UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 31, 2004

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                    

Commission File No. 0-17948

ELECTRONIC ARTS INC.

(650) 628-1500
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES S NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
YES S NO o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

ELECTRONIC ARTS INC.
FORM 10-Q
FOR THE PERIOD ENDED DECEMBER 31, 2004

Table of Contents

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PART I – FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying Notes to Condensed Consolidated Financial Statements.

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ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying Notes to Condensed Consolidated Financial Statements.

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ELECTRONIC ARTS INC. AND SUBSIDIARIES

See accompanying Notes to Condensed Consolidated Financial Statements.

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ELECTRONIC ARTS INC. AND SUBSIDIARIES

(1) DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Electronic Arts develops, markets, publishes and distributes interactive software games that are playable by consumers on home videogame machines (such as the Sony PlayStation^®2, Microsoft Xbox^® and Nintendo GameCube^TM consoles), personal computers (PC), hand-held game machines also known as mobile platforms (such as the Game Boy^® Advance and Nintendo DS^TM) and online, over the Internet and other proprietary online networks. Many of our games are based on content that we license from others (e.g., Madden NFL Football, Harry Potter and FIFA Soccer), and many of our games are based on intellectual property that is wholly-owned by us (e.g., The Sims^TM and Medal of Honor^TM). Our goal is to develop titles which appeal to the mass market and as a result, we develop, market, publish and distribute our games in over 100 countries, often translating and localizing them for sale in non-English-speaking countries. Our goal is to create software game “franchises” that allow us to publish new titles on a recurring basis that are based on the same property. Examples of this are our annual iterations of our sports-based franchises (e.g., NCAA Football and FIFA Soccer), titles based on long-lived movie properties (e.g., James Bond^TM) and wholly-owned properties that can be successfully sequeled (e.g., SimCity^TM).

The Condensed Consolidated Financial Statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The preparation of these condensed consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in these condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. The results of operations for the current interim periods are not necessarily indicative of results to be expected for the current year or any other period.

Certain prior year amounts have been reclassified to conform to the fiscal 2005 presentation.

At our Annual Meeting of Stockholders, held on July 29, 2004, our stockholders elected to amend and restate our Certificate of Incorporation to consolidate our Class A and Class B common stock into a single class of common stock by reclassifying each outstanding share of Class A common stock as one share of common stock and converting each outstanding share of Class B common stock into 0.001 share of common stock. Our stockholders also elected to further amend and restate our Certificate of Incorporation to increase the authorized common stock from 500 million total shares of Class A and Class B common stock combined to 1 billion shares of the newly consolidated single class of common stock. These amendments were effective on August 2, 2004. Prior year Class A common stock has been reclassified to common stock to reflect these amendments.

On October 18, 2004, our Board of Directors authorized a program to repurchase up to an aggregate of $750 million of shares of our common stock. Pursuant to the authorization, we may repurchase shares of our common stock from time to time in the open market or through privately negotiated transactions over the course of a twelve-month period. During the three months ended December 31, 2004, we repurchased and retired 655,500 shares of our common stock for approximately $31 million.

These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004 as filed with the Securities and Exchange Commission on June 4, 2004.

(2) FISCAL YEAR AND FISCAL QUARTER

Our fiscal year is reported on a 52/53-week period that ends on the final Saturday of March in each year. The results of operations for fiscal 2005 and 2004 contain 52 weeks. The results of operations for the fiscal quarters ended December 31, 2004 and December 31, 2003 each contain 13 weeks ending on December 25, 2004 and December 27, 2003, respectively. For simplicity of presentation, all fiscal periods are reported as ending on a calendar month end. On October 28, 2004, our Board of Directors approved a change in our fiscal year, such that beginning in fiscal 2006, we will end our fiscal year on the Saturday nearest March 31. This will result in fiscal 2006 being reported as a 53 week year with the first quarter containing 14 weeks instead of 13 weeks.

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(3) EMPLOYEE STOCK-BASED COMPENSATION

We account for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”. We have adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, as amended.

Had compensation cost for our stock-based compensation plans been measured based on the estimated fair value at the grant dates in accordance with the provisions of SFAS No. 123, we estimate that our reported net income and net earnings per share would have been the pro forma amounts indicated below. 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 were used for grants made under our stock-based compensation plan during the three and nine months ended December 31, 2004 and 2003:

Our calculations are based on a multiple option valuation approach and forfeitures are recognized when they occur.

At our Annual Meeting of Stockholders, held on July 29, 2004, our stockholders approved an amendment to our 2000 Equity Incentive Plan (the “Equity Plan”) to (a) increase by 11 million the number of shares of common stock reserved for issuance under the Equity Plan, (b) provide for the issuance of awards of restricted stock units, (c) limit the total number of shares underlying awards of restricted stock and restricted stock units to 3 million, (d) provide that the exercise price of nonqualified stock options may not be less than 100% of the fair market value of a share of common stock, (e) reduce the size of initial and annual option grants to Directors under the Equity Plan, and (f) authorize the Compensation Committee to determine the vesting provisions of options granted to Directors under the Equity Plan. Our stockholders also approved an amendment to the 2000 Employee Stock Purchase Plan (the “ESPP”) to increase by 1.5 million the number of shares of common stock reserved for issuance under the ESPP.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment”. SFAS 123R requires that the cost resulting from all share-based payment transactions be recognized in

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the financial statements using a fair-value-based method. The statement replaces SFAS 123, supersedes APB 25, and amends SFAS No. 95, “Statement of Cash Flows”. We are required to adopt SFAS 123R no later than our second quarter of fiscal 2006 which ends September 30, 2005. While the fair value method under SFAS 123R is very similar to the fair value method under SFAS 123 with regards to measurement and recognition of stock-based compensation, management is currently evaluating the impact of several of the key differences between the two standards on our financial statements. For example, SFAS 123 permits us to recognize forfeitures as they occur while SFAS 123R will require us to estimate future forfeitures and adjust our estimate on a quarterly basis. SFAS 123R will also require a classification change in the statement of cash flows; whereby, a portion of the tax benefit from stock options will move from operating cash flows to financing cash flows (total cash flows will remain unchanged). While we continue to evaluate the impact of SFAS 123R on our financial statements, we believe that the expensing of stock-based compensation will have an impact on our Condensed Consolidated Income Statement similar to our pro forma disclosure under SFAS 123, as amended.

(4) BUSINESS COMBINATIONS

Criterion
On October 19, 2004, we completed our acquisition of 100 percent of Criterion Software Group Ltd. (“Criterion”) for an aggregate accounting purchase price of $67.7 million including transaction costs and the assumption of outstanding stock options under certain Criterion stock option plans. Based in the United Kingdom, Criterion is a developer of videogames and a provider of middleware solutions for the game development and publishing industry. The results of operations of Criterion and the estimated fair market values of the acquired assets and liabilities have been included in the Condensed Consolidated Financial Statements since the date of acquisition. Except for acquired in-process technology, which is discussed below, the acquired intangible assets are being amortized on a straight-line basis over estimated lives ranging from two to four years.

