tax benefit - 1.7 -
Research and development credits (0.6) - -
Tax exemptions on Puerto Rico
operation - (0.8) (0.6)
Other (0.2) (1.5) (0.6)
- ------------------------------------------------------------------
33.0% 34.2% 32.5%
- ------------------------------------------------------------------
The Company provides for U.S. taxes on an insignificant portion of the
undistributed earnings of its foreign subsidiaries and does not provide taxes on
the remainder. At March 31, 1998, the undistributed foreign earnings of the
foreign subsidiaries amounted to approximately $118,000,000. If these earnings
were distributed to the parent company, foreign tax credits available under
current law would substantially eliminate the resulting Federal tax liability.
The Company's manufacturing subsidiary in Puerto Rico operates under a Puerto
Rican tax incentive program which grants the Company certain percentage
exemptions from Puerto Rican income, property and municipal taxes for a period
of 20 years from the date of the commencement of operations. The U.S. tax
benefit derived for the years ended March 31, 1998, 1997 and 1996 was
approximately $31,000, $600,000, and $411,000, respectively. The U.S. tax
benefit of Puerto Rico operations is not expected to be significant in future
years. Long-term reinvestment in Puerto Rico of the undistributed earnings of
the Puerto Rico subsidiary enables the Company to take advantage of certain tax
incentives.
45
The Company is currently undergoing examination by the Internal Revenue Service.
The Company believes that additional liabilities, if any, that may arise from
this examination will not be material to the Company's financial statements.
(12) INTEREST AND OTHER INCOME, NET
Interest and other income, net for the years ended March 31, 1998, 1997 and 1996
consisted of:
================================================================
(in thousands) 1998 1997 1996
- ----------------------------------------------------------------
Interest income $13,649 $9,699 $7,937
Interest expense (389) (66) (141)
Gain on disposition of
assets, net 14,910 8,229 2,223
Foreign currency gains
(losses) (517) (1,024) 433
Equity in net loss of
affiliates (1,162) (1,566) (1,746)
Other expense, net (1,680) (1,993) (1,192)
- ----------------------------------------------------------------
$24,811 $13,279 $7,514
- ----------------------------------------------------------------
(13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash, short-term investments, receivables, accounts payable and accrued
liabilities - the carrying amount approximates fair value because of the short
maturity of these instruments.
Long-term investments, investments classified as held-to-maturity and marketable
securities - fair value is based on quoted market prices.
46
(14) OPERATIONS BY GEOGRAPHIC AREAS
The Company operates in one industry segment. Information about the Company's
operations in the North America and foreign areas for the fiscal years ended
March 31, 1998, 1997 and 1996 is presented below:
Asia
(in thousands) Pacific
North (excluding
America Europe Japan) Japan Eliminations Total
-----------------------------------------------------------------
Fiscal 1998:
Net revenues from unaffiliated
customers $519,423 $325,938 $41,494 $21,997 $ -- $908,852
Intersegment sales 45,913 21,613 513 133 (68,172) --
-----------------------------------------------------------------
Total net revenues $565,336 $347,551 $42,007 $22,130 $(68,172) $908,852
=================================================================
Operating income (loss) $ 31,852 $ 51,807 $ 6,995 $(7,205) $ -- $ 83,449
Identifiable assets $515,728 $201,988 $17,347 $10,618 $ -- $745,681
Fiscal 1997:
Net revenues from unaffiliated
customers $372,616 $233,614 $28,072 $38,726 $ -- $673,028
Intersegment sales 54,530 6,938 603 122 (62,193) --
-----------------------------------------------------------------
Total net revenues $427,146 $240,552 $28,675 $38,848 $(62,193) $673,028
=================================================================
Operating income (loss) $ 17,035 $ 43,295 $ 5,652 $(3,213) $ -- $ 62,769
Identifiable assets $430,055 $121,673 $12,820 $19,493 $ -- $584,041
Fiscal 1996:
Net revenues from unaffiliated
customers $354,630 $165,010 $21,794 $45,865 $ -- $587,299
Intersegment sales 49,975 9,801 54 100 (59,930) --
-----------------------------------------------------------------
Total net revenues $404,605 $174,811 $21,848 $45,965 $(59,930) $587,299
=================================================================
Operating income $ 19,435 $ 36,706 $ 5,028 $ 882 $ -- $ 62,051
Identifiable assets $372,844 $ 90,187 $ 8,469 $17,996 $ -- $489,496
(15) SUBSEQUENT EVENT (UNAUDITED)
On April 27, 1998, the Company and Square Co., Ltd. ("Square"), a third-party
video game console software publisher in Japan, announced the formation of two
new joint ventures in North America and Japan. In North America, the companies
will form Square Electronic Arts, LLC, which will have exclusive publishing
rights in North America for future interactive entertainment titles created by
Square. Additionally, the Company will have the exclusive right to distribute in
North America products published by this joint venture. The investment in the
North American joint venture will be accounted for on the equity basis. The
Company will own a 30% minority interest in this joint venture while Square will
own 70%.
