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 September 30, 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
.
Delaware
(State or other jurisdiction of
incorporation or organization)
94-2838567
(I.R.S. Employer
Identification No.)
209 Redwood Shores Parkway
Redwood City, California (Address of principal executive offices) |
94065 (Zip Code) |
(650) 628-1500
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES x NO o
Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date.
Outstanding as of
Par Value
November 1, 2004
$
0.01
305,332,110
ELECTRONIC ARTS INC.
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
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2
PART I FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
ELECTRONIC ARTS INC. AND SUBSIDIARIES
ASSETS
Current assets:
Property and equipment, net
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Other liabilities
Commitments and contingencies
Stockholders equity:
See accompanying Notes to Condensed Consolidated Financial Statements.
3
ELECTRONIC ARTS INC. AND SUBSIDIARIES
Net revenue
Gross profit
Operating expenses:
Total operating expenses
Operating income
Income before provision for income taxes
Net income
See accompanying Notes to Condensed Consolidated Financial Statements.
4
ELECTRONIC ARTS INC. AND SUBSIDIARIES
OPERATING ACTIVITIES
Net cash provided by operating activities
INVESTING ACTIVITIES
Net cash used in investing activities
FINANCING ACTIVITIES
Net cash provided by financing activities
Effect of foreign exchange on cash and cash equivalents
Ending cash, cash equivalents and short-term investments
Supplemental cash flow information:
Non-cash investing activities:
See accompanying Notes to Condensed Consolidated Financial Statements.
5
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 (such as the Game Boy
®
Advance) 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 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 reflect these amendments.
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
September 30, 2004 and September 30, 2003 each contain 13 weeks ending on
September 25, 2004 and September 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.
(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
6
using the Black-Scholes option-pricing model. The following weighted-average
assumptions were used for grants made during the three and six months ended
September 30, 2004 and 2003 under the stock plans:
Our calculations are based on a multiple option valuation approach and
forfeitures are recognized when they occur.
Net income as reported
Net income pro forma
Net earnings per share:
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 March 2004, the Financial Accounting Standards Board (FASB) issued an
exposure draft on the Proposed SFAS,
Share-Based Payment an amendment of
FASB Statements No. 123 and 95
. The proposed statement addresses the
accounting for share-based payment transactions with employees and other third
parties. The proposed standard would eliminate the ability to account for
share-based compensation transactions using APB No. 25, and generally would
require that such transactions be accounted for using a fair-value-based
method. If the final standard is approved as currently drafted in the exposure
draft, it would have a material impact on the amount of earnings we report
beginning in the second quarter of fiscal 2006. We have not yet determined the
impact that the proposed statement will have on our business.
7
(4) 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 six months ended September 30,
2004 was $0.6 million and $1.2 million, respectively. Amortization of
intangibles for the three and six months ended September 30, 2003 was $0.8
million and $1.5 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
September 30, 2004 and March 31, 2004, the weighted-average remaining useful
life for finite-lived intangible assets was approximately 7.0 years and 7.5
years, respectively.
As of September 30, 2004, future amortization of finite-lived intangibles was
estimated as follows (in thousands):
8
(5) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
The following table summarizes the activity in the accrued restructuring
accounts for all restructuring plans (in thousands):
Over the last three fiscal years, we have entered into various restructurings
based on management decisions as discussed in more detail below. As of
September 30, 2004, an aggregate of $21.3 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 $9.6 million,
$1.9 million is expected to be utilized in the third and fourth quarters of
fiscal 2005, while the remaining $7.7 million is expected to be utilized by
January 30, 2009. The facilities-related commitments discussed above are shown
net of $16.5 million of estimated future sub-lease income. The restructuring
accrual is included in other accrued expenses presented in Note 7 of the Notes
to Condensed Consolidated Financial Statements.
Fiscal 2004 Studio Restructuring
Fiscal 2003 Studio Restructuring
Fiscal 2003 Online Restructuring
Fiscal 2002 Online Restructuring
9
(6) 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 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 September 30, 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 have unpaid royalty amounts due to these parties that are
recognized 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):
10
In addition, at September 30, 2004, we have approximately $69.1 million that we
are obligated to pay co-publishing and/or distribution affiliates and content
licensors but that are generally contingent upon performance by the
counterparty (i.e., delivery of the product or content) and are therefore not
recorded in our Condensed Consolidated Financial Statements. See Note 8 of the
Notes to Condensed Consolidated Financial Statements.
(7) BALANCE SHEET DETAILS
Inventories
Property and Equipment, Net
Depreciation and amortization expense associated with property and equipment
amounted to $16.3 million and $31.9 million for the three and six months ended
September 30, 2004, respectively. Depreciation and amortization expense
associated with property and equipment amounted to $16.8 million and $29.4
million for the three and six months ended September 30, 2003, respectively.
Accrued and Other Liabilities
11
(8) COMMITMENTS AND CONTINGENCIES
Lease Commitments and Residual Value Guarantees
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
marketing, sales and research and development. 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
September 30, 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 September 30, 2004.
Consolidated Net Worth
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.
12
In June 2004, we entered into a lease agreement with an independent third party
for a studio facility in Orlando, Florida, which will commence in January 2005
and expire 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 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 September 30, 2004, we did not have a
payable balance on this standby letter of credit.
Development, Celebrity,
League and Content Licenses: Payments and Commitments
The following table summarizes our minimum contractual obligations and
commercial commitments as of September 30, 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 licensers that have been included
in our Condensed Consolidated Balance Sheet as of September 30, 2004 because the developer does not have any
significant performance obligations to us. These commitments are
included in both current and long-term assets and liabilities.
13
The lease commitments disclosed above exclude commitments included in our
restructuring activities for contractual rental commitments of $26.0 million
under real estate leases for unutilized office space, offset by $16.5 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
September 30, 2004. Please see Note 5 in the Notes to Condensed Consolidated
Financial Statements for additional information.
Litigation
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 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
(9) 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 includes primarily foreign currency
translation adjustments and unrealized gains (losses) on investments.
The change in the components of accumulated other comprehensive income, net of
tax, for the three and six months ended September 30, 2004 and 2003 are
summarized as follows (in thousands):
Net income
The foreign currency translation adjustments are not adjusted for income taxes
as they relate to indefinite investments in non-U.S. subsidiaries.
14
(10) NET INCOME PER SHARE
The following summarizes the computations of Basic Earnings Per Share (EPS)
and Diluted EPS. Basic EPS is computed as net earnings divided by the
weighted-average number of common shares outstanding for the period. Diluted
EPS reflects the potential dilution that could occur from common shares
issuable through stock-based compensation plans including stock options,
restricted stock awards, warrants and other convertible securities using the
treasury stock method. 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
details.
Net income
Net earnings per share:
Excluded from the above computation of weighted-average common shares for
Diluted EPS for the three and six months ended September 30, 2004 were options
to purchase 899,000 and 537,000 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 $51.77 and
$52.17 per share, respectively.
Excluded from the above computation of weighted-average common shares for
Diluted EPS for the three and six months ended September 30, 2003 were options
to purchase 339,000 and 574,000 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 $44.49 and
$40.78 per share, respectively.
(11) 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 September 30, 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.
(12) 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 lines for purposes of making operating
decisions and assessing financial performance. Our view and reporting of
15
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 six
months ended September 30, 2004 and 2003 is presented below (in thousands):
PlayStation 2
Information about our operations in North America and in international regions
for the three and six months ended September 30, 2004 and 2003 is presented
below (in thousands):
Three months ended September 30, 2004
Three months ended September 30, 2003
16
Six months ended September 30, 2004
Six months ended September 30, 2003
Our direct sales to Wal-Mart Stores, Inc. represented approximately 15 and 14
percent of total net revenue for the three and six months ended September 30,
2004, respectively, and approximately 15 and 14 percent of total net revenue
for the three and six months ended September 30, 2003, respectively.
(13) 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 (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 FSP has delayed the effective date until such time
that they issue the final standard. Management has not determined what impact
the adoption of the measurement and recognition guidance in EITF Issue No. 03-1
will have on our financial statements.
(14) SUBSEQUENT EVENTS
In October 2004, Congress enacted, and the President signed into law,
the American Jobs Creation Act of 2004 which provides for a reduced rate of tax on certain
repatriations of accumulated foreign earnings. While we currently intend to indefinitely reinvest
our accumulated foreign earnings outside the U.S., management is studying the new law and has not determined
what impact the repatriation of our accumulated foreign earnings would have on our effective
income tax rate or our financial statements were we to change our intention.
On October 18, 2004, our Board of Directors authorized a program to repurchase
up to an aggregate of $750.0 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.
On October 19, 2004, we completed our acquisition of Criterion Software Group
Ltd., an indirect wholly-owned subsidiary of Canon Inc., for an approximate
purchase price of $57 million plus the assumption of outstanding stock options
under certain stock option plans. Based in
the United Kingdom, Criterion Software Group Ltd. is a developer of video games
and a provider of middleware solutions for the game development and publishing
industry. While we are in the process of allocating the purchase price to the
various assets and liabilities we have acquired or assumed, we anticipate
recognizing pre-tax acquisition-related charges of between $10 million and $15
million during the third quarter of fiscal 2005.
17
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
We have reviewed the condensed consolidated balance sheet of Electronic Arts,
Inc. and subsidiaries (the Company) as of September 30, 2004, the related
condensed consolidated statements of operations for the three and six-month
periods ended September 30, 2004 and 2003, and the related condensed
consolidated statements of cash flows for the six-month periods ended September
30, 2004 and 2003. These condensed consolidated financial statements are the
responsibility of the Companys management.
We conducted our reviews 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 reviews, 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 with 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
18
Item 2. Managements 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
managements expectations, and are inherently uncertain and difficult to
predict. Our actual results could differ materially from managements
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 September 30, 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 Managements
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
TM
consoles),
personal computers (PC), hand-held game machines (such as the Game Boy
®
Advance) 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
).
Overview of Financial Results
Total net revenue for the three months ended September 30, 2004 was $716
million, up 35 percent, as compared to the three months ended September 30,
2003. Sales were driven by
Madden NFL 2005, The Sims 2, Burnout
TM
3: Takedown
and
NCAA
®
Football 2005
each reaching platinum status (over one million
copies sold) in the quarter.
Net income for the three months ended September 30, 2004 was $97 million, a 27
percent increase as compared to the three months ended September 30, 2003 and
diluted earnings per share were $0.31 as compared with $0.25 for the prior
year.
We generated $23 million of cash in operations during the six months ended
September 30, 2004 as compared to $28 million in the six months ended September
30, 2003. The decrease in cash flow was primarily the result of tax payments
made during the six months ended September 30, 2004, partially offset by an
increase in net income during the same period.
19
Managements Overview of Historical and Prospective Business Trends
Sales of Hit Titles.
During fiscal 2004, sales of a number of hit titles
contributed to our revenue growth, several of which were top sellers across a
number of international markets. Continuing this trend, our top-five-selling
titles across all platforms worldwide during the three months ended September
30, 2004 were the franchise titles
Madden NFL 2005
,
The Sims 2
,
NCAA Football
2005
,
Burnout 3:Takedown
and
Def Jam
®
Fight for NY
TM
. 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, this increases the console installed base. 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 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 six
months ended September 30, 2004 as compared to the three and six months ended
September 30, 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
price 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 three and six months ended September 30, 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, which may have a negative impact on our gross
margin.