Acquired in-process technology includes the value of products in the development stage that are not considered to have reached technological feasibility or have alternative future use. Accordingly, the acquired in-process technology was expensed in the Condensed Consolidated Statement of Operations upon consummation of the acquisition. Stock-based employee compensation represents the intrinsic value of certain unvested employee stock options that were assumed as part of the transaction. They are considered modified for accounting purposes and are being amortized over the remaining vesting period into the Condensed Consolidated Statement of Operations commencing on the date of acquisition. The acquisition-related charges for in-process technology and stock-based employee compensation decreased diluted earnings per share by approximately $0.05 in the three months ended December 31, 2004.

The purchase price for the Criterion transaction was allocated to assets acquired and liabilities assumed as set forth below (in thousands):

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(5) GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill information is as follows (in thousands):

Finite-lived intangibles consist of the following (in thousands):

Amortization of intangibles for the three and nine months ended December 31, 2004, was $1.9 million and $3.1 million, respectively. Amortization of intangibles for the three and nine months ended December 31, 2003, was $0.6 million and $2.1 million, respectively. Finite-lived intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from two to twelve years. As of December 31, 2004, and March 31, 2004, the weighted-average remaining useful life for finite-lived intangible assets was approximately 4.6 years and 7.5 years, respectively.

As of December 31, 2004, future amortization of finite-lived intangibles was estimated as follows (in thousands):

(6) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

The following table summarizes the activity in the accrued restructuring accounts for all restructuring plans (in thousands):

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Over the last three fiscal years, we have entered into various restructurings based on management decisions as discussed in more detail below. As of December 31, 2004, an aggregate of $22.5 million in cash had been paid out under the fiscal 2004, 2003 and 2002 restructuring plans. In addition, we have made subsequent net adjustments of approximately $0.4 million during fiscal 2005 relating to projected future cash outlays under the fiscal 2004 restructuring plan. Of the remaining projected cash outlay of $8.4 million, $0.7 million is expected to be utilized in the three months ending March 31, 2005, while the remaining $7.7 million is expected to be utilized by January 2009. The facilities-related accrued obligation shown above is net of $15.6 million of estimated future sub-lease income. The restructuring accrual is included in other accrued expenses presented in Note 8 of the Notes to Condensed Consolidated Financial Statements.

Fiscal 2004 Studio Restructuring
During fiscal 2004, we closed the majority of our leased studio facility in Walnut Creek, California and our wholly-owned studio facility in Austin, Texas. As a result, we recorded total pre-tax charges of $9.2 million, consisting of $7.0 million for consolidation of facilities, $1.7 million for workforce reductions and $0.5 million for the write-off of non-current assets, primarily leasehold improvements.

Fiscal 2003 Studio Restructuring
During fiscal 2003, we closed our office located in San Francisco, California, our studio located in Seattle, Washington and approved a plan to consolidate the Los Angeles and Irvine, California and Las Vegas, Nevada, studios into one major game studio in Los Angeles. We recorded total pre-tax charges of $14.5 million, consisting of $8.9 million for consolidation of facilities, $3.5 million for the write-off of non-current assets, primarily leasehold improvements and equipment, and $2.1 million for workforce reductions.

Fiscal 2003 Online Restructuring
In March 2003, we consolidated the operations of EA.com into our core business and eliminated separate reporting for our Class B common stock for all future reporting periods after fiscal 2003. As a result, we recorded restructuring charges, including asset impairment, of $67.0 million, consisting of $1.8 million for workforce reductions, $2.3 million for consolidation of facilities and other administrative charges and $62.9 million for the write-off of non-current assets.

Fiscal 2002 Online Restructuring
In October 2001, we announced restructuring initiatives involving EA.com and the closure of EA.com’s San Diego studio and consolidation of its San Francisco and Virginia facilities. As a result, we recorded restructuring charges of $20.3 million, consisting of $4.2 million for workforce reductions, $3.3 million for consolidation of facilities and other administrative charges and $12.8 million for the write-off of non-current assets and facilities.

(7) ROYALTIES AND LICENSES

Our royalty expenses consist of payments to (1) content licensors, (2) independent software developers, and (3) co-publishing and/or distribution affiliates. License royalties consist of payments made to celebrities, professional sports organizations, movie studios and other organizations for our use of their trademarks, copyrights, personal publicity rights, content and/or other intellectual property. Royalty payments to independent software developers are payments for the development of intellectual property related to our games. Co-publishing and distribution royalties are payments made to third parties for delivery of product.

Royalty-based payments made to content licensors and distribution affiliates are generally capitalized as prepaid royalties and expensed to cost of goods sold at the greater of the contractual or effective royalty rate based on net product sales. With regard to payments made to independent software developers and co-publishing affiliates, these payments are generally in connection with the development of a particular product and, therefore, we are generally subject to development risk prior to the general release of the product. Accordingly, payments that are due prior to completion of a product are generally expensed as research and development as the services are incurred. Payments due after completion of the product (primarily royalty-based in nature) are generally expensed as cost of goods sold at the higher of the contractual or effective royalty rate based on net product sales.

Minimum guaranteed royalty obligations are initially recorded as an asset and as a liability at the contractual amount when no significant performance remains with the licensor. When significant performance remains with the licensor, we record royalty payments as an asset when actually paid rather than upon execution of the contract. Minimum royalty payment obligations are classified as current liabilities to the extent such royalty payments are contractually due within the next twelve months. As of

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December 31, 2004 and March 31, 2004, approximately $49.1 million and $63.4 million, respectively, of minimum guaranteed royalty obligations had been recognized and are included in the tables below.

Each quarter, we also evaluate the future realization of our royalty-based assets as well as any unrecognized minimum commitments not yet paid to determine amounts we deem unlikely to be realized through product sales. Any impairments determined before the launch of a product are charged to research and development expense. Impairments determined post-launch are charged to cost of goods sold. In either case, we rely on estimated revenue to evaluate the future realization of prepaid royalties. If actual sales or revised revenue estimates fall below the initial revenue estimates, then the actual charge taken may be greater in any given quarter than anticipated.

The current and long-term portions of prepaid royalties and minimum guaranteed royalty-related assets, included in other current assets and other assets, consisted of (in thousands):

At any given time, depending on the timing of our payments to our co-publishing and/or distribution affiliates, content licensors and/or independent software developers, we recognize unpaid royalty amounts due to these parties as either accounts payable or accrued liabilities. The current and long-term portions of accrued royalties, included in accrued and other liabilities as well as other liabilities, consisted of (in thousands):

In addition, as of December 31, 2004, we had approximately $503.6 million that we were obligated to pay co-publishing and/or distribution affiliates and content licensors but that were generally contingent upon performance by the counterparty (i.e., delivery of the product or content) and were therefore not recorded in our Condensed Consolidated Financial Statements. See Note 9 of the Notes to Condensed Consolidated Financial Statements.