In Japan, the companies will establish Electronic Arts Square KK, which will
localize and publish in Japan the Company's properties originally created in
North America and Europe, as well as develop and publish original video games in
Japan. The Company will contribute cash and certain assets to this joint
venture. The Company will have a 70% majority ownership interest, while Square
will own 30%. The transactions are anticipated to be completed in the quarter
ending June 30, 1998.
47
QUARTERLY FINANCIAL AND MARKET INFORMATION (UNAUDITED)
Quarter Ended
------------------------------------------------------- Year
June 30 Sept. 30 Dec. 31 March 31 Ended
- -------------------------------------------------------------------------------------------------------------
(In thousands, except per share data)
Fiscal 1998
Net revenues $123,712 $189,828 $391,245 $204,067 $908,852
Operating income (loss) (4,807) (3,080) 70,983 20,353 83,449
Net income (loss) (1,451) 41 58,620 15,352 72,562
Net income (loss) per share - basic $ (0.02) $ -- $ 0.99 $ 0.26 $ 1.23
Net income (loss) per share - diluted $ (0.02) $ -- $ 0.96 $ 0.25 $ 1.19
Common stock price per share
High $ 35.38 $ 37.50 $ 39.56 $ 46.94 $ 46.94
Low $ 20.13 $ 30.75 $ 29.94 $ 34.94 $ 20.13
Fiscal 1997
Net revenues $ 88,735 $137,271 $290,849 $156,173 $673,028
Operating income (loss) (9,038) 727 58,641 12,439 62,769
Net income (loss) (1,381) 3,388 38,703 10,617 51,327
Net income (loss) per share - basic $ (0.02) $ 0.06 $ 0.67 $ 0.18 $ 0.89
Net income (loss) per share - diluted $ (0.02) $ 0.06 $ 0.65 $ 0.18 $ 0.86
Common stock price per share
High $ 34.50 $ 39.13 $ 37.63 $ 36.13 $ 39.13
Low $ 25.25 $ 24.75 $ 27.88 $ 26.25 $ 24.75
Fiscal 1996
Net revenues $ 91,855 $105,814 $260,186 $129,444 $587,299
Operating income 1,569 5,138 46,414 8,930 62,051
Net income 1,932 4,715 32,807 7,223 46,677
Net income per share - basic $ 0.04 $ 0.08 $ 0.58 $ 0.13 $ 0.84
Net income per share - diluted $ 0.03 $ 0.08 $ 0.56 $ 0.12 $ 0.80
Common stock price per share
High $ 30.00 $ 41.75 $ 38.75 $ 28.50 $ 41.75
Low $ 20.13 $ 27.13 $ 23.13 $ 22.13 $ 20.13
The Company's common stock is traded in the over-the-counter market under the
Nasdaq Stock Market symbol ERTS. The closing prices for the common stock in the
table above represent the high and low closing prices as reported on the Nasdaq
National Market.
48
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable.
49
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors who are nominated for re-election required
by Item 10 is incorporated herein by reference to the information in the
Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders
(the "Proxy Statement") under the caption "Proposal No. 1 - Election of
Directors." The information regarding executive officers required by Item 10 is
included in Item 4A hereof.
ITEM 11: EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the
information in the Proxy Statement under the caption "Director and Executive
Officer Compensation" specifically excluding the "Compensation Committee Report
on Executive Compensation," and "Stock Option Plan."
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the
information in the Proxy Statement under the caption "Security Ownership of
Certain Beneficial Owners and Management."
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to the
information in the Proxy Statement under the caption "Certain Transactions."