International Sales Growth.
During the first six months of fiscal 2005, net
revenue from international sales accounted for approximately 40 percent of our
total net revenue, up from 37 percent during the first six months of fiscal
2004. Our second quarter increase in international net revenue was primarily
driven by increased sales in Europe, where
UEFA Euro 2004
benefited from being
released in conjunction with the UEFA Euro 2004 football (soccer) tournament.
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 $1.13 per Euro during the three months ended September 30, 2003 to $1.22
per Euro during the three months ended September 30, 2004. As a result of the
fluctuations in currency prices, we had a total foreign exchange benefit on
total net revenue of approximately $23 million during the three months ended
September 30, 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 in 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 potentially 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.
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 expect
to devote significant resources primarily to the expansion of our studios
20
in North America and Europe. As we move through the life cycle of current
generation consoles, we will devote 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 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.
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 (such as the Nintendo Game
Boy Advance). 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 pass the
midpoint of their lifecycle 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 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.
21
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 September 30, 2004 and
March 31, 2004, approximately $49.1 million and $63.4 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 September 30, 2004,
we had $74.9 million of royalty-based assets and $69.1 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 (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 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 six months ended September 30, 2004 or September 30, 2003.
22
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, changes in the
geographic location of business functions, changes in the geographic mix of
income, as well as changes in 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 fourth quarter of fiscal 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 fourth quarter of fiscal 2004. By contrast, an adverse development
in an audit, applicable law, or a new election that we may make under the U.S.
income tax rules regarding the allocation between U.S. and foreign
jurisdictions tax deductions attributable to employee stock option
compensation, could, for example, result in an increase in our tax expense.
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
September 30, 2004 and September 30, 2003 each contain 13 weeks ending on
September 25, 2004 and September 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 (such as the Nintendo
Game Boy Advance). 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 on our online web pages.
23
From a geographical perspective, our total net revenue for the three and six
months ended September 30, 2004 and 2003 were as follows (in thousands):
North America
North America
North America
For the three months ended September 30, 2004, net revenue in North America
increased by 32.0 percent as compared to the three months ended September 30,
2003. From a franchise perspective, the net revenue increase was primarily
driven by higher sales of products in the following franchises: Def Jam,
Madden, The Sims, Burnout and NCAA Football. Increased sales in these
franchises resulted in increased net revenue of $119.8 million for the three
months ended September 30, 2004 as compared to the three months ended September
30, 2003. This increase was offset by an $11.7 million decrease in our SimCity
and Battlefield franchises during the three months ended September 30, 2004 as
compared to the three months ended September 30, 2003.
For the six months ended September 30, 2004, net revenue in North America
increased by 22.8 percent as compared to the six months ended September 30,
2003. From a franchise perspective, the net revenue increase was primarily
driven by higher sales of products in the following franchises: Fight Night,
Harry Potter, Madden, Burnout, Need for Speed, The Sims and MVP Baseball.
Increased sales in these franchises resulted in increased net revenue of $174.0
million for the six months ended September 30, 2004 as compared to the six
months ended September 30, 2003. This increase was offset by a $47.6 million
decrease in our NBA STREET franchise during the six months ended September 30,
2004 as compared to the six months ended September 30, 2003.
Europe
For the three months ended September 30, 2004, net revenue in Europe increased
by 44.6 percent as compared to the three months ended September 30, 2003. We
estimate foreign exchange rates (primarily the Euro and the British pound
sterling) strengthened reported European net revenue by approximately $21
million, or 14 percent, for the three months ended September 30, 2004 as
compared to the three months ended September 30, 2003. From a franchise
perspective, the net revenue increase was primarily due to (1) higher sales of
The Sims franchise, (2) sales from our Burnout franchise and (3) sales of
Catwoman,
which was released in conjunction with the movie of the same title
during the three months ended September 30, 2004. Titles from these franchises
were released in the three months ended September 30, 2004 with no
corresponding release in fiscal 2004. Together, the three items noted above
increased net revenue by $93.3 million during the three months ended September
30, 2004 as compared to the three months ended September 30, 2003. This
increase was partially offset by lower sales of
Soul Calibur II
and
Freedom Fighters
, which reduced net revenue by $27.4 million in the three
months ended September 30, 2004 as compared to the three months ended September
30, 2003.
24
For the six months ended September 30, 2004, net revenue in Europe increased by
46.4 percent as compared to the six months ended September 30, 2003. We
estimate foreign exchange rates (primarily the Euro and the British pound
sterling) strengthened reported European net revenue by approximately $32
million, or 12 percent, for the six months ended September 30, 2004 as compared
to the six months ended September 30, 2003. From a franchise perspective, the
net revenue increase was primarily due to (1) higher sales of the Harry Potter
franchise as
Harry Potter and the Prisoner of Azkaban
was released in
conjunction with the blockbuster movie of the same title during the six months
ended September 30, 2004, (2) sales of the Burnout franchise, (3) sales of the
UEFA Euro franchise as
UEFA Euro 2004
was released during the six months ended
September 30, 2004 in conjunction with the UEFA Euro 2004 football tournament
held in Europe, and (4) higher sales of The Sims franchise. Titles from these
franchises were released in the six months ended September 30, 2004 with no
corresponding release in fiscal 2004. Together, the four items noted above
increased net revenue by $145.5 million during the six months ended September
30, 2004 as compared to the six months ended September 30, 2003. This increase
was partially offset by lower sales of
Soul Calibur II
and
Freedom Fighters
,
which reduced net revenue by $25.1 million in the six months ended September
30, 2004 as compared to the six months ended September 30, 2003.
Asia Pacific
For the three months ended September 30, 2004, net revenue from sales in the
Asia Pacific region, excluding Japan, increased by 21.2 percent as compared to
the three months ended September 30, 2003. The growth in net revenue was
primarily due to higher sales of The Sims and Burnout franchises, as discussed
above, partially offset by lower sales in our Rugby franchise. We estimate
foreign exchange rates strengthened reported Asia Pacific net revenue by
approximately $1 million, or 8 percent, for the three months ended September
30, 2004.
For the six months ended September 30, 2004, net revenue from sales in the Asia
Pacific region, excluding Japan, increased by 21.4 percent as compared to the
six months ended September 30, 2003. The growth in net revenue was primarily
due to higher sales in the Need for Speed, Harry Potter and The Sims
franchises, partially offset by lower sales in our Rugby and Command and
Conquer franchises. We estimate foreign exchange rates strengthened reported
Asia Pacific net revenue by approximately $3 million, or 9 percent, for the six
months ended September 30, 2004.
Japan
For the three months ended September 30, 2004, net revenue from sales in Japan
increased by 29.3 percent as compared to the three months ended September 30,
2003 primarily due to sales of
Gundam GNO 2
,
Monocrome (Limited)
, the Need for
Speed franchise and
Blood Rayne
, partially offset by lower sales of the F1
franchise. In addition, we estimate foreign exchange rates strengthened
reported Japan net revenue by approximately $1 million, or 9 percent, for the
three months ended September 30, 2004.
For the six months ended September 30, 2004, net revenue from sales in Japan
increased by 16.1 percent as compared to the six months ended September 30,
2003 primarily due to higher sales of the Harry Potter franchise,
Memories Off
Soreka
and
Gundam GNO 2
, partially offset by lower sales of
MAX Payne
and the
MVP Baseball franchise. In addition, we estimate foreign exchange rates
strengthened reported Japan net revenue by approximately $2 million, or 8
percent, for the six months ended September 30, 2004.
25
Our total net revenue by product line for the three and six months ended
September 30, 2004 and 2003 were as follows (in thousands):
PlayStation 2
PlayStation 2
PlayStation 2
In the three and six months ended September 30, 2004, net revenue from
PlayStation 2 products increased $90.7 million and $134.3 million,
respectively, as compared to the corresponding periods in the prior year. As a
percentage of total net revenue, sales of PlayStation 2 products increased by
1.9 percentage points and 2.9 percentage points in the three and six months
ended September 30, 2004, respectively. The increase in net revenue was
primarily due to growth in the installed base driven by Sonys price reductions
in the U.S. in May 2004 and in Europe in August 2004, and overall greater
demand for our products. We released nine and twelve titles, respectively, on
the PlayStation 2 platform during the three and six months ended September 30,
2004, as compared to six and nine titles, respectively, being released in the
three and six months ended September 30, 2003.
PC
In the three and six months ended September 30, 2004, net revenue from PC-based
products increased $47.7 million and $34.1 million, respectively, as compared
to the corresponding periods in the prior year. As a percentage of total net
revenue, sales of PC products increased by 2.1 percentage points and decreased
by 1.5 percentage points, respectively, during the three and six months ended
September 30, 2004. PC net revenue increased primarily due to higher sales in
The Sims and Harry Potter franchises as discussed above, which were partially offset by lower sales in
the Medal of Honor and Command and Conquer franchises. We released six and nine
titles, respectively, for the PC during the three and six months ended
September 30, 2004, as compared to ten and twelve titles, respectively, being
released in the three and six months ended September 30, 2003.
26
Xbox
In the three and six months ended September 30, 2004, net revenue from Xbox
products increased $73.2 million and $98.9 million, respectively, as compared
to the corresponding periods in the prior year. As a percentage of total net
revenue, sales of Xbox products increased by 6.8 percentage points and 6.0
percentage points, respectively, in the three and six months ended September
30, 2004. The increase in net revenue was primarily due to growth in the
installed base driven by Microsofts price reductions in the U.S. in March 2004
and in Europe in August 2004, and overall greater demand for our products. We
released eight and eleven titles, respectively, on the Xbox platform during the
three and six months ended September 30, 2004, as compared to five and seven
titles, respectively, being released in the three and six months ended
September 30, 2003.
Nintendo GameCube
In the three and six months ended September 30, 2004, net revenue from Nintendo
GameCube products increased $13.6 million and $18.9 million, respectively, as
compared to the corresponding periods in the prior year. As a percentage of
total net revenue, sales of Nintendo GameCube products increased by 0.7
percentage points and 0.4 percentage points, respectively, in the three and six
months ended September 30, 2004. The increase in net revenue was primarily due
to growth in the installed base of the Nintendo GameCube driven by Nintendos
price reduction in the U.S. in September 2003. We released seven and eight
titles, respectively, on the Nintendo GameCube platform during the three and
six months ended September 30, 2004, as compared to four and seven titles,
respectively, being released in the three and six months ended September 30,
2003.
Game Boy Advance
In the three and six months ended September 30, 2004, net revenue from Game Boy
Advance products increased $6.3 million and $21.9 million, respectively, as
compared to the corresponding periods in the prior year, primarily due to sales
in the Harry Potter franchise.
Co-Publishing and Distribution
In the three and six months ended September 30, 2004, net revenue from
co-publishing and distribution products decreased $43.6 million and $48.0
million, respectively, as compared to the corresponding periods in the prior
year. The decrease was primarily due to no co-publishing and distribution
titles being released during the three months ended September 30, 2004 and two
co-publishing and distribution titles being released during the six months
ended September 30, 2004 as compared to six co-publishing and distribution
titles being released during the three and six months ended September 30, 2003.
Advertising, Programming, Licensing and Other
In the three months ended September 30, 2004, net revenue from advertising,
programming, licensing and other products decreased from $15.1 million to $11.5
million as compared to the three months ended September 30, 2003. The decrease
was primarily due to lower net revenue from the Sony PlayStation platform,
partially offset by an increase in advertising net revenue.