(8) BALANCE SHEET DETAILS

Inventories
Inventories as of December 31, 2004 and March 31, 2004 consisted of (in thousands):

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Property and Equipment, Net
Property and equipment, net, as of December 31, 2004 and March 31, 2004 consisted of (in thousands):

Depreciation and amortization expense associated with property and equipment amounted to $17.9 million and $49.8 million for the three and nine months ended December 31, 2004, respectively. Depreciation and amortization expense associated with property and equipment amounted to $28.4 million and $57.8 million for the three and nine months ended December 31, 2003, respectively.

Accrued and Other Liabilities
Accrued and other liabilities as of December 31, 2004 and March 31, 2004 consisted of (in thousands):

Income Taxes
Change in Effective Income Tax Rate

During the three months ended December 31, 2004, our effective income tax rate was 30.8 percent. This differs from our previously projected annual effective income tax rate of 29.0 percent due to an adjustment recorded in the three months ended December 31, 2004 related to certain tax audit developments and tax charges related to the Criterion acquisition. As a result, we recognized $9.7 million (or $0.03 per basic and diluted share) more income tax expense during the three months ended December 31, 2004 than we would have recognized had our projected effective income tax rate remained at 29.0 percent.

The American Jobs Creation Act of 2004

The American Jobs Creation Act of 2004 (the “Jobs Act”), enacted on October 22, 2004, provides for a temporary 85% dividends received deduction on certain foreign earnings repatriated in our current or subsequent fiscal year. The deduction would result in an approximate 5.25% federal tax on a portion of the foreign earnings repatriated. State, local and foreign taxes could apply as well. To qualify for this federal tax deduction, the earnings must be reinvested in the United States pursuant to a domestic reinvestment plan established by a company’s chief executive officer and approved by the company’s board of directors. Certain other criteria in the Jobs Act must be satisfied as well. The maximum amount of our foreign earnings that we may repatriate subject to the Jobs Act deduction is $500 million.

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We have historically considered undistributed earnings of our foreign subsidiaries to be indefinitely reinvested and, accordingly, no U.S. taxes have been provided thereon. As a result of the Jobs Act, we are in the process of evaluating whether we will change our intentions regarding a portion of our foreign earnings and take advantage of the repatriation provisions of the Jobs Act, and if so, the amount that we would repatriate. We may not take advantage of the new law at all. In addition to not having made a decision to repatriate any foreign earnings, we are not yet in a position to accurately determine the impact of a qualifying repatriation, should we choose to make one, on our income tax expense for fiscal 2005 or fiscal 2006. Accordingly, our projected tax expense for fiscal 2005 does not reflect any taxes attributable to a possible repatriation. If we decide to repatriate a portion of our foreign earnings, we would be required to recognize income tax expense related to the federal, state, local and foreign taxes that we would incur on the repatriated earnings when the decision is made. We estimate that the reasonably possible amount of the income tax expense could be up to $35 million.

(9) COMMITMENTS AND CONTINGENCIES

Lease Commitments and Residual Value Guarantees
We lease certain of our current facilities and certain equipment under non-cancelable operating lease agreements. We are required to pay property taxes, insurance and normal maintenance costs for certain of our facilities and will be required to pay any increases over the base year of these expenses on the remainder of our facilities.

In February 1995, we entered into a build-to-suit lease with a third party for our headquarters facility in Redwood City, California, which was refinanced with Keybank National Association in July 2001 and expires in July 2006. We accounted for this arrangement as an operating lease in accordance with SFAS No. 13, “Accounting for Leases”, as amended. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. We have an option to purchase the property (land and facilities) for a maximum of $145.0 million or, at the end of the lease, to arrange for (i) an extension of the lease or (ii) sale of the property to a third party while we retain an obligation to the owner for approximately 90 percent of the difference between the sale price and the guaranteed residual value of up to $128.9 million if the sales price is less than this amount, subject to certain provisions of the lease.

In December 2000, we entered into a second build-to-suit lease with Keybank National Association for a five-year term beginning December 2000 to expand our Redwood City, California headquarters facilities and develop adjacent property adding approximately 310,000 square feet to our campus. Construction was completed in June 2002. We accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. The facilities provide space for sales, marketing, administration and research and development functions. We have an option to purchase the property for a maximum of $130.0 million or, at the end of the lease, to arrange for (i) an extension of the lease, or (ii) sale of the property to a third party while we retain an obligation to the owner for approximately 90 percent of the difference between the sale price and the guaranteed residual value of up to $118.8 million if the sales price is less than this amount, subject to certain provisions of the lease.

We believe the estimated fair values of both properties under these operating leases are in excess of their respective guaranteed residual values as of December 31, 2004.

For the two lease agreements with Keybank National Association, as described above, the lease rates are based upon the Commercial Paper Rate and require us to maintain certain financial covenants as shown below, all of which we were in compliance with as of December 31, 2004.

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In July 2003, we entered into a lease agreement with an independent third party (the “Landlord”) for a studio facility in Los Angeles, California, which commenced in October 2003 and expires in September 2013 with two five-year options to extend the lease term. Additionally, we have options to purchase the property after five and ten years based on the fair market value of the property at the date of sale, a right of first offer to purchase the property upon terms offered by the Landlord, and a right to share in the profits from a sale of the property. We have accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. Existing campus facilities comprise a total of 243,000 square feet and provide space for research and development functions. Our rental obligation under this agreement is $50.2 million over the initial ten-year term of the lease. This commitment is offset by sublease income of $5.8 million for the sublet to an affiliate of the Landlord of 18,000 square feet of the Los Angeles facility, which commenced in October 2003 and expires in September 2013, with options of early termination by the affiliate after five years and by us after four and five years.

In June 2004, we entered into a lease agreement with an independent third party for a studio facility in Orlando, Florida, which commenced in January 2005 and expires in June 2010, with one five-year option to extend the lease term. The campus facilities comprise a total of 117,000 square feet, which we intend to use for research and development functions. We have accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. Our rental obligation over the initial five-and-a-half year term of the lease is $13.2 million.

Letters of Credit
In July 2002, we provided an irrevocable standby letter of credit to Nintendo of Europe. The standby letter of credit guarantees performance of our obligations to pay Nintendo of Europe for trade payables of up to €18.0 million. The standby letter of credit expires in July 2005. As of December 31, 2004, we had €0.9 million payable to Nintendo of Europe covered by this standby letter of credit.

In August 2003, we provided an irrevocable standby letter of credit to 300 California Associates II, LLC as a replacement for our security deposit for office space. The standby letter of credit guarantees performance of our obligations to pay our lease commitment up to $1.1 million. The standby letter of credit expires in December 2006. As of December 31, 2004, we did not have a payable balance on this standby letter of credit.