50
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Index to Financial Statements. Page(s) in Form 10-K
Independent Auditors' Report 31
Consolidated Balance Sheets as of
March 31, 1998 and 1997 32
Consolidated Statements of Income for
the Years Ended March 31, 1998, 1997
and 1996 33
Consolidated Statements of Stockholders'
Equity for the Years Ended March
31, 1998, 1997 and 1996 34
Consolidated Statements of Cash Flows for
the Years Ended March 31, 1998, 1997 and 1996 35
Notes to Consolidated Financial Statements for the Years
Ended March 31, 1998, 1997 and 1996 36-48
2. Financial Statement Schedule.
The following financial statement schedule of Electronic Arts for
the years ended March 31, 1998, 1997 and 1996 is filed as part of
this report and should be read in conjunction with the
Consolidated Financial Statements of Electronic Arts.
Schedule II - Valuation and Qualifying Accounts
Other financial statement schedules are omitted because the
information called for is not required or is shown either in the
Consolidated Financial Statements or the notes thereto.
3. Exhibits.
The following exhibits are filed as part of, or incorporated by
reference into, this report:
Number Exhibit Title
------ -------------
3.01 Registrant's Certificate of Incorporation, as amended to
December 1, 1992. (1)
3.02 Registrant's Certificate of Amendment of Certificate of
Incorporation. (2)
3.03 Registrant's By-Laws, as amended to date. (3)
4.01 Specimen Certificate of Registrant's Common Stock. (4)
10.01 Registrant's 1982 Stock Option Plan, as amended to date,
and related documents. (5) (6)
10.02 Registrant's Directors Stock Option Plan and related
documents. (6) (7)
10.03 Description of Registrant's FY 1998 Executive Bonus Plan.
(6)
10.04 Directors and Officers and Company Reimbursement Indemnity
Policy by and between Registrant and certain underwriters
at Lloyd's, London and Continental Insurance Company, dated
June 20, 1992. (8)
10.05 Lease by and between Registrant, Electronic Arts Limited
and Allied Dunbar Assurance PLC, dated June 24, 1987, for
the Registrant's U.K. facilities. (9)
51
Number Exhibit Title
------ -------------
10.06 Lease by and between Registrant and H.G.C. Associates,
dated June 24, 1992, for the Registrant's warehouse and
production facilities. (10)
10.07 Lease Agreement by and between Registrant and 1450 Fashion
Island Boulevard Associates, L.P., dated March 22, 1991.
(11)
10.08 Registrants' 1991 Stock Option Plan and related documents
as amended. (6) (12)
10.09 Form of Indemnity Agreement with Directors. (13)
10.10 Registrants' Employee Stock Purchase Plan and related
documents as amended. (6) (14)
10.11 Lease Agreement by and between Registrant and The Canada
Life Assurance Company, dated December 20, 1991, for the
Registrant's Canadian facilities. (15)
10.13 Amendment to Lease Agreement by and between Registrant and
1450 Fashion Island Boulevard Associates, L.P., dated March
22, 1991. (17)
10.14 Agreement between Registrant and Sega Enterprises, Ltd.,
dated July 14, 1992. (18) (19)
10.15 Lease Agreement by and between Registrant and Century
Centre II Associates, dated July 27, 1992. (19)
10.16 Amendment to Lease Agreement by and between Registrant and
1450 Fashion Island Boulevard Associates, L.P., dated
October 1, 1992. (19)
10.17 Amendment to Lease Agreement by and between Registrant and
Century Centre II Associates, dated February 2, 1993. (19)
10.18 Amendment to Lease Agreement by and between Registrant and
Century Centre II Associates, dated February 22, 1993. (19)
10.19 Directors and Officers and Company Reimbursement Indemnity
Policy by and between Registrant and certain underwriters
at Lloyd's, London and Continental Insurance Company, dated
June 20, 1993. (19)
10.20 Lease by and between Registrant and 1450 Fashion Island
Boulevard Associates, L.P., dated August 27, 1992 for
additional space at corporate headquarters. (10)
10.22 Lease by and between Registrant, Electronic Arts Limited
and Heron Slough Limited, dated June 12, 1992, for the
Registrant's U.K. facilities. (20)
10.23 Lease by and between Registrant and the Travelers Insurance
Company, dated April 14, 1993, for the Registrant's
production facilities. (21)
10.24 Amendment to Lease Agreement by and between Registrant and
1450 Fashion Island Boulevard Associates, L.P., dated June
1, 1993. (22)
10.25 Amendment to Lease Agreement by and between Registrant and
the Travelers Insurance Company, dated November 30, 1993.