In the six months ended September 30, 2004, net revenue from advertising,
programming, licensing and other products increased from $29.6 million to $33.2
million as compared to the six months ended September 30, 2003. The increase
was primarily due to license revenue related to the Nokia N-Gage in the six
months ended September 30, 2004, partially offset by a decrease in net revenue
from the Sony PlayStation platform.
Cost of Goods Sold
Cost of goods sold for our disk-based and cartridge-based products consists of
(1) product costs, (2) certain royalty expenses for celebrities, professional
sports and other organizations and independent software developers, (3)
manufacturing royalties, net of volume discounts, (4) expenses for defective
products, (5) write-off of post-launch prepaid royalty costs, and (6)
operations expenses. Cost of goods sold for our online product subscription
business consists primarily of data center and bandwidth costs associated with
hosting our websites, credit card fees and royalties for use of third-party
properties. Cost of goods sold for our website advertising business primarily
consists of ad serving costs.
27
Costs of goods sold for the three and six months ended September 30, 2004 and
2003 were as follows (in thousands):
In the three months ended September 30, 2004, cost of goods sold as a
percentage of total net revenue decreased by 0.6 percentage points to 39.7
percent from 40.3 percent for the three months ended September 30, 2003. This
was primarily due to a 2.7 percent decrease in royalty costs offset by
increases in inventory-related costs, online and warranty costs, all as a
percentage of total net revenue. We also experienced a higher average selling
price driven by the release of
The Sims 2
on the PC platform.
The 2.7 percent decrease in royalty costs was primarily the result of:
The decrease in cost of goods sold was partially offset by the following:
In the six months ended September 30, 2004, cost of goods sold as a percentage
of total net revenue decreased by 1.1 percentage points to 40.1 percent from
41.2 percent for the six months ended September 30, 2003. This decrease was
primarily due to a 3.5 percent decrease in royalty costs offset by increases in
inventory-related costs, online and warranty costs, all as a percentage of
total net revenue.
The 3.5 percent decrease in royalty costs was primarily the result of:
The decrease in cost of goods sold was partially offset by:
Cost of goods sold as a percentage of total net revenue may increase in fiscal
2005 as compared to fiscal 2004 as a result of (1) a gradual decrease in
average selling prices as current-generation platforms mature and our industry
transitions to next-generation
28
technology, (2) overall product mix, and (3)
higher inventory-related costs offset by lower co-publishing and distribution
royalties, both as a percentage of total net revenue.
Marketing and Sales
Marketing and sales expenses consist of personnel-related costs and
advertising, marketing and promotional expenses, net of advertising expense
reimbursements from third parties.
Marketing and sales expenses for the three and six months ended September 30,
2004 and 2003 were as follows (in thousands):
Marketing and sales expenses increased by 67.9 percent and 38.7 percent, for
the three and six months ended September 30, 2004, respectively, as compared to
the three and six months ended September 30, 2003, primarily due to:
As a percentage of total net revenue, marketing and sales expenses increased
for both the three and six months ended September 30, 2004 as compared to the
three and six months ended September 30, 2003.
General and Administrative
General and administrative expenses consist of personnel and related expenses
of executive and administrative staff, fees for professional services such as
legal and accounting, and allowances for bad debts.
General and administrative expenses for the three and six months ended
September 30, 2004 and 2003 were as follows (in thousands):
For the three and six months ended September 30, 2004, general and
administrative expenses increased by 16.7 percent and 15.4 percent,
respectively, as compared to the three and six months ended September 30, 2003
primarily due to:
The increases discussed above were partially offset in the six months ended
September 30, 2004 by a gain of $2.4 million on the sale of our property in
Austin, Texas.
29
As a percentage of total net revenue, general and administrative expenses
declined for both the three and six months ended September 30, 2004 as compared
to the three and six months ended September 30, 2003.
Research and Development
Research and development expenses consist of expenses incurred by our
production studios for personnel-related costs, consulting, equipment
depreciation and any impairment of prepaid royalties for pre-launch products.
Research and development expenses for our online business include expenses
incurred by our studios consisting of direct development costs and related
overhead costs in connection with the development and production of our online
games. Research and development expenses also include expenses associated with
development of website content, network infrastructure direct expenses,
software licenses and maintenance, and network and management overhead.
Research and development expenses for the three and six months ended September
30, 2004 and 2003 were as follows (in thousands):
For the three and six months ended September 30, 2004, research and development
expenses increased by 38.2 percent and 40.5 percent, respectively, as compared
to the three and six months ended September 30, 2003 primarily due to:
As a percentage of total net revenue, research and development expenses
increased during the three and six months ended September 30, 2004 as compared
to the three and six months ended September 30, 2003, as we continued to
support the global growth of our research and development capabilities. We
expect increased research and development spending to continue in fiscal 2005
as we continue to invest in next-generation tools and technologies, products
for new platforms, and, to a lesser extent, as we increase spending on titles
for the PC and current-generation console products.
Interest and Other Income, Net
Interest and other income, net, for the three and six months ended September
30, 2004 and 2003 were as follows (in thousands):
Interest and other income, net, during the three and six months ended September
30, 2004 increased from the three and six months ended September 30, 2003
primarily due to:
30
The increases discussed above were partially offset by increases in the net
losses from our foreign currency activities $4.7 million in the three months
ended September 30, 2004; $2.1 million in the six months ended September 30,
2004.
Income Taxes
Income taxes for the three and six months ended September 30, 2004 and 2003
were as follows (in thousands):
Our effective income tax rate reflects tax benefits derived from significant
operations outside the U.S., which are generally taxed at rates lower than the
U.S. statutory rate of 35 percent. Our effective income tax rate was 29
percent for the three and six months ended September 30, 2004 and 31 percent
for the three and six months ended September 30, 2003. Our reduced effective
income tax rate in the three and six months ended September 30, 2004 primarily
reflects the projected geographic mix of taxable income subject to lower tax
rates for fiscal 2005.
We intend to indefinitely reinvest our international earnings outside the U.S.
and, accordingly, have not provided U.S. taxes that would be incurred if such
earnings were repatriated back to the U.S.
We are currently projecting an effective income tax rate of approximately 29
percent for fiscal 2005; however, our actual effective income tax rates for
fiscal 2005 and future periods can differ from this projected effective income
tax rates due to a variety of factors.
Impact of Recently Issued Accounting Standards
In March 2004, the Financial Accounting Standards Board (FASB) issued an
exposure draft on the Proposed Statement of Financial Accounting Standards,
Share-Based Payment an amendment of FASB Statements No. 123 and 95
. The
proposed statement addresses the accounting for share-based payment
transactions with employees and other third-parties. The proposed standard
would eliminate the ability to account for share-based compensation
transactions using Accounting Principles Board Opinion
(APB) No. 25,
Accounting for Stock Issued to Employees
, and generally would require that
such transactions be accounted for using a fair-value-based method. If the
final standard is approved as currently drafted in the exposure draft, it would
have a material impact on the amount of earnings we report beginning in the
second quarter of fiscal 2006. We have not yet determined the impact that the
proposed statement will have on our business.
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 (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 FSP has delayed the effective date until such time
that they issue the final standard. Management has not determined what impact
the adoption of the measurement and recognition guidance in EITF Issue No. 03-1
will have on our financial statements.
31
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments
Percentage of total assets
Cash provided by operating activities
Changes in Cash Flow
Receivables, net
Inventories
Other current assets
32
Accounts payable
Accrued and other liabilities
Financial Condition
A portion of our cash is generated from operations domiciled in foreign tax
jurisdictions (approximately $505.5 million as of September 30, 2004) that is
designated as indefinitely reinvested in the respective tax jurisdiction. While
we have no plans to repatriate these funds to the United States in the
short-term, if we were required to do so to fund our operations in the United
States, we would accrue and pay additional taxes in connection with their
repatriation.
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.
On January 8, 2004, we filed an amended registration statement on Form S-3 with
the SEC. This registration statement, including the base prospectus contained
therein, became effective on January 15, 2004 and uses a shelf registration
process. This shelf registration statement allows us, at any time, to offer any
combination of securities described in the prospectus in one or more offerings
up to a total amount of $2.0 billion. Unless otherwise specified in a
prospectus supplement accompanying the base prospectus, we will use the net
proceeds from the sale of any securities offered pursuant to the shelf
registration statement for general corporate purposes, including for working
capital, financing capital expenditures, research and development, marketing
and distribution efforts and, if opportunities arise, for acquisitions or
strategic alliances. Pending such uses, we may invest the net proceeds in
interest-bearing securities. In addition, we may conduct concurrent or other
financings at any time.
Our ability to maintain sufficient liquidity could be affected by various risks
and uncertainties including, but not limited to, those related to (1) customer
demand and acceptance of our titles on new platforms and new versions of our
titles on existing platforms, (2) our ability to collect our accounts
receivable as they become due, (3) successfully achieving our product release
schedules and attaining our forecasted sales objectives, (4) the impact of
competition, (5) domestic and international economic conditions, (6)
seasonality in operating results, (7) risks of product returns and the other
risks described in the Risk Factors section below.
Contractual Obligations and Commercial Commitments
Letters 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 September 30, 2004, we did not have a
payable balance on this standby letter of credit.
33
Development, Celebrity, League and Content Licenses: Payments and Commitments
The following table summarizes our minimum contractual obligations and
commercial commitments as of September 30, 2004, and the effect we expect them
to have on our liquidity and cash flow in future periods (in thousands):
(1)
See discussion on operating leases in the
Off-Balance Sheet Commitments
section below and Note 8 in the Notes to Condensed Consolidated
Financial Statements, included in Item 1 hereof, for additional information.
The lease commitments disclosed above exclude commitments included in our
restructuring activities for contractual rental commitments of $26.0 million
under real estate leases for unutilized office space, offset by $16.5 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
September 30, 2004. Please see Note 5 in the Notes to Condensed Consolidated
Financial Statements, included in Item 1 hereof, for additional information.
Litigation
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 claims and
34
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
Transactions with Related Parties
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 September 30, 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.
OFF-BALANCE SHEET COMMITMENTS
Lease Commitments
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
Statement of Financial Accounting Standards (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
marketing, sales and research and development. 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
September 30, 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 September 30, 2004.
35
Consolidated Net Worth
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 will commence in January 2005
and expire 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.
36
RISK FACTORS
Our business is subject to many risks and uncertainties, which may affect our
future financial performance. The risks and uncertainties discussed below are
not the only ones we face. There may be additional risks and uncertainties not
currently known to us or that we currently do not believe are material that may
harm our business and financial performance. If any of the events or
circumstances described below occurs, our business and financial performance
could be harmed, our actual results could differ materially from our
expectations and the market value of our securities could decline.
Our industry is cyclical and if we experience a decline in sales as consumers
anticipate next generation products, our operating results will suffer.
Our industry is cyclical. Videogame platforms have historically had a life
cycle of four to six years. Over the course of the next few years, we expect
Sony, Microsoft and Nintendo to introduce new videogame platforms into the
market. As one group of platforms is reaching the end of its cycle and new
platforms are emerging, sales of videogames for such consoles generally
decline. For example, consumers often defer game software purchases until the
new platforms are available. This decline may not be offset by increased sales
of products for the new platform. For example, following the launch of Sonys
PlayStation 2 platform, we experienced a significant decline in revenue from
sales of products for Sonys older PlayStation game console, which was not
immediately offset by revenue generated from sales of products for the
PlayStation 2 platform. If we experience a similar trend as the next
generation of products is introduced into the market, our operating results
will suffer and our financial position will be harmed.