Development, Celebrity, League and Content Licenses: Payments and Commitments
The products produced by our studios are designed and created by our employee designers, artists, software programmers and by non-employee software developers (“independent artists” or “third-party developers”). We typically advance development funds to the independent artists and third-party developers during development of our games, usually in installment payments made upon the completion of specified development milestones. Contractually, these payments are considered advances against subsequent royalties on the sales of the products. These terms are set forth in written agreements entered into with the independent artists and third-party developers. In addition, we have certain celebrity, league and content license contracts that contain minimum guarantee payments and marketing commitments that are not dependent on any deliverables. Celebrities and organizations with whom we have contracts include: FIFA and UEFA (professional soccer); NASCAR (stock car racing); John Madden (professional football); National Basketball Association (professional basketball); PGA TOUR (professional golf); Tiger Woods (professional golf); National Hockey League and NHLPA (professional hockey); Warner Bros. (Harry Potter, Catwoman and Superman); MGM/Danjaq (James Bond); New Line Productions (The Lord of the Rings); National Football League and PLAYERS Inc. (professional football); Collegiate Licensing Company (collegiate football and basketball); ISC (stock car racing); Island Def Jam (fighting) and Viacom Consumer Products (The Godfather). These developer and content license commitments represent the sum of (i) the cash payments due under non-royalty-bearing licenses and services agreements, and (ii) the minimum payments and advances against royalties due under royalty-bearing licenses and services agreements, the majority of which are conditional upon performance by the counterparty. These minimum guarantee payments and any related marketing commitments are included in the table below.

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The following table summarizes our minimum contractual obligations and commercial commitments as of December 31, 2004 and the effect we expect them to have on our liquidity and cash flow in future periods (in thousands):

⁽¹⁾ Developer/licensee commitments include $49.1 million of commitments to developers or licensors that have been included in our Condensed Consolidated Balance Sheet as of December 31, 2004 because the developer or licensor does not have any significant performance obligations to us. These commitments are included in both current and long-term assets and liabilities. During the three months ended December 31, 2004, our developer/licensor and marketing commitments increased primarily as a result of agreements we renewed with the National Football League and PLAYERS Inc.

The lease commitments disclosed above exclude commitments included in our restructuring activities for contractual rental commitments of $23.9 million under real estate leases for unutilized office space, offset by $15.6 million of estimated future sub-lease income. These amounts were expensed in the periods of the related restructuring and are included in our accrued and other liabilities reported on our Condensed Consolidated Balance Sheet as of December 31, 2004. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements for additional information.

Litigation
On July 29, 2004, a class action lawsuit, Kirschenbaum v. Electronic Arts Inc., was filed against us in Superior Court in San Mateo, California. The complaint alleges that we improperly classified “Image Production Employees” in California as exempt employees and seeks injunctive relief, unspecified monetary damages, interest and attorneys’ fees. The complaint was first amended on or about November 30, 2004 to add two former employees as named-plaintiffs, and amended again on or about January 5, 2005 to add another former employee as a named-plaintiff. The allegations in the complaint were not materially changed by the amendments. We have not yet responded to the complaint.

In addition, we are subject to other claims and litigation arising in the ordinary course of business. Our management, after review and consultation with counsel, considers that any liability from any reasonably foreseeable disposition of such other claims and litigation, individually or in the aggregate, would not have a material adverse effect on our consolidated financial position or results of operations.

Director Indemnity Agreements
We have entered into an indemnification agreement with the members of our Board of Directors to indemnify our Directors to the extent permitted by law against any and all liabilities, costs, expenses, amounts paid in settlement and damages incurred by the Directors as a result of any lawsuit, or any judicial, administrative or investigative proceeding in which the Directors are sued as a result of their service as members of our Board of Directors.

(10) COMPREHENSIVE INCOME

SFAS No. 130, “Reporting Comprehensive Income”, requires classification of other comprehensive income in a financial statement and display of other comprehensive income separately from retained earnings and additional paid-in capital. Other comprehensive income primarily includes foreign currency translation adjustments and unrealized gains (losses) on investments and derivative instruments.

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The change in the components of accumulated other comprehensive income, net of tax, for the three and nine months ended December 31, 2004 and 2003 are summarized as follows (in thousands):

The foreign currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries. See Note 8 to the Condensed Consolidated Financial Statements for more tax-related information.

(11) NET INCOME PER SHARE

The following table summarizes the computations of Basic earnings per share (“Basic EPS”) and Diluted earnings per share (“Diluted EPS”). Basic EPS is computed as net income 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. Effective August 2, 2004, each outstanding share of Class A common stock was reclassified as one share of common stock and prior year Class A common stock has been reclassified to reflect these amendments. See Note 1 in the Notes to Condensed Consolidated Financial Statements for more information.

Excluded from the above computation of weighted-average common shares for Diluted EPS for the three and nine months ended December 31, 2004 were options to purchase 1,448,000 and 616,000 shares of common stock, respectively, as the options’

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exercise price was greater than the average market price of the common shares. The weighted-average exercise price of these options was $51.05 and $52.18 per share, respectively.

Excluded from the above computation of weighted-average common shares for Diluted EPS for the three and nine months ended December 31, 2003 were options to purchase 3,084,000 and 1,971,000 shares of common stock, respectively, as the options’ exercise price was greater than the average market price of the common shares. The weighted-average exercise price of these options was $49.03 and $46.79 per share, respectively.

(12) RELATED PARTY TRANSACTION

On June 24, 2002, we hired Warren Jenson and agreed to loan him $4,000,000, to be forgiven over four years based on his continuing employment. The loan does not bear interest. On June 24, 2004, pursuant to the terms of the loan agreement, we forgave two million dollars of the loan and provided Mr. Jenson approximately $1.6 million to offset the tax implications of the forgiveness. As of December 31, 2004, the remaining outstanding loan balance was $2,000,000, which will be forgiven on June 24, 2006, provided that Mr. Jenson has not voluntarily resigned his employment with us or been terminated for cause prior to that time. No additional funds will be provided to offset the tax implications of the forgiveness of the remaining two million dollars.

(13) SEGMENT INFORMATION

SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information”, establishes standards for the reporting by public business enterprises of information about product lines, geographic areas and major customers. The method for determining what information to report is based on the way that management organizes our operating segments for making operational decisions and assessments of financial performance.

Our chief operating decision maker is considered to be our Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenue by geographic region and by product line for purposes of making operating decisions and assessing financial performance. Our view and reporting of business segments may change due to changes in the underlying business facts and circumstances and the evolution of our reporting to our CEO.

Information about our total net revenue by product line for the three and nine months ended December 31, 2004 and 2003 is presented below (in thousands):

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Information about our operations in North America and international regions for the three and nine months ended December 31, 2004 and 2003 is presented below (in thousands):

Our direct sales to Wal-Mart Stores, Inc. represented approximately 13 and 14 percent of total net revenue for the three and nine months ended December 31, 2004, respectively, and approximately 12 and 13 percent of total net revenue for the three and nine months ended December 31, 2003, respectively.

