-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WsDSRKoeVIKWhQk66JYjdtgtak2xUaz/2mF9oq/UEwXRBogX4an0vDlJvwotGWGf HJIPwcC0VNzpADAIbYSxpQ== 0000898430-98-000618.txt : 19980218 0000898430-98-000618.hdr.sgml : 19980218 ACCESSION NUMBER: 0000898430-98-000618 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980217 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELECTRONIC ARTS INC CENTRAL INDEX KEY: 0000712515 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 942838567 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-17948 FILM NUMBER: 98542821 BUSINESS ADDRESS: STREET 1: 1450 FASHION ISLAND BLVD CITY: SAN MATEO STATE: CA ZIP: 94404 BUSINESS PHONE: 4155717171 FORMER COMPANY: FORMER CONFORMED NAME: ELECTRONIC ARTS DATE OF NAME CHANGE: 19911211 10-Q 1 FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ______ to_____ Commission File No. 0-17948 ELECTRONIC ARTS INC. (Exact name of registrant as specified in its charter) Delaware 94-2838567 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1450 Fashion Island Boulevard San Mateo, California 94404 (Address of principal executive offices) (Zip Code) (650) 571-7171 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO _____ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock January 24, 1998 --------------------- ---------------- $0.01 par value per share 59,242,893 ELECTRONIC ARTS INC. AND SUBSIDIARIES INDEX Part I - Financial Information Page - ------------------------------ ---- Item 1. Consolidated Financial Statements Consolidated Balance Sheets at December 31, 1997 and March 31, 1997 3 Consolidated Statements of Income for the Three Months Ended December 31, 1997 and 1996 4 and the Nine Months Ended December 31, 1997 and 1996 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 1997 and 1996 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Part II - Other Information Item 1. Legal Proceedings 29 Item 4. Submission of Matters to a Vote of Security Holders 29 Item 6. Exhibits and Reports on Form 8-K 29 Signatures 30 Exhibit Index 31
2 PART I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) ASSETS
December 31, March 31, 1997 1997 ----------------- ------------- (unaudited) (unaudited) Current assets: Cash and short-term investments $287,813 $268,141 Marketable securities 3,128 5,548 Receivables, less allowances of $68,935 and $43,268, respectively 273,257 103,244 Inventories 32,259 17,873 Prepaid royalties 14,378 10,311 Deferred income taxes 6,008 5,259 Other current assets 13,005 10,724 -------- -------- Total current assets 629,848 421,100 Property and equipment, net 93,101 89,762 Prepaid royalties 6,310 9,351 Long-term investments 27,311 34,478 Investments in affiliates 20,041 25,657 Other assets 4,166 3,693 -------- -------- $780,777 $584,041 ======== ======== LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $95,491 $43,450 Accrued liabilities 160,705 92,787 -------- -------- Total current liabilities 256,196 136,237 Minority interest in consolidated joint venture - 28 Stockholders' equity: Preferred stock, $0.01 par value. Authorized 1,000,000 shares - - Common stock, $0.01 par value. Authorized 104,000,000 shares; issued and outstanding 59,166,510 and 58,263,058, respectively 592 583 Paid-in capital 210,633 188,547 Retained earnings 315,188 257,978 Unrealized appreciation of investments 1,227 2,593 Translation adjustment (3,059) (1,925) -------- -------- Total stockholders' equity 524,581 447,776 -------- -------- $780,777 $584,041 ======== ========
See accompanying notes to consolidated financial statements. 3 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (unaudited)
Three Months Ended Nine Months Ended December 31, December 31, 1997 1996 1997 1996 -------------- ------------------- -------------- ---------------- Net revenues $391,245 $290,849 $704,785 $516,855 Cost of goods sold 210,799 142,655 376,752 253,142 ------- ------- ------- ------- Gross profit 180,446 148,194 328,033 263,713 ------- ------- ------- ------- Operating expenses: Marketing and sales 45,027 38,886 100,695 79,377 General and administrative 17,578 13,614 42,658 37,028 Research and development 45,358 37,053 109,292 96,978 Charge for acquired in-process technology 1,500 - 1,500 - Merger costs - - 10,792 - ------- ------ ------- ------ Total operating expenses 109,463 89,553 264,937 213,383 ------- ------ ------- ------- Operating income 70,983 58,641 63,096 50,330 Interest and other income, net 16,558 1,343 22,250 10,147 ------- ------ ------- ------- Income before provision for income taxes and minority interest 87,541 59,984 85,346 60,477 Provision for income taxes 28,921 21,281 28,164 21,058 ------- ------ ------- ------- Income before minority interest 58,620 38,703 57,182 39,419 Minority interest in consolidated joint venture - - 28 1,291 ------- ------- ------- ------- Net income $58,620 $38,703 $57,210 $40,710 ======= ====== ======= ======= Net income per share - basic $0.99 $0.67 $0.98 $0.71 ======= ====== ======= ======= Net income per share - diluted $0.96 $0.65 $0.94 $0.68 ======= ====== ======= ======= Number of shares used in computation - - basic 58,961 57,800 58,615 57,366 ======= ====== ======= ======= Number of shares used in computation - - diluted 61,134 59,989 60,571 59,445 ======= ====== ======= =======
See accompanying notes to consolidated financial statements. 4 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (unaudited)