Our business is highly dependent on the success and timely release of new
videogame platforms, as well as our ability to develop commercially successful
products for these platforms.
We derive most of our revenue from the sale of products for play on videogame
platforms manufactured by third parties, such as Sonys PlayStation 2. The
success of our products is driven in large part by the timely release and
success of new videogame hardware systems, our ability to accurately predict
which platforms will be most successful in the marketplace, and our ability to
develop commercially successful products for these platforms. We must make
product development decisions and commit significant resources well in advance
of the anticipated introduction of a new platform. A new platform for which we
are developing products may be delayed, may not succeed or may have a shorter
life cycle than anticipated. If the platforms for which we are developing
products are not released when anticipated or do not attain wide market
acceptance, our revenue growth will suffer, we may be unable to fully recover
the resources we have committed, and our financial performance will be harmed.
Our platform licensors set the royalty rates and other fees that we must pay to
publish games for their platforms, and therefore have significant influence on
our costs. If one or more of the platform licensors adopt a different fee
structure for future game consoles or we are unable to obtain such licenses,
our profitability will be materially impacted.
In the next few years, we expect our platform licensors to introduce new game
machines into the market. For example, Sony has indicated that it plans to
release a next-generation successor to the PlayStation 2 as soon as late 2005
or early 2006. In order to publish products for a new game machine, we must
take a license from the platform licensor which gives the platform licensor the
opportunity to set the fee structure that we must pay in order to publish games
for that platform. Similarly, the platform licensors have retained the
flexibility to change their fee structures for online gameplay and features for
their consoles. The control that platform licensors have over the fee
structures for their future platforms and online access makes it difficult for
us to predict our costs and profitability in the medium to long term. It is
also possible that platform licensors will not renew our licenses. Because
publishing products for videogame consoles is the largest portion of our
business, any increase in fee structures or failure to secure a license
relationship would have a significant negative impact on our business model and
profitability.
If we do not consistently meet our product development schedules, our operating
results will be adversely affected.
Our business is highly seasonal, with the highest levels of consumer demand,
and a significant percentage of our revenue, occurring in the December quarter.
In addition, we seek to release many of our products in conjunction with
specific events, such as the release of a related movie or the beginning of a
sports season or major sporting event. If we miss these key selling periods,
due to product delays or delayed introduction of a new platform for which we
have developed products, our sales will suffer disproportionately. Our ability
to meet product development schedules is affected by a number of factors,
including the creative processes involved, the coordination of large and
sometimes geographically dispersed development teams required by
37
the increasing complexity of our products, and the need to refine and tune our
products prior to their release. We have in the past experienced development
delays for several of our products. Failure to meet anticipated production or
go live schedules may cause a shortfall in our revenue and profitability and
cause our operating results to be materially different from expectations.
Our business is intensely competitive and increasingly hit driven. If we do
not continue to deliver hit products or if consumers prefer our competitors
products over our own, our operating results could suffer.
Competition in our industry is intense, new products are regularly introduced,
and a relatively small number of hit titles accounts for a significant
portion of total sales. If our competitors develop more successful products,
offer competitive products at lower price points, or if we do not continue to
develop consistently high-quality and well-received products, our revenue,
margins, and profitability will decline.
If we are unable to maintain or acquire licenses to intellectual property, we
will publish fewer hit titles and our revenue, profitability and cash flows
will decline. Competition for these licenses may make them more expensive, and
increase our costs.
Many of our products are based on or incorporate intellectual property owned by
others. For example, our EA SPORTS
TM
products include rights licensed from the
major sports leagues and players associations. Similarly, many of our hit EA
GAMES
TM
franchises, such as Bond, Harry Potter and Lord of the Rings, are based
on key film and literary licenses. Competition for these licenses is intense.
If we are unable to maintain these licenses and obtain additional licenses with
significant commercial value, our revenues and profitability will decline
significantly. Competition for these licenses may also drive up the advances,
guarantees and royalties that we must pay to the licensor, which could
significantly increase our costs.
If patent claims continue to be asserted against us, we may be unable to
sustain our current business models or profits.
Many patents have been issued that may apply to widely used game technologies.
Additionally, infringement claims under many recently issued patents are now
being asserted against Internet implementations of existing games. Several such
claims have been asserted against us. Such claims can harm our business. We
incur substantial expenses in evaluating and defending against such claims,
regardless of the merits of the claims. In the event that there is a
determination that we have infringed a third-party patent, we could incur
significant monetary liability and be prevented from using the rights in the
future.
Other intellectual property claims may increase our product costs or require us
to cease selling affected products.
Many of our products include extremely realistic graphical images, and we
expect that as technology continues to advance, images will become even more
realistic. Some of the images and other content are based on real-world
examples that may inadvertently infringe upon the intellectual property rights
of others. Although we believe that we make reasonable efforts to ensure that
our products do not violate the intellectual property rights of others, it is
possible that third parties still may claim infringement. From time to time, we
receive communications from third parties regarding such claims. Existing or
future infringement claims against us, whether valid or not, may be time
consuming and expensive to defend. Such claims or litigations could require us
to stop selling the affected products, redesign those products to avoid
infringement, or obtain a license, all of which would be costly and harm our
business.
From time to time we may become involved in other litigation which could
adversely affect us.
We are currently, and from time to time in the future may become, subject to
other claims and litigation, which could be expensive, lengthy, and disruptive
to normal business operations. For further information regarding certain claims
and litigation in which we are involved, see Part II Item 1. Legal
Proceedings below. The outcome of any claims or litigation may be difficult to
predict and could have a material adverse effect on our business, operating
results, or financial condition.
Our business, our products and our distribution are subject to increasing
regulation in key territories of content, consumer privacy and online delivery.
If we do not successfully respond to these regulations, our business may
suffer.
Legislation is continually being introduced that may affect both the content of
our products and their distribution. For example, privacy laws in the United
States and Europe impose various restrictions on our web sites. Those rules
vary by territory although the Internet recognizes no geographical boundaries.
Other countries, such as Germany, have adopted laws regulating content both in
packaged goods and those transmitted over the Internet that are stricter than
current United States laws. In the United
38
States, the federal and several state governments are considering content
restrictions on products such as ours, as well as restrictions on distribution
of such products. Any one or more of these factors could harm our business by
limiting the products we are able to offer to our customers and by requiring
additional differentiation between products for different territories to
address varying regulations. This additional product differentiation would be
costly.
Technology changes rapidly in our business, and if we fail to anticipate new
technologies, the quality, timeliness and competitiveness of our products will
suffer.
Rapid technology changes in our industry require us to anticipate, sometimes
years in advance, which technologies our products must take advantage of in
order to make them competitive in the market at the time they are released.
Therefore, we usually start our product development with a range of technical
development goals that we hope to be able to achieve. We may not be able to
achieve these goals, or our competition may be able to achieve them more
quickly than we can. In either case, our products may be technologically
inferior to competitive products, or less appealing to consumers, or both. If
we cannot achieve our technology goals within the original development schedule
of our products, then we may delay products until these technology goals can be
achieved, which may delay or reduce revenue and increase our development
expenses. Alternatively, we may increase the resources employed in research and
development in an attempt to accelerate our development of new technologies,
either to preserve our product launch schedule or to keep up with our
competition, which would increase our development expenses.
If we do not continue to attract and retain key personnel, we will be unable to
effectively conduct our business.
The market for technical, creative, marketing and other personnel essential to
the development and marketing of our products and management of our businesses
is extremely competitive. Our leading position within the interactive
entertainment industry makes us a prime target for recruiting of executives and
key creative talent. If we cannot successfully recruit and retain the employees
we need, or replace key employees following their departure, our ability to
develop and manage our businesses will be impaired.
Our platform licensors are our chief competitors and frequently control the
manufacturing of and/or access to our videogame products. If they do not
approve our products, we will be unable to ship to our customers.
Our agreements with hardware licensors (such as Sony for the PlayStation 2,
Microsoft for the Xbox and Nintendo for the Nintendo GameCube) typically give
significant control to the licensor over the approval and manufacturing of our
products, which could, in certain circumstances, leave us unable to get our
products approved, manufactured and shipped to customers. These hardware
licensors are also our chief competitors. In most events, control of the
approval and manufacturing process by the platform licensors increases both our
manufacturing lead times and costs as compared to those we can achieve
independently. While we believe that our relationships with our hardware
licensors are currently good, the potential for these licensors to delay or
refuse to approve or manufacture our products exists. Such occurrences would
harm our business and our financial performance.
We compete directly with Microsoft and Sony for sales of products with online
capabilities. We also require compatibility code and the consent of each in
order to include online capabilities in our products for their respective
platforms. As online capabilities for videogame platforms become more
significant, Microsoft and Sony could restrict our ability to provide online
capabilities for our console platform products. If Microsoft or Sony refused to
approve our products with online capabilities or significantly impacted the
financial terms on which these services are offered to our customers, our
business could be harmed.
Our international net revenue is subject to currency fluctuations.
For the six months ended September 30, 2004, international net revenue
comprised 40 percent of our total net revenue. For the fiscal year ended March
31, 2004, international net revenue comprised 45 percent of total net revenue.
We expect foreign sales to continue to account for a significant portion of our
total net revenue. Such sales are subject to unexpected regulatory
requirements, tariffs and other barriers. Additionally, foreign sales are
primarily made in local currencies, which may fluctuate against the dollar.
While we utilize foreign exchange forward contracts to mitigate foreign
currency risk associated with foreign currency denominated assets and
liabilities (primarily certain intercompany receivables and payables) and from
time to time, foreign currency option contracts to hedge foreign currency
forecasted transactions (primarily related to revenue generated by our
operational subsidiaries), our results of operations and financial condition
may, nonetheless, be adversely affected by foreign currency fluctuations.
39
Changes in our tax rates or exposure to additional tax liabilities could
adversely affect our operating results and financial condition.
We are subject to income taxes in the United States and in various foreign
jurisdictions. Significant judgment is required in determining our worldwide
provision for income taxes and, in the ordinary course of our business, there
are many transactions and calculations where the ultimate tax determination is
uncertain. We are also required to estimate what our taxes will be in the
future. Although we believe our tax estimates are reasonable, they are not
binding on tax authorities. Our effective tax rate could be adversely affected
by changes in our business, including the mix of earnings in countries with
differing statutory tax rates, changes in the elections we make, changes in
applicable tax laws as well as other factors. Further, our tax determinations
are regularly subject to audit by tax authorities and developments in those
audits could adversely affect our income tax provision. Should our ultimate
tax liability exceed our estimates, our income tax provision and net income
could be materially affected.
We are also required to pay taxes other than income taxes, such as payroll,
sales, use, value-added, net worth, property and goods and services taxes, in
both the United States and various foreign jurisdictions. We are regularly
under examination by tax authorities with respect to these non-income taxes.
There can be no assurance that the outcomes from these examinations, changes in
our business or changes in applicable tax rules will not have an adverse effect
on our operating results and financial condition.
Changes in our worldwide operating structure could have adverse tax
consequences.