(14) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In March 2004, the FASB ratified the measurement and recognition guidance and certain disclosure requirements for impaired securities as described in Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. In September 2004, the FASB issued a proposed Staff Position

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(“FSP”) EITF Issue No. 03-1-a, “Implementation Guidance for the Application of Paragraph 16 of EITF 03-1”. The proposed FSP will provide measurement and recognition guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads. The FASB has delayed the effective date of the FSP until such time that they issue the final standard. Management is unable to determine what impact the adoption of the measurement and recognition guidance in EITF Issue No. 03-1 will have on our financial statements.

In November 2004, the FASB issued SFAS No. 151 (“SFAS 151”), “Inventory Costs – an amendment of ARB No. 43, Chapter 4”. SFAS 151 amends the guidance in Accounting Research Bulletin (“ARB”) 43, “Restatement and Pension of Accounting Research Bulletins”, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and requires that those items be recognized as current-period charges. SFAS 151 also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Management believes the adoption of SFAS 151 will not have a material impact on our financial statements.

In December 2004, the FASB issued SFAS No. 153 (“SFAS 153”), “Exchange of Non-monetary Assets – an amendment of APB Opinion No. 29”. SFAS 153 amends APB No. 29, “Accounting for Nonmonetary transactions”, to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. SFAS 153 is effective for non-monetary exchanges occurring in fiscal periods beginning after June 15, 2005. Management believes the adoption of SFAS 153 will not have a material impact on our financial statements.

(15) SUBSEQUENT EVENTS

On January 14, 2005, we entered into an exclusive long-term agreement with ESPN Inc. (“ESPN”) for the development and integrated marketing of ESPN content in EA SPORTS™ games, beginning in calendar 2006. The relationship will include established EA SPORTS franchises on current and next-generation platforms, which will be enhanced by ESPN telecast, print and online content, as well as new sports games based on ESPN media properties. The agreement runs until 2021, though ESPN has the option to terminate in 2016. In connection with this agreement, we committed to pay ESPN a minimum of approximately $190 million in royalties and advertising purchases through 2011. Over the remaining ten years of the agreement, we committed to pay ESPN up to a potential minimum amount of $600 million, subject to reduction based on a variety of factors, including: future sales volumes of certain of our sports and related titles; our ability to renew existing licenses; our ability to secure the consent of existing licensors to include ESPN content in the relevant EA SPORTS games; the future development of new ESPN-related properties; and early termination of the agreement by ESPN.

As of January 27, 2005, we had acquired an additional 4,160,917 shares, or 41.2 percent, of the Swedish game developer Digital Illusions C.E. (“DICE”) for approximately $37 million plus transaction costs since December 31, 2004. We now own 60.1 percent of the outstanding shares, or a controlling interest, in DICE and will begin to consolidate DICE into our consolidated financial statements for the year ending March 31, 2005.

On or about February 3, 2005, we will purchase 3,497,049 ordinary shares of Ubisoft Entertainment, an international game developer and publisher, headquartered in Rennes, France. We will purchase the shares, which represent approximately 19.9 percent of Ubisoft’s outstanding ordinary shares, from Talpa Beheer B.V. for approximately $90 million. We will use the cost method of accounting to account for this investment.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
Electronic Arts Inc.:

We have reviewed the accompanying condensed consolidated balance sheet of Electronic Arts Inc. and subsidiaries (the Company) as of December 31, 2004, the related condensed consolidated statements of operations for the three-month and nine-month periods ended December 31, 2004 and 2003, and the related condensed consolidated statement of cash flows for the nine-month periods ended December 31, 2004 and 2003. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Electronic Arts Inc. and subsidiaries as of March 31, 2004, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for the year then ended (not presented herein); and in our report dated April 28, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of March 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

KPMG LLP

San Francisco, California
January 25, 2005

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking. We use words such as “anticipates”, “believes”, “expects”, “intends”, “future” and similar expressions to help identify forward-looking statements. These forward-looking statements are subject to business and economic risk and management’s expectations, and are inherently uncertain and difficult to predict. Our actual results could differ materially from management’s expectations due to such risks. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results include, but are not limited to, those discussed in this report below under the heading “Risk Factors”, as well as in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004 as filed with the Securities and Exchange Commission (“SEC”) on June 4, 2004 and in other documents we have filed with the SEC.

OVERVIEW

The following overview is a top-level discussion of our operating results and the primary trends and drivers that affect our business. Management believes that an understanding of these trends and drivers is important in order to understand our results for the quarter ended December 31, 2004, as well as our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Form 10-Q, including in the remainder of “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors” or the condensed consolidated financial statements and related notes. Additional information can be found within the “Business” section of our Annual Report on Form 10-K for the fiscal year ended March 31, 2004 as filed with the SEC on June 4, 2004 and in other documents we have filed with the SEC.

About Electronic Arts

Electronic Arts develops, markets, publishes and distributes interactive software games that are playable by consumers on home videogame machines (such as the Sony PlayStation^®2, Microsoft Xbox^® and Nintendo GameCube^™ consoles), personal computers (PC), hand-held game machines also known as mobile platforms (such as the Game Boy^® Advance and Nintendo DS^™) and online, over the Internet and other proprietary online networks. Many of our games are based on content that we license from others (e.g., Madden NFL Football, Harry Potter and FIFA Soccer), and many of our games are based on intellectual property that is wholly-owned by us (e.g., The Sims^™ and Medal of Honor^™). Our goal is to develop titles which appeal to the mass market and as a result, we develop, market, publish and distribute our games in over 100 countries, often translating and localizing them for sale in non-English-speaking countries. Our goal is to create software game “franchises” that allow us to publish new titles on a recurring basis that are based on the same property. Examples of this are our annual iterations of our sports-based franchises (e.g., NCAA Football and FIFA Soccer), titles based on long-lived movie properties (e.g., James Bond^™) and wholly-owned properties that can be successfully sequeled (e.g., SimCity^™).

Overview of Financial Results

Total net revenue for the three months ended December 31, 2004 was $1.428 billion, down 3.2 percent, as compared to the three months ended December 31, 2003. Sales were driven by Need for Speed^™ Underground 2, FIFA 2005, The Lord of the Rings^™, The Third Age^™, NBA LIVE 2005, The Urbz^™: Sims in the City^™, Golden Eye: Rogue Agent^™ and The Lord of the Rings^™: The Battle for Middle-earth^™ – each reaching platinum status (over one million copies sold) in the quarter.

Net income for the three months ended December 31, 2004 was $375 million, a 4.4 percent decrease as compared to the three months ended December 31, 2003 and diluted earnings per share were $1.18 as compared with $1.26 for the prior year.

We generated $160 million from cash in operations during the nine months ended December 31, 2004 as compared to $107 million in the nine months ended December 31, 2003. The increase in cash flow was primarily the result of the timing and collection of our sales in the nine months ended December 31, 2004.