(23)
10.26 Amendment to Lease Agreement by and between Registrant and
the Travelers Insurance Company, dated November 30, 1993.
(23)
10.27 Lease Agreement by and between Registrant and Arthur J.
Rogers & Co., dated January 14, 1994. (24)
10.28 Lease Agreement by and between Registrant and the
Prudential Insurance Company of America, dated January 10,
1994. (24)
10.29 Agreement for Lease between Flatirons Funding, LP and
Electronic Arts Redwood, Inc. dated February 14, 1995. (25)
10.30 Guarantee from Electronic Arts Inc. to Flatirons Funding,
LP dated February 14, 1995. (25)
52
Number Exhibit Title
------ -------------
10.31 Lease Agreement by and between Registrant and Dixie
Warehouse & Cartage Co., dated April 10, 1995. (25)
10.32 Commercial Earnest Money Contract between Novell, Inc. and
ORIGIN Systems, Inc. dated April 13, 1995. (26)
10.33 First Amendment to Commercial Earnest Money Contract
between Novell, Inc. and ORIGIN Systems, Inc. dated June 1,
1995. (27)
10.34 Amendment No. 1 to Agreement between Registrant and Sega
Enterprises, Inc. effective December 31, 1995. (28)
10.35 Lease Agreement by and between Registrant and Don Mattrick
dated October 16, 1996. (29)
10.36 Amended and Restated Guaranty from Electronic Arts Inc. to
Flatirons Funding, LP dated March 7, 1997.
10.37 Amended and Restated Agreement for Lease between Flatirons
Funding, LP and Electronic Arts Redwood Inc. dated March 7,
1997.
10.38 Amendment No. 1 to Lease Agreement between Electronic Arts
Redwood Inc. and Flatirons Funding, LP dated March 7, 1997.
10.39 Employment Agreement by and between the Registrant and John
Riccitiello dated August 29, 1997.
10.40 Lease Agreement by and between Registrant and John
Riccitiello dated August 29, 1997.
21.01 Subsidiaries of the Registrant.
23.01 Report on Financial Statement Schedule and Consent of
Independent Auditors.
23.02 Consent of Independent Auditors
27 Financial Data Schedule
99.01 Report of Ernst & Young LLP, Independent Auditors
---------
(1) Incorporated by reference to Exhibit 3.01 to Registrant's Current
Report on Form 8-K filed on October 16, 1991.
(2) Incorporated by reference to Exhibit 4.01 to Registrant's
Registration Statement on Form S-8 filed on December 1, 1992
(File No. 33-55212) (the "1992 Form S-8").
(3) Incorporated by reference to Exhibit 3.02 to Registrant's Current
Report on Form 8-K filed on October 16, 1991.
(4) Incorporated by reference to Exhibit 4.01 to Registrant's
Registration Statement on Form S-4 filed on March 3, 1994 (File
No. 33-75892).
(5) Incorporated by reference to Exhibit 4.03 to Post-Effective
Amendment No. 2 to Registrant's Registration Statement on Form
S-8 filed on November 6, 1991 (File No. 33-32616) ("S-8 Amendment
No. 2").
(6) Management contract or compensatory plan or arrangement.
(7) Incorporated by reference to Exhibit 4.04 to S-8 Amendment No. 2.
53
(8) Incorporated by reference to Exhibit 10.08 to Registrant's Annual
Report on Form 10-K for the year ended March 31, 1992 (the "1992
Form 10-K").
(9) Incorporated by reference to Exhibit 10.07 to the Registrant's
Registration Statement on Form S-1 filed on September 20, 1989,
and all amendments thereto (File No. 33-30346) (the "Form S-1").
(10) Incorporated by reference to similarly numbered exhibits to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1992.
(11) Incorporated by reference to Exhibit 10.11 to Registrant's Annual
Report on Form 10-K for the year ended March 31, 1991.
(12) Incorporated by reference to Exhibit 4.01 to the Registrant's
Registration Statement on Form S-8 filed on July 29, 1993 (File
No. 33-66836) (the "1993 Form S-8").
(13) Incorporated by reference to Exhibit 10.09 to the Form S-1.