We are in the process of examining our worldwide operating structure in light
of changing tax laws, our current and anticipated business operations, and the
pending expiration of an offshore advanced pricing agreement with a foreign tax
authority in December 2005 under which our current business operates. In
addition, while our current intention is to invest indefinitely our
undistributed foreign earnings offshore, we are studying certain provisions of
the American Jobs Creation Act of 2004 which provide for a reduced rate of tax
on certain repatriations of accumulated foreign earnings. Although we have not
yet determined the impact on our effective income tax rate, any significant
changes to our operating structure, the failure to reach agreements with tax
authorities in the future, or the repatriation of our offshore cash could
adversely affect our effective income tax rates for fiscal 2005 and beyond.
Our reported financial
results could be adversely affected by changes in financial
accounting standards or by the application of existing or future
accounting standards to our business as it evolves.
As a result of the enactment
of the Sarbanes-Oxley Act and the review of accounting policies by
the SEC and national and international accounting standards bodies,
the frequency of accounting policy changes may accelerate. For
example, the FASB has proposed changes to GAAP that would require us
to adopt a different method of determining and accounting for the
compensation expense of our employee stock options. This change, as
well as other possible changes to accounting standards, could
adversely affect our reported results of operations although not
necessarily our cash flows. Further, accounting policies affecting
software revenue recognition have been the subject of frequent
interpretations, which could significantly affect the way we account
for revenue related to our products. As we enhance, expand and
diversify our business and product offerings, the application of
existing or future financial accounting standards, particularly those
relating to the way we account for revenue, could have a significant
adverse effect on our reported results although not necessarily on
our cash flows.
The majority of our sales are made to a relatively small number of key
customers. If these customers reduce their purchases of our products or become
unable to pay for them, our business could be harmed.
In the U.S., during the six months ended September 30, 2004, over 65 percent of
our U.S. sales were made to six key customers. In Europe, our top ten
customers accounted for over 35 percent of our sales in that territory in the
six months ended September 30, 2004. Worldwide, we had direct sales to one
customer, Wal-Mart Stores, Inc., which represented 14 percent of total net
revenue during the six months ended September 30, 2004. Though our products
are available to consumers through a variety of retailers, the concentration of
our sales in one, or a few, large customers could lead to short-term disruption
in our sales if one or more of these customers significantly reduced their
purchases or ceased to carry our products, and could make us more vulnerable to
collection risk if one or more of these large customers became unable to pay
for our products. Additionally, our receivables from these large customers
increase significantly in the December quarter as they stock up for the holiday
selling season. Also, having such a large portion of our total net revenue
concentrated in a few customers reduces our negotiating leverage with these
customers.
40
Acquisitions, investments and other strategic transactions could result in
operating difficulties, dilution to our investors and other negative
consequences.
We have evaluated, and expect to continue to evaluate, a wide array of
potential strategic transactions, including (1) acquisitions of companies,
businesses, intellectual properties, and other assets and (2) investments in
new interactive entertainment businesses (for example, online and mobile
games). Any of these strategic transactions could be material to our financial
condition and results of operations. Although we regularly search for
opportunities to engage in strategic transactions, we may not be successful in
identifying suitable opportunities. We may not be able to consummate potential
acquisitions or investments or an acquisition or investment may not enhance our
business or may decrease rather than increase our earnings. In addition, the
process of integrating an acquired company or business, or successfully
exploiting acquired intellectual property or other assets, could divert a
significant amount of our managements time and focus and may create unforeseen
operating difficulties and expenditures. Additional risks we face include:
Future acquisitions and investments could involve the issuance of our equity
securities, potentially diluting our existing stockholders, the incurrence of
debt, contingent liabilities or amortization expenses, or write-offs of
goodwill, any of which could harm our financial condition. Our stockholders
may not have the opportunity to review, vote on or evaluate future acquisitions
or investments.
We have begun the implementation of a common set of financial information
systems throughout our worldwide organization, which, if not completed in a
successful and timely manner, could impede our ability to accurately process,
prepare and analyze important financial data.
As part of our effort to improve efficiencies throughout our worldwide
organization, we have begun the implementation of a common set of practices,
processes and financial information systems. The successful conversion from
our current financial information systems to new financial information systems
entails a number of risks due to the complexity of the conversion and
implementation process. Such risks include verifying the accuracy of the
business data and information prior to conversion, the actual conversion of
that data and information to the new systems and then using that business data
and information in the new systems after the conversion. In addition, because
the implementation is company-wide, there is a need for substantial and
comprehensive company-wide employee training. While testing of these new
systems and processes and training of employees are done in advance of
implementation, there are inherent limitations in our ability to simulate a
full-scale operating environment in advance of implementation. Finally, there
can be no assurance that the conversion to, and the implementation of, the new
financial information systems will not impede our ability to accurately and
timely process, prepare and analyze the financial data we use in making
operating decisions and which form the basis of the financial information we
include in the periodic reports we file with the SEC.
Our products are subject to the threat of piracy by a variety of organizations
and individuals. If we are not successful in combating and preventing piracy,
our sales and profitability could be harmed significantly.
In many countries around the world, more pirated copies of our products are
sold than legitimate copies. Though piracy has not had a material impact on
our operating results to date, highly organized pirate operations have been
expanding globally. In addition, the proliferation of technology designed to
circumvent the protection measures we use in our products, the availability of
broadband access to the Internet, the ability to download pirated copies of our
games from various Internet sites, and the widespread proliferation of Internet
cafes using pirated copies of our products, all have contributed to ongoing and
expanding piracy. Though we take steps to make the unauthorized copying and
distribution of our products more difficult, as do the manufacturers of
consoles on which our games are played, neither our efforts nor those of the
console manufacturers may be
41
successful in controlling the piracy of our products. This could have a
negative effect on our growth and profitability in the future.
Our stock price has been volatile and may continue to fluctuate significantly.
As a result of the factors discussed in this report and other factors that may
arise in the future, the market price of our common stock historically has
been, and we expect will continue to be, subject to significant fluctuations.
These fluctuations may be due to factors specific to us, to changes in
analysts earnings estimates, to factors affecting the computer, software,
Internet, entertainment, media or electronics businesses, or to national and
international economic conditions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
We are exposed to various market risks, including changes in foreign currency
exchange rates and interest rates. Market risk is the potential loss arising
from changes in market rates and prices. Foreign exchange forward and option
contracts used to either mitigate or hedge foreign currency exposures and
short-term investments are subject to market risk. We do not consider our cash
and cash equivalents to be subject to interest rate risk due to their short
maturities. We do not enter into derivatives or other financial instruments for
trading or speculative purposes.
Foreign Currency Exchange Rate Risk
From time to time, we hedge our foreign currency risk related to anticipated
future sales transactions by purchasing option contracts that generally have
maturities of 15 months or less. If qualified, these transactions are
designated as cash flow hedges. For the three and six months ended September
30, 2004, we recognized a loss of $0.6 million and $1.2 million, respectively,
in earnings associated with the time value of these option contracts.
The counterparties to these forward and options contracts are creditworthy
multinational commercial and investment banks. The risks of counterparty
nonperformance associated with these contracts are not considered to be
material. Notwithstanding our efforts to manage foreign exchange risks, there
can be no assurances that our mitigating or hedging activities will adequately
protect us against the risks associated with foreign currency fluctuations.
The following table provides information about our foreign currency forward and
option contracts as of September 30, 2004. The information is provided in U.S.
dollar equivalents. The weighted average contract rate is stated in terms of
how many U.S. dollars would be purchased by one unit of foreign currency. The
forward contract rates approximate the foreign exchange rates as of September
30, 2004; therefore, the mark-to-market on the contracts is approximately zero.
The fair value of our forward and option contracts are recorded in other
current assets on our Condensed Consolidated Balance Sheets.
42
Interest Rate Risk
As of September 30, 2004, our cash equivalents and short-term investments
included $2.3 billion of debt securities, consisting primarily of U.S. agency
bonds and money market funds. Notwithstanding our efforts to manage interest
rate risks, there can be no assurances that we will be adequately protected
against the risks associated with interest rate fluctuations.
The table below presents the amounts and related weighted-average interest
rates of our investment portfolio as of September 30, 2004 (in thousands):
Maturity dates for short-term investments range from 4 months to 23 months,
with call dates ranging from 1 month to 4 months.
43
Item 4. Controls and Procedures
Definition and limitations of disclosure controls.
Our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) are controls and other
procedures that are designed to ensure that information required to be
disclosed in our reports filed under the Exchange Act, such as this report, is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms. Disclosure controls and procedures are also
designed to ensure that such information is accumulated and communicated to our
management, including the Chief Executive Officer and Chief Financial and
Administrative Officer, as appropriate to allow timely decisions regarding
required disclosure. Our management evaluates these controls and procedures on
an ongoing basis.
There are inherent limitations to the effectiveness of any system of disclosure
controls and procedures. These limitations include the possibility of human
error, the circumvention or overriding of the controls and procedures and
reasonable resource constraints. In addition, because we have designed our
system of controls based on certain assumptions, which we believe are
reasonable, about the likelihood of future events, our system of controls may
not achieve its desired purpose under all possible future conditions.
Accordingly, our disclosure controls and procedures provide reasonable
assurance, but not absolute assurance, of achieving their objectives.
Evaluation of disclosure controls and procedures.
Our Chief Executive Officer
and Chief Financial and Administrative Officer, after evaluating the
effectiveness of our disclosure controls and procedures, believe that as of the
end of the period covered by this report, our disclosure controls and
procedures were effective in providing the requisite reasonable assurance that
material information required to be disclosed in the reports that we file or
submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms, and is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial and Administrative Officer, as appropriate to allow
timely decisions regarding the required disclosure.
Changes in internal controls.
During our last fiscal quarter, no changes
occurred in our internal control over financial reporting that materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting. However, following the enactment of the
Sarbanes-Oxley Act and related SEC regulations, we have enhanced our internal
controls and disclosure systems through various measures including: detailing
certain internal accounting policies; establishing a disclosure committee for
the preparation of all periodic SEC reports; establishing an internal audit
function; requiring certifications from various trial balance controllers and
other financial personnel responsible for our financial statements; and
automating certain manual-entry royalty accounting activities through the
implementation of new software management systems.
44
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30,
March 31,
(In thousands, except share data)
2004
2004 (a)
$
1,386,026
$
2,149,885
1,103,633
264,461
259
1,225
379,389
211,916
79,272
55,143
80,804
84,312
140,883
161,867
3,170,266
2,928,809
297,485
298,073
15,341
14,332
92,648
91,977
17,215
18,468
43,639
40,755
66,061
71,612
$
3,702,655
$
3,464,026
$
172,017
$
114,087
587,275
630,138
759,292
744,225
36,615
41,443
795,907
785,668
3,051
3,013
2
1,264,563
1,153,680
1,622,662
1,501,184
16,472
20,479
2,906,748
2,678,358
$
3,702,655
$
3,464,026
(a)
Derived from audited financial statements.