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Management’s Overview of Historical and Prospective Business Trends

Sales of “Hit” Titles. Sales of “hit” titles, several of which were top sellers across a number of international markets, continued to contribute to our revenue growth. Our top five selling titles across all platforms worldwide during the three months ended December 31, 2004 were Need for Speed Underground 2, FIFA 2005, Lord of the Rings, The Third Age, NBA LIVE 2005 and The Urbz: Sims in the City. Hit titles are important to our financial performance because they benefit from overall economies of scale. We have developed, and it is our objective to continue to develop, many of our hit titles to become franchise titles that can be regularly iterated.

Increased Console Installed Base. As consumers purchase the current generation of consoles, either as a first-time buyer or by upgrading from a previous generation, the console installed base increases. As the installed base for a particular console increases, we are generally able to increase our unit volume; however, these unit volumes often begin to decrease as consumers anticipate the release of next generation of consoles. In the U.S. and Europe, we believe the installed base for the current generation of consoles – the PlayStation 2, Xbox and Nintendo GameCube – increased significantly during the three and nine months ended December 31, 2004 as compared to the three and nine months ended December 31, 2003. In March 2004, Microsoft reduced the retail price of its Xbox console in the U.S. and in May 2004 Sony did the same with its PlayStation 2 console. In August 2004, both companies also reduced their console retail prices in Europe. As price reductions drive sales of consoles and the related installed base of these current generation consoles increases during fiscal 2005, we expect unit sales of current generation titles to remain strong. Accordingly, we believe the significant increase in the installed base for these consoles was a contributing factor to our total net revenue growth during the nine months ended December 31, 2004.

Software Prices. As current-generation console prices decrease, we expect more value-oriented consumers to become part of the interactive entertainment software market. We experienced this trend several years ago when prices were reduced on previous-generation consoles (e.g., Sony PlayStation and Nintendo 64). We believe that most hit titles will continue to be launched at premium price points and will maintain those premium price points longer than less popular games. However, as a result of a more value-oriented consumer base, and a greater number of software titles being published, we expect average software prices to gradually decline on current generation consoles, which may have a negative impact on our gross margin.

International Sales Growth. During the first nine months of fiscal 2005, net revenue from international sales accounted for approximately 47 percent of our total net revenue, up from 44 percent during the first nine months of fiscal 2004. Our third quarter increase in international net revenue was primarily driven by strong sales in Europe and Asia Pacific of Need for Speed: Underground 2. For the remainder of fiscal 2005, we anticipate that international net revenue will continue to increase – although not at the same rate as in fiscal 2004 – as we strengthen our presence in new territories (particularly in Asia) and as the console installed base expands outside of North America.

Foreign Exchange Impact. Given that a significant portion of our business is conducted internationally in foreign currency, fluctuations in currency prices can have a material impact on our results of operations. For example, the average exchange rate for the Euro, as compared to the U.S. dollar, increased from $1.18 per Euro during the three months ended December 31, 2003 to $1.26 per Euro during the three months ended December 31, 2004. As a result of the fluctuations in currency prices, we had a total foreign exchange benefit on net revenue of approximately $47 million during the three months ended December 31, 2004. Although we intend to continue to utilize foreign exchange forward and option contracts to either mitigate or hedge against some foreign currency exposures, we cannot predict the effect foreign currency fluctuations will have on us during the remainder of fiscal 2005.

Increasing Cost of Titles. Hit titles have become increasingly more expensive to produce and market as the platforms on which they are played continue to advance technologically and consumers demand continual improvements in the overall game play experience. We expect this trend to continue as (1) we require larger production teams to create our titles, (2) the technology needed to develop titles becomes more complex, (3) the number and nature of the platforms for which we develop titles increases and becomes more diverse, (4) the cost of licensing the third-party intellectual property we use in many of our titles increases, (5) we continue to develop additional Internet capabilities included in our products, and (6) we develop new methods to distribute our content via the Internet and on hand-held and wireless devices.

Expansion of Studio Resources and Technology. During fiscal 2004, as part of our effort to more efficiently utilize our resources and technology, we expanded our studio facilities in Los Angeles and Vancouver, allowing us to consolidate several smaller studios and resources. In fiscal 2005, we are devoting significant resources primarily to the overall expansion of our studios in North America and Europe. As we move through the life cycle of current generation consoles, we will devote

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increased resources to developing selected current generation titles and increase spending associated with tools and technologies for the next generation of platforms and technology. We also expect our overall studio expansions to enable us to support these investments and allow us to develop new titles. We expect these activities to increase our research and development expenses and decrease our third-party development costs, both as a percentage of total net revenue.

Increased Presence in China and Japan. We believe that in order to succeed in China and Japan, it is important to develop content locally for each market. As such, we expect to devote significant resources to hire local development talent and expand our infrastructure in each market, most notably, the expansion and creation of studio facilities in those countries. In addition, we anticipate establishing online game marketing, publishing and distribution functions in China. As part of this strategy, we may seek to partner with established local companies through acquisitions, joint ventures or other similar arrangements.

Leader in Interactive Sports Entertainment. We are a leading developer and publisher of interactive sports entertainment. Through our EA SPORTS^TM lineup, we generate a significant portion of our revenue from product franchises such as FIFA Soccer, Madden NFL Football, NCAA Football, Tiger Woods Golf, NASCAR, NBA Basketball, and NCAA Basketball. We have recently taken a number of steps to strengthen our leadership position and enhance our products in the interactive sports category by entering into exclusive license agreements with ESPN, the NFL, PLAYERS, Inc. (the NFL players’ association), and the Arena Football League. In addition, we have long-standing, exclusive relationships with various sports organizations and celebrities, including FIFA, UEFA, NASCAR, Tiger Woods and the PGA TOUR, and, in the future, we may enter into other exclusive relationships with other sports partners. While we expect to generate increased revenue as a result of these agreements, it may not be enough to offset the impact of the associated costs on our gross profit, which could negatively affect our gross margin on these products.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, and revenue and expenses during the reporting periods. The policies discussed below are considered by management to be critical because they are not only important to the portrayal of our financial condition and results of operations but also because application and interpretation of these policies requires both judgment and estimates of matters that are inherently uncertain and unknown. As a result, actual results may differ materially from our estimates.

Sales returns and allowances and bad debt reserves

We principally derive revenue from sales of packaged interactive software games designed for play on videogame platforms (such as the PlayStation 2, Xbox and Nintendo GameCube), PCs and hand-held game machines also known as mobile platforms (such as the Nintendo Game Boy Advance and Nintendo DS). Product revenue is recognized net of sales allowances. We also have stock-balancing programs for our PC products, which allow for the exchange of PC products by resellers under certain circumstances. We may decide to provide price protection for both our personal computer and videogame system products. In making this determination, we evaluate inventory remaining in the channel, the rate of inventory sell-through in the channel, and our remaining inventory on hand. It is our general practice to exchange products or give credits, rather than give cash refunds.