(14) Incorporated by reference to Exhibit 4.02 to 1993 Form S-8.
(15) Incorporated by reference to Exhibit 10.16 to the 1992 Form 10-K.
(16) Not Used.
(17) Incorporated by reference to Exhibit 10.18 to the 1992 Form 10-K.
(18) Confidential treatment has been granted with respect to certain
portions of this document.
(19) Incorporated by reference to similarly numbered exhibits to
Registrants Annual Report on Form 10-K for the year ended March
31, 1993.
(20) Incorporated by reference to Exhibit 19.01 of Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1992.
(21) Incorporated by reference to Exhibit 10.23 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1993.
(22) Incorporated by reference to Exhibit 10.24 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1993.
(23) Incorporated by reference to similarly numbered exhibits to
Registrant's Quarterly Report on Form 10-Q for the quarter ended
December 31, 1993.
(24) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March
31, 1994 (the "1994 Form 10-K").
(25) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March
31, 1995 (the "1995 Form 10-K").
54
(26) Incorporated by reference to Exhibit 10.01 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1995.
(27) Incorporated by reference to Exhibit 10.02 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1995.
(28) Incorporated by reference to similarly numbered exhibits to
Registrant's Annual Report on Form 10-K for the year ended March
31, 1996 (the "1996 Form 10-K").
(29) Incorporated by reference to Exhibit 10.35 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended December 31,
1996.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the quarter ended March 31,
1998.
(c) Exhibits:
The Registrant hereby files as part of this Form 10-K the exhibits
listed in Item 14(a)3, as set forth above.
(d) Financial Statement Schedule:
The Registrant hereby files as part of this Form 10-K the financial
statement schedule listed in Item 14(a)2, as set forth on page 57.
55
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
ELECTRONIC ARTS
By: /s/ Lawrence F. Probst III
----------------------------------------
(Lawrence F. Probst III, Chairman of the
Board and Chief Executive Officer)
Date: June 26, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons, on behalf of the
Registrant in the capacities indicated and on the 26th of June 1998.
Name Title
---- -----
/s/ Lawrence F. Probst III Chairman of the Board
- ------------------------------------- and Chief Executive Officer
(Lawrence F. Probst III)
/s/ E. Stanton McKee, Jr. Executive Vice President and Chief
- ------------------------------------- Financial and Administrative Officer
(E. Stanton McKee, Jr.) (Principal Accounting Officer)
/s/ David L. Carbone Vice President, Finance
- -------------------------------------
(David L. Carbone)
Directors:
/s/ M. Richard Asher Director
- -------------------------------------
(M. Richard Asher)
/s/ William J. Byron Director
- -------------------------------------
(William J. Byron)
/s/ Daniel H. Case III Director
- -------------------------------------
(Daniel H. Case III)
/s/ Gary M. Kusin Director
- -------------------------------------
(Gary M. Kusin)
/s/ Timothy J. Mott Director
- -------------------------------------
(Timothy J. Mott)
56
ELECTRONIC ARTS INC. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Years Ended March 31, 1998, 1997 and 1996
(in thousands)
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
Description of Period Expenses Accounts (1) Deductions of Period
- ----------- --------- -------- ------------ ---------- ---------
Year Ended March 31, 1998
Allowance for doubtful
accounts and returns $43,268 $82,706 $(3,243) $71,156 $51,575
======= ======= ======== ======= =======
Year Ended March 31, 1997
Allowance for doubtful
accounts and returns $33,176 $63,114 $ 2,240 $55,262 $43,268
======= ======= ======= ======= =======
Year Ended March 31, 1996
Allowance for doubtful
accounts and returns $36,478 $53,340 $ (461) $56,181 $33,176
======= ======= ======= ======= =======
(1) Primarily the translation effect of using the average exchange rate for
expense items and the year-ended exchange rate for the balance sheet item
(allowance account).
57
ELECTRONIC ARTS INC.
1998 FORM 10-K ANNUAL REPORT
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -------------
10.03 Description of Registrant's FY 1999 Executive Bonus Plan
21.01 Subsidiaries of the Registrant.
23.01 Report on Financial Statement Schedule and Consent of
Independent Auditors.
23.02 Consent of Ernst & Young LLP, Independent Auditors
27 Financial Data Schedule
99.01 Report of Ernst & Young LLP, Independent Auditors
- --------------
58