Table of Contents
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
Six Months Ended
(unaudited)
September 30,
September 30,
(In thousands, except per share data)
2004
2003
2004
2003
$
715,728
$
530,005
$
1,147,369
$
883,386
283,911
213,762
460,666
363,725
431,817
316,243
686,703
519,661
107,518
64,041
170,738
123,125
42,043
36,032
77,097
66,792
156,839
113,493
287,481
204,615
623
810
1,245
1,490
388
307,023
214,376
536,949
396,022
124,794
101,867
149,754
123,639
12,183
9,130
21,342
13,979
136,977
110,997
171,096
137,618
39,724
34,409
49,618
42,662
$
97,253
$
76,588
$
121,478
$
94,956
$
0.32
$
0.26
$
0.40
$
0.32
$
0.31
$
0.25
$
0.38
$
0.31
304,076
294,836
303,127
292,263
316,049
307,779
315,778
304,013
Table of Contents
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
(unaudited)
September 30,
(In thousands)
2004
2003
$
121,478
$
94,956
33,167
30,847
(587
)
(113
)
589
(3,893
)
45
273
429
25,138
40,169
(168,217
)
(133,034
)
(24,097
)
(406
)
26,590
19,063
57,885
25,309
(44,598
)
(49,607
)
23,139
28,247
(45,339
)
(28,690
)
15,537
88
3,115
(250
)
8,467
(1,658,105
)
(1,270,579
)
812,521
547,792
(2,513
)
(12
)
(872,533
)
(745,435
)
85,508
139,875
(225
)
128
(2,587
)
85,508
137,191
27
6,127
(763,859
)
(573,870
)
2,149,885
949,995
1,386,026
376,125
1,103,633
1,358,049
$
2,489,659
$
1,734,174
$
43,276
$
4,567
$
(6,794
)
$
(2,186
)
Table of Contents
(unaudited)
Table of Contents
Three Months Ended
Six Months Ended
September 30,
September 30,
2004
2003
2004
2003
3.0%
2.2%
3.0%
2.1%
37.5%
54.4%
38.4%
54.9%
2.96
3.08
3.04
3.03
None
None
None
None
Three Months Ended
Six Months Ended
September 30,
September 30,
(In thousands, except per share data)
2004
2003
2004
2003
$
97,253
$
76,588
$
121,478
$
94,956
(22,935
)
(23,750
)
(42,579
)
(43,923
)
25
25
50
74
$
74,343
$
52,863
$
78,949
$
51,107
$
0.32
$
0.26
$
0.40
$
0.32
$
0.24
$
0.18
$
0.26
$
0.17
$
0.31
$
0.25
$
0.38
$
0.31
$
0.24
$
0.17
$
0.25
$
0.17
Table of Contents
Effects of
As of
Foreign
As of
March 31,
Goodwill
Currency
September 30,
2004
Acquired
Translation
2004
$
91,977
$
12
$
659
$
92,648
As of September 30, 2004
Gross
Other
Carrying
Accumulated
Intangibles,
Amount
Amortization
Impairment
Other
Net
$
28,263
$
(18,886
)
$
(9,377
)
$
$
35,169
(16,739
)
(1,211
)
(7
)
17,212
8,694
(6,302
)
(1,776
)
(613
)
3
$
72,126
$
(41,927
)
$
(12,364
)
$
(620
)
$
17,215
As of March 31, 2004
Gross
Other
Carrying
Accumulated
Intangibles,
Amount
Amortization
Impairment
Other
Net
$
28,263
$
(18,886
)
$
(9,377
)
$
$
35,169
(15,494
)
(1,211
)
18,464
8,694
(6,302
)
(1,776
)
(612
)
4
$
72,126
$
(40,682
)
$
(12,364
)
$
(612
)
$
18,468
$
1,245
2,489
2,489
2,489
2,489
6,014
$
17,215
Table of Contents
Accrual
Charges
Charges
Accrual
Beginning
Charges to
Utilized
Utilized
Adjustments
Ending
Balance
Operations
in Cash
Non-cash
to Operations
Balance
$
1,585
$
$
(1,582
)
$
$
142
$
145
12,731
(3,479
)
246
9,498
$
14,316
$
$
(5,061
)
$
$
388
$
9,643
$
1,692
$
1,741
$
(1,778
)
$
$
(70
)
$
1,585
9,063
7,007
(3,903
)
564
12,731
466
(466
)
$
10,755
$
9,214
$
(5,681
)
$
(466
)
$
494
$
14,316
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.
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.
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.
In October 2001, we announced restructuring initiatives involving EA.com and
the closure of EA.coms 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.
Table of Contents
As of
As of
September 30,
March 31,
2004
2004
$
28,274
$
31,165
46,640
54,921
$
74,914
$
86,086
As of
As of
September 30,
March 31,
2004
2004
$
113,476
$
104,603
36,615
41,443
$
150,091
$
146,046
Table of Contents
Inventories as of September 30, 2004 and March 31, 2004 consisted of (in thousands):
As of
As of
September 30,
March 31,
2004
2004
$
7,544
$
2,263
71,728
52,880
$
79,272
$
55,143
Property and equipment, net, as of September 30, 2004 and March 31, 2004
consisted of (in thousands):
As of
As of
September 30,
March 31,
2004
2004
$
360,122
$
355,626
99,227
118,251
57,492
60,209
56,202
37,409
46,845
45,964
12,934
11,757
632,822
629,216
(335,337
)
(331,143
)
$
297,485
$
298,073
Accrued and other liabilities as of September 30, 2004 and March 31, 2004
consisted of (in thousands):
As of
As of
September 30,
March 31,
2004
2004
$
213,027
$
225,878
142,572
134,000
113,476
104,603
88,982
142,756
29,218
22,901
$
587,275
$
630,138
Table of Contents
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.
Actual as of
Financial Covenants
Requirement
September 30, 2004
$1,775 million
$2,906 million
3.00
25.12
60%
7.9%
1.00
11.52
1.75
N/A
Table of Contents
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
8.0 million.
The standby letter of credit expires in July 2005. As of September 30, 2004, we
had
5.3 million payable to Nintendo of Europe covered by this standby letter
of credit.
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); Major League Baseball Properties; MLB
Players Association (professional baseball) and Island Def Jam (fighting).
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 marketing commitments are included in the table below.
Contractual Obligations
Commercial Commitments
Fiscal Year
Developer/
Bank and
Letters
Ended
Licensee
Other
of
March 31,
Leases
Commitments
(1)
Marketing
Guarantees
Credit
Total
$
13,467
$
31,302
$
15,753
$
1,973
$
6,464
$
68,959
27,807
32,951
6,892
223
67,873
22,524
15,470
3,586
223
41,803
17,372
15,822
3,586
223
37,003
13,217
10,755
3,586
222
27,780
40,875
11,899
3,587
222
56,583
$
135,262
$
118,199
$
36,990
$
3,086
$
6,464
$
300,001
Table of Contents
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. We have not yet answered the
complaint.
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.
Three Months Ended
Six Months Ended
September 30,
September 30,
2004
2003
2004
2003
$
97,253
$
76,588
$
121,478
$
94,956
4,826
(1,811
)
(3,067
)
(1,504
)
(974
)
(974
)
(7
)
5,408
1,174
34
12,875
$
9,260
$
(637
)
$
(4,007
)
$
11,364
$
106,513
$
75,951
$
117,471
$
106,320
Table of Contents
Three Months Ended
Six Months Ended
September 30,
September 30,
(In thousands, except per share amounts):
2004
2003
2004
2003
$
97,253
$
76,588
$
121,478
$
94,956
304,076
294,836
303,127
292,263
11,973
12,943
12,651
11,750
316,049
307,779
315,778
304,013
$
0.32
$
0.26
$
0.40
$
0.32
$
0.31
$
0.25
$
0.38
$
0.31
Table of Contents
Three Months Ended
Six Months Ended
September 30,
September 30,
2004
2003
2004
2003
$
311,839
$
221,180
$
473,815
$
339,549
140,702
93,022
207,453
173,360
141,936
68,691
199,146
100,212
38,181
24,553
64,605
45,707
10,081
3,809
28,069
6,168
12,554
11,124
24,994
24,755
655,293
422,379
998,082
689,751
48,913
92,512
116,105
164,059
11,522
15,114
33,182
29,576
$
715,728
$
530,005
$
1,147,369
$
883,386
Asia
Pacific
North
(excluding
America
Europe
Japan)
Japan
Total
$
472,838
$
209,639
$
21,352
$
11,899
$
715,728
7,348
1,853
61
9,262
11,343
5,083
272
262
16,960
2,764,922
866,886
41,727
29,120
3,702,655
13,466
4,996
549
219
19,230
263,197
137,950
2,748
3,453
407,348
$
358,184
$
145,002
$
17,617
$
9,202
$
530,005
5,949
689
27
6,665
11,138
6,087
241
158
17,624
2,051,368
573,289
29,908
25,666
2,680,231
12,610
3,621
324
(52
)
16,503
240,050
137,157
2,244
2,288
381,739
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Asia
Pacific
North
(excluding
America
Europe
Japan)
Japan
Total
$
683,989
$
399,643
$
38,952
$
24,785
$
1,147,369
14,247
2,889
116
17,252
20,580
11,545
533
509
33,167
34,893
9,255
931
260
45,339
$
557,025
$
272,928
$
32,088
$
21,345
$
883,386
12,137
1,660
64
13,861
20,226
9,831
477
313
30,847
22,268
5,804
607
11
28,690
Table of Contents
Electronic Arts, Inc.:
October 19, 2004
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Three Months Ended September 30,
%
2004
2003
Increase
Change
$
472,838
66.1
%
$
358,184
67.6
%
$
114,654
32.0
%
209,639
29.3
%
145,002
27.4
%
64,637
44.6
%
21,352
3.0
%
17,617
3.3
%
3,735
21.2
%
11,899
1.6
%
9,202
1.7
%
2,697
29.3
%
242,890
33.9
%
171,821
32.4
%
71,069
41.4
%
$
715,728
100.0
%
$
530,005
100.0
%
$
185,723
35.0
%
Six Months Ended September 30,
%
2004
2003
Increase
Change
$
683,989
59.6
%
$
557,025
63.1
%
$
126,964
22.8
%
399,643
34.8
%
272,928
30.9
%
126,715
46.4
%
38,952
3.4
%
32,088
3.6
%
6,864
21.4
%
24,785
2.2
%
21,345
2.4
%
3,440
16.1
%
463,380
40.4
%
326,361
36.9
%
137,019
42.0
%
$
1,147,369
100.0
%
$
883,386
100.0
%
$
263,983
29.9
%
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Three Months Ended September 30,
Increase/
%
2004
2003
(Decrease)
Change
$
311,839
43.6
%
$
221,180
41.7
%
$
90,659
41.0
%
140,702
19.7
%
93,022
17.6
%
47,680
51.3
%
141,936
19.8
%
68,691
13.0
%
73,245
106.6
%
38,181
5.3
%
24,553
4.6
%
13,628
55.5
%
10,081
1.4
%
3,809
0.7
%
6,272
164.7
%
12,554
1.8
%
11,124
2.1
%
1,430
12.9
%
655,293
91.6
%
422,379
79.7
%
232,914
55.1
%
48,913
6.8
%
92,512
17.5
%
(43,599
)
(47.1
%)
11,522
1.6
%
15,114
2.8
%
(3,592
)
(23.8
%)
$
715,728
100.0
%
$
530,005
100.0
%
$
185,723
35.0
%
Six Months Ended September 30,
Increase/
%
2004
2003
(Decrease)
Change
$
473,815
41.3
%
$
339,549
38.4
%
$
134,266
39.5
%
207,453
18.1
%
173,360
19.6
%
34,093
19.7
%
199,146
17.4
%
100,212
11.4
%
98,934
98.7
%
64,605
5.6
%
45,707
5.2
%
18,898
41.3
%
28,069
2.4
%
6,168
0.7
%
21,901
355.1
%
24,994
2.2
%
24,755
2.8
%
239
1.0
%
998,082
87.0
%
689,751
78.1
%
308,331
44.7
%
116,105
10.1
%
164,059
18.6
%
(47,954
)
(29.2
%)
33,182
2.9
%
29,576
3.3
%
3,606
12.2
%
$
1,147,369
100.0
%
$
883,386
100.0
%
$
263,983
29.9
%
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September 30,
% of Net
September 30,
% of Net
2004
Revenue
2003
Revenue
% Change
$
283,911
39.7%
$
213,762
40.3%
32.8%
$
460,666
40.1%
$
363,725
41.2%
26.7%
Lower co-publishing and distribution royalties as a percentage of
total net revenue due to the lower mix of co-publishing and distribution
net revenue during the three months ended September 30, 2004 as compared
to the three months ended September 30, 2003. We estimate that lower
co-publishing and distribution royalties as a percentage of total net
revenue increased gross margin by 3.9 percentage points.