We estimate potential future product returns, price protection and stock-balancing programs related to current-period product revenue. We analyze historical returns, current sell-through of distributor and retailer inventory of our products, current trends in the videogame market and the overall economy, changes in customer demand and acceptance of our products and other related factors when evaluating the adequacy of the sales returns and price protection allowances. In addition, management monitors the volume of our sales to retailers and distributors and their inventories, as substantial overstocking in the distribution channel can result in high returns or substantial price protection requirements in subsequent periods. In the past, actual returns and price protection have not generally exceeded our reserves. However, actual returns and price protections may materially exceed our estimates as unsold products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing products. For example, the risk of product returns and/or price protection for our products may increase as the PlayStation 2, Xbox and Nintendo GameCube consoles move through their lifecycles and an increasing number and aggregate amount of competitive products heighten pricing and competitive pressures. While management believes it can make reliable estimates regarding these matters, these estimates are inherently subjective. Accordingly, if our estimates changed, our returns and price protection reserves would change, which would impact the total net revenue we report. For example, if actual returns and/or price protection were

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significantly greater than the reserves we have established, our actual results would decrease our reported total net revenue. Conversely, if actual returns and/or price protection were significantly less than our reserves, this would increase our reported total net revenue.

Similarly, significant judgment is required to estimate our allowance for doubtful accounts in any accounting period. We determine our allowance for doubtful accounts by evaluating customer creditworthiness in the context of current economic trends. Depending upon the overall economic climate and the financial condition of our customers, the amount and timing of our bad debt expense and cash collection could change significantly.

Royalties & licenses

Our royalty expenses consist of payments to (1) content licensors, (2) independent software developers, and (3) co-publishing and/or distribution affiliates. License royalties consist of payments made to celebrities, professional sports organizations, movie studios and other organizations for our use of their trademark, copyright, personal publicity rights, content and/or other intellectual property. Royalty payments to independent software developers are payments for the development of intellectual property related to our games. Co-publishing and distribution royalties are payments made to third parties for delivery of product.

Royalty-based payments made to content licensors and distribution affiliates are generally capitalized as prepaid royalties and expensed to cost of goods sold at the greater of the contractual or effective royalty rate based on net product sales. With regard to payments made to independent software developers and co-publishing affiliates, these payments are generally in connection with the development of a particular product and, therefore, we are generally subject to development risk prior to the general release of the product. Accordingly, payments that are due prior to completion of a product are generally expensed as research and development as the services are incurred. Payments due after completion of the product (primarily royalty-based in nature) are generally expensed as cost of goods sold at the higher of the contractual or effective royalty rate based on net product sales.

Minimum guaranteed royalty obligations are initially recorded as an asset and as a liability at the contractual amount when no significant performance remains with the licensor. When significant performance remains with the licensor, we record royalty payments as an asset when actually paid rather than upon execution of the contract. Minimum royalty payment obligations are classified as current liabilities to the extent such royalty payments are contractually due within the next twelve months. As of December 31, 2004 and March 31, 2004, approximately $49 million and $63 million, respectively, of minimum guaranteed royalty obligations had been recognized.

Each quarter, we also evaluate the future realization of our royalty-based assets as well as any unrecognized minimum commitments not yet paid to determine amounts we deem unlikely to be realized through product sales. Any impairments determined before the launch of a product are charged to research and development expense. Impairments determined post-launch are charged to cost of goods sold. In either case, we rely on estimated revenue to evaluate the future realization of prepaid royalties. If actual sales or revised revenue estimates fall below the initial revenue estimate, then the actual charge taken may be greater in any given quarter than anticipated. As of December 31, 2004, we had $76 million of royalty-based assets and $504 million of unrecognized minimum commitments not yet paid that could be impaired if our revenue estimates change.

Valuation of long-lived assets

We evaluate both purchased intangible assets and other long-lived assets in order to determine if events or changes in circumstances indicate a potential impairment in value exists. This evaluation requires us to estimate, among other things, the remaining useful lives of the assets and future cash flows of the business. These evaluations and estimates require the use of judgment. Our actual results could differ materially from our current estimates.

Under current accounting standards, we make judgments about the remaining useful lives of purchased intangible assets and other long-lived assets whenever events or changes in circumstances indicate a potential impairment in the remaining value of the assets recorded on our consolidated balance sheet. In order to determine if a potential impairment has occurred, management makes various assumptions about the future value of the asset by evaluating future business prospects and estimated cash flows. Our future net cash flows are primarily dependent on the sale of products for play on proprietary videogame consoles, hand-held game machines and PCs (collectively referred to as “platforms”). The success of our products is affected by our ability to accurately predict which platforms and which products we develop will be successful. Also, our revenue and earnings are dependent on our ability to meet our product release schedules. Due to product sales shortfalls, we may not realize the future net

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cash flows necessary to recover our long-lived assets, which may result in an impairment charge being recorded in the future. There were no impairment charges recorded in the three and nine months ended December 31, 2004 or December 31, 2003.

Income taxes

In the ordinary course of our business, there are many transactions and calculations where the tax law and ultimate tax determination is uncertain. As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate prior to the completion and filing of tax returns for such periods. This process requires estimating both our geographic mix of income and our current tax exposures in each jurisdiction where we operate. These estimates involve complex issues, require extended periods of time to resolve, and require us to make judgments, such as anticipating the positions that we will take on tax returns prior to our actually preparing the returns and the outcomes of disputes with tax authorities. We are also required to make the determinations of the need to record deferred tax liabilities and the recoverability of deferred tax assets. A valuation allowance is established to the extent recovery of deferred tax assets is not likely based on our estimation of future taxable income in each jurisdiction.

In addition, changes in our business, including acquisitions (such as Criterion and Digital Illusions C.E.), changes in our international structure, changes in the geographic location of business functions, changes in the geographic mix of income, as well as changes in our agreements with tax authorities, valuation allowances, the applicable accounting rules, the applicable tax laws and regulations, rulings and interpretations thereof, developments in tax audit and other matters, and variations in the estimated and actual level of annual pre-tax income can affect the overall effective income tax rate and result in a variance between the projected effective tax rate for any quarters and final effective tax rate for the fiscal year. For example, in the three months ended March 31, 2004, we resolved certain tax-related matters with the Internal Revenue Service, which lowered our income tax expense by $19.7 million and resulted in a 2.5 percent rate reduction during the three months ended March 31, 2004. By contrast, adverse developments in audits or applicable law result in increases in our tax expense. Similarly, we could experience an increase in our tax expense if we take advantage of a new election that we are entitled to make under the U.S. income tax rules regarding the allocation between U.S. and foreign jurisdictions of tax deductions attributable to employee stock option compensation.

To determine our projected effective income tax rate each quarter prior to the end of a fiscal year, we are required to make a projection of several items, including our projected mix of full-year income in each jurisdiction in which we operate and the related income tax expense in each jurisdiction. The estimated effective income tax rate is also adjusted for taxes related to significant unusual items. The actual results could vary from those projected, and as such, the overall effective income tax rate for a fiscal year could be different from that previously projected for the full year.