Partially offset by higher third-party development royalties as a
percentage of total net revenue primarily due to development royalties
incurred from sales of
Burnout 3: Takedown
with no comparable title in
the three months ended September 30, 2003. We estimate that higher
development royalties as a percentage of total net revenue decreased
gross margin by 1.3 percentage points.
A 1.2 percent increase in inventory-related costs, which was
partially the result of higher inventory management costs associated
with the recall of the PlayStation 2
Tiger Woods PGA Tour 2005
game in
Europe.
A 0.9 percent increase in warranty costs and online costs, which was
primarily the result of an increase in warranty usage and higher online
costs.
Lower co-publishing and distribution royalties as a percentage of
total net revenue due to the lower mix of co-publishing and distribution
net revenue during the six months ended September 30, 2004 as compared
to the six months ended September 30, 2003. We estimate that lower
co-publishing and distribution royalties as a percentage of total net
revenue increased gross margin by 3.2 percentage points.
Lower third-party development royalties as a percentage of total net
revenue primarily due to a higher mix of titles internally developed in
the six months ended September 30, 2004 offset by higher license royalty
rates as a percentage of total net revenue. We estimate that the lower
development royalties offset by the higher license royalties as a
percentage of total net revenue increased gross margin by 0.3 percentage
points.
A 1.8 percent increase in inventory-related costs, which was
partially the result of higher inventory management costs associated
with the recall of the PlayStation 2
Tiger Woods PGA Tour 2005
in
Europe.
A 0.6 percent increase in warranty and online costs, due to increased
warranty usage and higher online costs.
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September 30,
% of Net
September 30,
% of Net
2004
Revenue
2003
Revenue
$ Change
% Change
$
107,518
15.0%
$
64,041
12.1%
$
43,477
67.9%
$
170,738
14.9%
$
123,125
13.9%
$
47,613
38.7%
An increase in our marketing, advertising, contract services and
promotional expenses as we incrementally increased our advertising
campaigns in Europe, and to a lesser extent in North America, to support
the release of our new titles during the quarter, which included
Sims 2,
Burnout 3: Takedown, Catwoman
and
Def Jam Fight For NY
and increased
pre-launch spending to support
Madden NFL 2005
and
NCAA Football 2005
,
on multiple platforms $37.5 million in the three months ended
September 30, 2004; $37.6 million in the six months ended September 30,
2004.
An increase in personnel-related costs due to an increase in
headcount $4.4 million in the three months ended September 30, 2004;
$7.0 million in the six months ended September 30, 2004 and an increase
in facilities-related expenses $1.6 million in the three months ended
September 30, 2004; $3.0 million in the six months ended September 30,
2004, both to help support the growth of our marketing and sales
functions worldwide.
September 30,
% of Net
September 30,
% of Net
2004
Revenue
2003
Revenue
$ Change
% Change
$
42,043
5.9%
$
36,032
6.8%
$
6,011
16.7%
$
77,097
6.7%
$
66,792
7.6%
$
10,305
15.4%
An increase in professional and contracted services to support
various corporate initiatives $6.0 million in the three months ended
September 30, 2004; $9.9 million in the six months ended September 30,
2004.
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An increase in personnel-related costs due to an increase in employee
headcount in our North American studios $29.6 million in the three
months ended September 30, 2004; $51.2 million in the six months ended
September 30, 2004.
An overall increase in external development expenses primarily
related to the development of new products with our co-publishing
partners $8.6 million in the three months ended September 30, 2004;
$22.9 million in the six months ended September 30, 2004.
An increase in facilities-related expenses to support our studio
expansions in North America and Japan $5.2 million in the three months
ended September 30, 2004; $7.9 million in the six months ended September
30, 2004.
September 30,
% of Net
September 30,
% of Net
2004
Revenue
2003
Revenue
$ Change
% Change
$
12,183
1.7%
$
9,130
1.7%
$
3,053
33.4%
$
21,342
1.9%
$
13,979
1.6%
$
7,363
52.7%
An increase of $4.8 million due to a gain of $4.2 million on
investments in the three and six months ended September 30, 2004
compared to a loss of $0.6 million in the three and six months ended
September 30, 2003.
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An increase in interest income as a result of higher average cash,
cash equivalents and short-term investments balances in the current year
$2.9 million in the three months ended September 30, 2004; $3.7
million in the six months ended September 30, 2004.
September 30,
Effective
September 30,
Effective
2004
Tax Rate
2003
Tax Rate
% Change
$
39,724
29.0%
$
34,409
31.0%
15.4%
$
49,618
29.0%
$
42,662
31.0%
16.3%
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As of September 30,
Increase/
(In millions)
2004
2003
(Decrease)
$
2,490
$
1,734
$
756
1
(1
)
$
2,490
$
1,735
$
755
67.2%
64.7%
Six Months Ended
September 30,
September 30,
(In millions)
2004
2003
Decrease
$
23
$
28
$
(5
)
(873
)
(745
)
(128
)
86
137
(51
)
6
(6
)
$
(764
)
$
(574
)
$
(190
)
During the six months ended September 30, 2004, we generated $23.1 million of
cash in operating activities as compared to $28.2 million for the six months
ended September 30, 2003. The decrease in cash flow was primarily the result of
tax payments made during the six months ended September 30, 2004, partially
offset by an increase in net income during the same period. We expect to make
payments of approximately $57 million related to our acquisition of Criterion Software Group Ltd.
(an investing activity) during the third quarter of fiscal 2005; however, we
expect to generate significant operating cash flow during the remainder of
fiscal 2005. For the six months ended September 30, 2004, our primary use of
cash in non-operating activities consisted of net purchases of $845.6 million
in short-term investments and $45.3 million in capital expenditures, primarily
related to the expansions of our Los Angeles and Vancouver studios as well as
upgrades to our worldwide ERP systems. These non-operating expenditures were
partially offset by $85.5 million in proceeds from the sale of our common stock
through stock plans and $15.5 million in proceeds from the sale of property
during the six months ended September 30, 2004. We anticipate making continued
capital investments in our Vancouver studio during the remainder of fiscal
2005.
Our gross accounts receivable balances were $502.0 million and $366.6 million
as of September 30, 2004 and March 31, 2004, respectively. The increase in our
accounts receivable balance was expected, due to our seasonal product release
schedule. We typically experience our highest sales levels during our third
quarter ending December 31st, as a result of holiday season sales and,
accordingly, we expect our accounts receivable balance to increase during our
third quarter. Reserves for sales returns, pricing allowances and doubtful
accounts decreased from $154.7 million as of March 31, 2004 to $122.6 million
as of September 30, 2004. Our reserves remained relatively constant as a
percentage of trailing nine month total net revenue as of September 30, 2004.
We believe these reserves are adequate based on historical experience and our
current estimate of potential returns, price protection and allowances.
Inventories increased to $79.3 million as of September 30, 2004 from $55.1
million as of March 31, 2004 primarily due to the seasonality of our business
as we build inventory levels to support holiday season sales in the third
quarter. No single title represented more than $6.0 million of inventory as of
September 30, 2004.
Other current assets decreased to $140.9 million as of September 30, 2004 from
$161.9 million as of March 31, 2004 primarily due to the receipt of other
non-trade receivables.
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Accounts payable increased to $172.0 million as of September 30, 2004 from
$114.1 million as of March 31, 2004 primarily due to the higher cost of goods
sold volume and the increased marketing and advertising spending we experienced
in the second quarter of fiscal 2005 as compared to the fourth quarter of
fiscal 2004.
Our accrued and other liabilities decreased to $587.3 million as of September
30, 2004 from $630.1 million as of March 31, 2004, primarily as a result of the
payment of our fiscal 2004 bonus accrual. We anticipate that our accrued and
other liabilities balance will increase during our third quarter as we
typically experience higher balances to support our operations during the
holiday season.
We believe the existing cash, cash equivalents, short-term investments,
marketable equity securities and cash generated from operations will be
sufficient to meet our operating requirements for at least the next twelve
months, including working capital requirements, capital expenditures, our share
repurchase program, and potential future acquisitions or strategic investments.
We may choose at any time to raise additional capital to strengthen our
financial position, facilitate expansion, pursue strategic investments or to
take advantage of business opportunities as they arise. There can be no
guarantee that such additional capital will be available to us on favorable
terms, if at all, or that it will not result in substantial dilution to our
existing stockholders.
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
8.0 million.
The standby letter of credit expires in July 2005. As of September 30, 2004, we
had
5.3 million payable to Nintendo of Europe covered by this standby letter
of credit.
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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); Major League Baseball Properties; MLB
Players Association (professional baseball) and Island Def Jam (fighting).
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 marketing commitments are included in the table below.
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. We have not yet answered the
complaint.
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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.
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.
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Actual as of
September 30,
Financial Covenants
Requirement
2004
$1,775 million
$2,906 million
Fixed Charge Coverage Ratio
3.00
25.12
Total Consolidated Debt to Capital
60%
7.9%
Q1 & Q2
1.00
11.52
Q3 & Q4
1.75
N/A
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The need to implement or remediate controls, procedures and policies
appropriate for a public company in an acquired company that, prior to
the acquisition, lacked these controls, procedures and policies,
Cultural challenges associated with integrating employees from an
acquired company or business into our organization,
Retaining employees from the businesses we acquire,
The need to integrate an acquired companys accounting, management
information, human resource and other administrative systems to permit
effective management, and
To the extent that we engage in strategic transactions outside of the
United States, we face additional risks, including risks related to
integration of operations across different cultures and languages,
currency risks and the particular economic, political and regulatory
risks associated with specific countries.
Table of Contents
We utilize foreign exchange forward contracts to mitigate foreign currency risk
associated with foreign currency denominated assets and liabilities, primarily
certain intercompany receivables and payables. Our foreign exchange forward
contracts are accounted for as derivatives whereby the gains and losses on
these contracts are reflected in the Condensed Consolidated Statements of
Operations. Gains and losses on open contracts at the end of each accounting
period resulting from changes in the forward rate are recognized in earnings
and are designed to offset gains and losses on the underlying
foreign-currency-denominated assets and liabilities. As of September 30, 2004,
we had foreign exchange forward contracts, all with maturities of less than one
month, to sell approximately $240.7 million in foreign currencies, consisting
primarily of British Pounds, Euros and Japanese Yen. Of this amount, $230.1
million represents contracts to sell foreign currency in exchange for U.S.
dollars and $10.6 million represents contracts to sell foreign currency in
exchange for British Pounds.
Table of Contents
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments in our investment portfolio. We manage our interest rate risk by
maintaining an investment portfolio primarily consisting of debt instruments of
high credit quality and relatively short average maturities. Though we maintain
sufficient cash and cash equivalent balances such that we are typically able to
hold our investments to maturity, currently, the majority of our investments
are callable by the issuer.
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PART II OTHER INFORMATION
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. We have not yet answered 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 claims and litigation,
individually or in the aggregate, would not have a material adverse
effect on our consolidated financial position or results of
operations.
At our Annual Meeting of Stockholders, held on July 29, 2004, our
stockholders elected the following individuals to the Board of
Directors for one-year terms:
In addition, the following matters were voted on and approved by the
stockholders:
To amend our 2000 Equity Incentive Plan to (a) increase by 11
million the number of shares of common stock reserved for issuance
under the 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 Plan, and (f) authorize the Compensation
Committee to determine the vesting provisions of options granted to
Directors under the Plan.
To amend the 2000 Employee Stock Purchase Plan to increase by
1,500,000 the number of shares of common stock reserved for issuance
thereunder.
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.
45
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 to 1 billion shares of a single
class of common stock.
To ratify the appointment of KPMG LLP as our independent registered
public accounting firm for fiscal 2005.
The following exhibits (other than exhibits 32.1 and 32.2, which are
furnished with this report) are filed as part of this report:
46
Item 1.
Legal Proceedings
Item 4.
Submission of Matters to a Vote of Security Holders
For
Withheld
262,668,767
8,447,837
263,862,872
7,253,732
260,652,635
10,463,969
265,881,344
5,235,260
264,501,294
6,615,310
263,913,479
7,203,125
267,053,713
4,062,891
263,815,801
7,300,803
267,119,824
3,996,780
For
Against
Abstain
Broker Non-vote
43,426,675
1,887,173
20,488,901
For
Against
Abstain
Broker Non-vote
7,968,877
1,319,449
20,465,301
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For
Against
Abstain
Broker Non-vote
167,780
1,303,313
For
Against
Abstain
Broker Non-vote
42,006,711
1,280,951
For
Against
Abstain
Broker Non-vote
4,188,547
1,699,119
Item 6.
Exhibits
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
47
ELECTRONIC ARTS INC.
EXHIBIT INDEX
48
ELECTRONIC ARTS INC.
(Registrant)
/s/ Warren C. Jenson
WARREN C. JENSON
Executive Vice President,
Chief Financial and Administrative Officer
Table of Contents
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2004
Exhibit 3.01
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
OF
ELECTRONIC ARTS INC.
Electronic Arts Inc., a Delaware corporation, hereby certifies that:
1. The name of the corporation is Electronic Arts Inc. The date of
filing its original Certificate of Incorporation with the Secretary of State
was May 8, 1991.
2. This Amended and Restated Certificate of Incorporation of the
corporation attached hereto as
Exhibit A
, which is incorporated herein by
this reference, and which restates, integrates and further amends the
provisions of the Certificate of Incorporation of this corporation as
heretofore amended or supplemented, has been duly adopted by the corporations
Board of Directors and its stockholders in accordance with Sections 242 and
245 of the Delaware General Corporation Law.
IN WITNESS WHEREOF, said corporation has caused this Amended and Restated
Certificate of Incorporation to be signed by its duly authorized officer and
the foregoing facts stated herein are true and correct.
Dated:
August 2, 2004
ELECTRONIC ARTS INC.
By:
/s/ Stephen G. Bené
Name:
Stephen G. Bené
Title:
Vice President, Acting General Counsel
and Corporate Secretary
EXHIBIT A
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
OF
ELECTRONIC ARTS INC.
ARTICLE I
The name of the corporation is Electronic Arts Inc. (the Company).
ARTICLE II
The address of the registered office of the Company in the State of Delaware is 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of its registered agent at that address is The Company Trust Company.
ARTICLE III
The purpose of the Company is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware.
ARTICLE IV
The total number of shares of stock of all classes which the Company is authorized to issue is 1,010,000,000 shares, consisting of 1,000,000,000 shares of Common Stock, par value $0.01 per share (Common Stock), and 10,000,000 shares of Preferred Stock, par value $0.01 per share. Effective upon the filing of this Amended and Restated Certificate of Incorporation, each share of Class A Common Stock outstanding immediately prior thereto shall thereupon automatically be re-classified as one share of Common Stock (and outstanding certificates that had theretofore represented shares of Class A Common Stock shall thereupon represent an equivalent number of shares of Common Stock despite the absence of any indication thereon to that effect). Effective upon the filing of this Amended and Restated Certificate of Incorporation, each share of Class B Common Stock outstanding immediately prior thereto shall thereupon automatically be converted into 0.001 of a share of Common Stock (and outstanding certificates that had theretofore represented shares of Class B Common Stock shall thereupon represent the number of shares of Common Stock they have been converted into despite the absence of any indication thereon to that effect). No fractional share shall be issued in connection with the foregoing conversion of Class B Common Stock and all shares of Class B Common Stock so converted that are held by a stockholder will be aggregated and combined subsequent to the foregoing conversion and the Company shall pay in cash the fair value of such fractional shares remaining after such aggregation, as determined in good faith by the Companys Board of Directors when those entitled to receive such fractional shares are determined.
The Board of Directors is authorized, subject to any limitations prescribed by the law of the State of Delaware, to provide for the issuance of Preferred Stock in one or more series, to establish from time to time the number of shares to be included in each such series, to fix the designation, powers, preferences and rights of the shares of each such series and any qualifications, limitations or restrictions thereof, and to increase or decrease the shares of any such series (but not below the number of shares of such series then outstanding).
ARTICLE V
The stockholders of the Company shall have the power to adopt, amend or repeal the Bylaws. The Board of Directors of the Company shall also have the power to adopt, amend or repeal Bylaws of the Company, except insofar as Bylaws adopted by the stockholders shall otherwise provide.
ARTICLE VI
Election of Directors need not be by written ballot unless a stockholder demands election by written ballot at a stockholder meeting and before voting begins, or unless the Bylaws of the Company shall so provide.
ARTICLE VII
A Director of the Company shall not be personally liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the Directors duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law or (iv) for any transactions from which the Director derived an improper personal benefit.
If the Delaware General Corporation Law is hereafter amended to authorize the further elimination or limitation of the liability of a Director, then the liability of a director of the Company shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended.
Neither any amendment nor repeal of this Article VII, nor the adoption of any provision of this Certificate of Incorporation inconsistent with this Article VII, shall eliminate, reduce or otherwise adversely affect any limitation on the personal liability of a director of the Company existing at the time of such amendment, repeal or adoption of an inconsistent provision.
ARTICLE VIII
Any action required or permitted to be taken by the stockholders of the Company must be taken at a duly called annual or special meeting of such holders and may not be taken by consent in writing by such holders. Except as otherwise provided for herein or required by law, special meetings of stockholders of the Company for any purpose or purposes may be called only by the Chairman of the Board of Directors pursuant to a resolution stating the purpose or purposes thereof, and stockholders shall not have any power to call a special meeting.
Exhibit 15.1
Awareness Letter of KPMG LLP, Independent Registered Public Accounting Firm
The Board of Directors and
Stockholders
Electronic Arts Inc.:
With respect to the registration statements on Forms S-8 (Nos. 33-66836, 33-55212, 33-53302, 33-41955, 33-82166, 33-61781, 33-61783, 333-09683, 333-09893, 333-32239, 333-32771, 333-46937, 333-60513, 333-60517, 333-84215, 333-39430, 333-39432, 333-44222, 333-60256, 333-67430, 333-82888, 333-99525, 333-107710, and 333-117990), and the registration statement on Form S-3 (No. 333-102797), of Electronic Arts Inc., we acknowledge our awareness of the use therein of our report dated October 19, 2004 relating to the unaudited condensed consolidated interim financial statements of Electronic Arts Inc. and subsidiaries that are included in its Form 10-Q for the three and six-month periods ended September 30, 2004.
Pursuant to Rule 436 under the Securities Act of 1933 (the Act), such report is not considered part of a registration statement prepared or certified by an accountant, or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of the Act.
KPMG LLP
San Francisco, California
November 2, 2004
Exhibit 31.1
ELECTRONIC ARTS INC.
Pursuant to Rule 13a-14(a) of the Exchange Act
As Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Lawrence F. Probst III, Chairman and Chief Executive Officer, certify that:
1. | I have reviewed this Quarterly Report on Form 10-Q of Electronic Arts Inc.; | |||
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; | |||
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; | |||
4. | The registrants other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.
Dated: November 3, 2004
|
By: | /s/ Lawrence F. Probst III | ||
|
|
|||
|
Lawrence F. Probst III | |||
|
Chairman and Chief Executive Officer |
Exhibit 31.2
ELECTRONIC ARTS INC.
Pursuant to Rule 13a-14(a) of the Exchange Act
As Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
I, Warren C. Jenson, Executive Vice President, Chief Financial and Administrative Officer, certify that:
1. | I have reviewed this Quarterly Report on Form 10-Q of Electronic Arts Inc.; | |||
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; | |||
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; | |||
4. | The registrants other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: |
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrants disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrants internal control over financial reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrants internal control over financial reporting; and
5. | The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent functions): |
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal control over financial reporting.
Dated: November 3, 2004
|
By: | /s/ Warren C. Jenson | ||
|
|
|||
|
Warren C. Jenson | |||
|
Executive Vice President, | |||
|
Chief Financial and Administrative Officer |
Exhibit 32.1
ELECTRONIC ARTS INC.
Certification of Chairman and Chief Executive Officer
In connection with the Quarterly Report of Electronic Arts Inc. on Form 10-Q
for the period ended September 30, 2004 as filed with the Securities and
Exchange Commission on the date hereof (the Report), I, Lawrence F. Probst
III, Chairman and Chief Executive Officer of Electronic Arts Inc., certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Section 906), that to my knowledge:
A signed original of this written statement required by Section 906, or other
document authenticating, acknowledging, or otherwise adopting the signature
that appears in typed form within the electronic version of this written
statement required by Section 906, has been provided to Electronic Arts and
will be retained by Electronic Arts and furnished to the Securities and
Exchange Commission or its staff upon request.
Pursuant to 18 U.S.C. Section 1350
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
1.
The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2.
The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of Electronic Arts Inc. for the periods presented therein.
Exhibit 32.2
ELECTRONIC ARTS INC.
Certification of Executive Vice President, Chief Financial and Administrative Officer
In connection with the Quarterly Report of Electronic Arts Inc. on Form 10-Q
for the period ended September 30, 2004 as filed with the Securities and
Exchange Commission on the date hereof (the Report), I, Warren C. Jenson,
Executive Vice President and Chief Financial and Administrative Officer of
Electronic Arts Inc., certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 906), that
to my knowledge:
A signed original of this written statement required by Section 906, or other
document authenticating, acknowledging, or otherwise adopting the signature
that appears in typed form within the electronic version of this written
statement required by Section 906, has been provided to Electronic Arts and
will be retained by Electronic Arts and furnished to the Securities and
Exchange Commission or its staff upon request.
Pursuant to 18 U.S.C. Section 1350
As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
1.
The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2.
The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of Electronic Arts Inc. for the periods presented therein.