RESULTS OF OPERATIONS

Our fiscal year is reported on a 52/53-week period that ends on the final Saturday of March in each year. The results of operations for fiscal 2005 and 2004 contain 52 weeks. The results of operations for the fiscal quarters ended December 31, 2004 and December 31, 2003 each contain 13 weeks ending on December 25, 2004 and December 27, 2003, respectively. For simplicity of presentation, all fiscal periods are reported as ending on a calendar month end. On October 28, 2004, our Board of Directors approved a change in our fiscal year, such that beginning in fiscal 2006, we will end our fiscal year on the Saturday nearest March 31. This will result in fiscal 2006 being reported as a 53 week year with the first quarter containing 14 weeks instead of 13 weeks.

Net Revenue

We principally derive net revenue from sales of packaged interactive software games designed for play on videogame consoles (such as the PlayStation 2, Xbox and Nintendo GameCube), PCs and hand-held game machines also known as mobile platforms (such as the Nintendo Game Boy Advance and Nintendo DS). Additionally, in Europe and Asia we generate a significant portion of net revenue by marketing and selling third-party interactive software games through our established distribution network. We also derive net revenue from selling subscriptions to some of our online games, programming third-party web sites with our game content, allowing other companies to manufacture and sell our products in conjunction with other products, and selling advertisements in our games and on our online web pages.

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From a geographical perspective, our total net revenue for the three and nine months ended December 31, 2004 and 2003 were as follows (in thousands):

North America

For the three months ended December 31, 2004, net revenue in North America decreased by 8.1 percent as compared to the three months ended December 31, 2003. From a franchise perspective, the net revenue decrease was primarily due to (1) lower sales of products in the Medal of Honor franchise in fiscal 2005 as we only released on the PC platform in the three months ended December 31, 2004 as compared to four platforms in the three months ended December 31, 2003, (2) lower sales of products in the SSX and Harry Potter franchises as we did not release titles for these franchises in the three months ended December 31, 2004, and (3) lower net revenue from our EA SPORTS products primarily as a result of our price reduction on certain titles in the three months ended December 31, 2004. Together, decreased sales of products in these franchises resulted in a net revenue decrease of $151 million for the three months ended December 31, 2004 as compared to the three months ended December 31, 2003. This decrease was offset by a $93 million increase in sales of our products in our Need for Speed and NFL STREET franchises.

For the nine months ended December 31, 2004, net revenue in North America increased by 5.0 percent as compared to the nine months ended December 31, 2003. The net revenue increase was primarily driven by (1) higher sales of products in the Need for Speed, Fight Night and Bond franchises, and (2) sales of products in fiscal 2005 of the NFL STREET franchise, which was introduced after the comparable period in fiscal 2004. Together, these items resulted in a net revenue increase of $196 million for the nine months ended December 31, 2004 as compared to the nine months ended December 31, 2003. This increase was offset by a $124 million decrease in sales of products in our Medal of Honor and NBA STREET franchises during the nine months ended December 31, 2004 as compared to the nine months ended December 31, 2003.

Europe

For the three months ended December 31, 2004, net revenue in Europe increased by 1.2 percent as compared to the three months ended December 31, 2003. We estimate foreign exchange rates (primarily the Euro and the British pound sterling) strengthened reported European net revenue by approximately $45 million, or 7 percent, for the three months ended December 31, 2004 as compared to the three months ended December 31, 2003. The net revenue increase was primarily due to higher sales of products in our Need for Speed, Bond, The Sims and Def Jam franchises in the three months ended December 31, 2004. Together, these items resulted in a net revenue increase of $158 million for the three months ended December 31, 2004 as compared to the three months ended December 31, 2003. This increase was primarily offset by (1) lower sales of products in our Medal of Honor and Lord of the Rings franchises as well as (2) lower sales from our Harry Potter and SSX franchises as we did not release new titles in these franchises in the three months ended December 31, 2004. Together, the lower sales in these franchises resulted in a

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reduction of net revenue of $151 million in the three months ended December 31, 2004 as compared to the three months ended December 31, 2003.

For the nine months ended December 31, 2004, net revenue in Europe increased by 14.4 percent as compared to the nine months ended December 31, 2003. We estimate foreign exchange rates (primarily the Euro and the British pound sterling) strengthened reported European net revenue by approximately $76 million, or 8 percent, for the nine months ended December 31, 2004 as compared to the nine months ended December 31, 2003. The net revenue increase was primarily due to (1) higher sales of products in our Need for Speed, The Sims and Burnout franchises and (2) UEFA Euro 2004, which was released during the three months ended June 30, 2004 in conjunction with the UEFA Euro 2004 football tournament held in Europe. Together, these items resulted in a net revenue increase of $243 million during the nine months ended December 31, 2004 as compared to the nine months ended December 31, 2003. This increase was partially offset by lower sales of products in our Medal of Honor, SSX, and Lord of the Rings franchises and our co-published title Freedom Fighters, which reduced net revenue by $112 million in the nine months ended December 31, 2004 as compared to the nine months ended December 31, 2003.

Asia Pacific

For the three months ended December 31, 2004, net revenue from sales in the Asia Pacific region, excluding Japan, increased by 6.8 percent as compared to the three months ended December 31, 2003. The growth in net revenue was primarily due to higher sales of products in our Need for Speed franchise, partially offset by lower sales of products in our Medal of Honor and Lord of the Rings franchises. We estimate foreign exchange rates strengthened reported Asia Pacific net revenue by approximately $2 million, or 5 percent, for the three months ended December 31, 2004.

For the nine months ended December 31, 2004, net revenue from sales in the Asia Pacific region, excluding Japan, increased by 13.1 percent as compared to the nine months ended December 31, 2003. The growth in net revenue was primarily due to higher sales of products in our Need for Speed franchise, partially offset by lower sales of products in our Medal of Honor franchise. We estimate foreign exchange rates strengthened reported Asia Pacific net revenue by approximately $5 million, or 7 percent, for the nine months ended December 31, 2004.

Japan

For the three months ended December 31, 2004, net revenue from sales in Japan increased by 15.0 percent as compared to the three months ended December 31, 2003, primarily due to (1) higher sales of products in our Burnout, Need for Speed, Lord of the Rings and Ultima Online franchises, and (2) revenue from the distribution of Star Wars Battlefront. These increases were partially offset by lower sales of products in our Medal of Honor franchise as compared to the three months ended December 31, 2003. In addition, we estimate foreign exchange rates strengthened reported Japan net revenue by approximately $1 million, or 3 percent, for the three months ended December 31, 2004.

For the nine months ended December 31, 2004, net revenue from sales in Japan increased by 15.6 percent as compared to the nine months ended December 31, 2003, primarily due to (1) revenue from the distribution of Gundam GNO 2 and Star Wars Battlefront, and (2) higher sales of the Need for Speed, Burnout and Lord of the Rings franchises. These increases were partially offset by lower sales of the Medal of Honor franchise. In addition, we estimate foreign exchange rates strengthened reported Japan net revenue by approximately $2 million, or 5 percent, for the nine months ended December 31, 2004.

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Our total net revenue by product line for the three and nine months ended December 31, 2004 and 2003 were as follows (in thousands):