Nine Months Ended December 31, 1997 1996 -------------- ------------- Operating activities: Net income $ 57,210 $ 40,710 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Minority interest in consolidated joint venture (28) (1,291) Equity in net loss of affiliates 1,162 1,149 Gain on sale of affiliate (12,625) - Depreciation and amortization 20,393 16,247 (Gain) loss on sale of fixed assets 480 (38) Loss on disposition of assets related to merger 5,607 - Gain on sale of marketable securities (3,757) (6,700) Charge for acquired in-process technology 1,500 - Change in assets and liabilities: Receivables (170,013) (131,011) Inventories (14,386) (4,341) Prepaid royalties (1,026) 7,878 Other assets (1,760) (958) Accounts payable 52,041 19,377 Accrued liabilities 64,110 69,349 Deferred income taxes 53 (169) ------------- ------------ Net cash provided by (used in) operating activities (1,039) 10,202 ------------- ------------ Investing activities: Proceeds from sales of furniture and equipment 25 152 Proceeds from sales of marketable securities 6,824 19,121 Purchase of marketable securities (2,762) - Capital expenditures (25,358) (29,946) Acquisition of minority interest in EA Japan (3,225) - Investment in affiliates 17,079 (4,770) Purchase of held to maturity securities (1,008) (18,521) Proceeds from maturity of securities 6,240 17,253 Change in short-term investments, net (4,428) 335 Other 211 216 ------------- ------------ Net cash used in investing activities (6,402) (16,160) ------------- ------------ Financing activities: Proceeds from issuance of common stock 19,306 16,174 Tax benefit from exercise of stock options 2,789 7,437 ------------- ------------ Net cash provided by financing activities 22,095 23,611 ------------- ------------ Translation adjustment (1,134) 2,151 Minority interest on translation adjustment - 14 ------------- ------------ Increase in cash and cash equivalents 13,520 19,818 Beginning cash and cash equivalents 141,996 125,730 ------------- ------------ Ending cash and cash equivalents 155,516 145,548 Short-term investments 132,297 61,447 ------------- ------------ Ending cash and short-term investments $287,813 $206,995 ============= ============
5 ELECTRONIC ARTS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (Dollars in thousands) (unaudited)
Nine Months Ended December 31, 1997 1996 --------------------- Supplemental cash flow information: Cash paid during the year for income taxes $ 4,348 $ 2,099 ======= ======== Non-cash investing activities: Decline on unrealized appreciation of investments $(2,115) $(12,719) ======== ========
See accompanying notes to consolidated financial statements. 6 ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The 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 period. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. Certain amounts have been reclassified to conform to the fiscal 1998 presentation. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Electronic Arts Inc. (the "Company") Annual Report on Form 10-K for the fiscal year ended March 31, 1997 as filed with the Securities and Exchange Commission ("Commission") on June 23, 1997 and certain other information included in the Company's Registration Statement on Form S-4 as filed with the Commission on June 25, 1997. NOTE 2. PREPAID ROYALTIES Prepaid royalties consist primarily of prepayments for manufacturing royalties, original equipment manufacturer (OEM) fees and license fees paid to celebrities and professional sports organizations for use of their trade name. Also included in prepaid royalties are prepayments made to independent software developers under development arrangements that have alternative future uses. Prepaid royalties are expensed at the contractual royalty rate as cost of goods sold based on actual net product sales. Management evaluates the future realization of prepaid royalties quarterly and charges to income any amounts that management deems unlikely to be realized through product sales. Royalty advances are classified as current and non-current assets based upon estimated net product sales within the year. NOTE 3. INVENTORIES Inventories are stated at the lower of cost or market. Inventories at December 31, 1997 and March 31, 1997 consisted of (in thousands):
December 31, 1997 March 31, 1997 ----------------- -------------- Raw materials and work in process $ 7,153 $ 4,714 Finished goods 25,106 13,159 ------- ------ $32,259 $17,873 ======= =======
NOTE 4. ACCRUED LIABILITIES Accrued liabilities at December 31, 1997 and March 31, 1997 consisted of (in thousands):
December 31, 1997 March 31, 1997 ----------------- -------------- Accrued royalties $ 57,890 $33,592 Accrued expenses 48,892 24,792 Accrued income taxes 21,922 12,611 Accrued compensation and benefits 27,259 19,750 Deferred income taxes 1,438 1,385 Deferred revenue 2,640 657 Accrued merger expenses 664 - -------- ------- $160,705 $92,787 ======== =======
7 ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 5. OPERATIONS BY GEOGRAPHIC AREAS The Company operates in one industry segment. Information about the Company's operations in North America, Europe, South Asia Pacific and Japan for the three and nine months ended December 31, 1997 and 1996 is presented below (in thousands).
North South Asia America Europe Pacific Japan Eliminations Total ------- ------ ---------- ----- ------------ ----- Three months ended December 31, 1997 Net revenues from unaffiliated customers $230,079 $140,778 $15,070 $5,318 $ - $391,245 Intersegment net revenues 25,127 2,187 141 109 (27,564) - -------- -------- ------- ------ -------- -------- Total net revenues $255,206 $142,965 $15,211 $5,427 $(27,564) $391,245 ======== ======== ======= ====== ========= ======== Operating income (loss) $45,206 $24,001 $3,379 $(1,603) $ - $70,983 Identifiable assets $541,576 $204,554 $24,036 $10,611 $ - $780,777 Nine months ended December 31, 1997 Net revenues from unaffiliated customers $406,930 $247,979 $33,845 $16,031 $ - $704,785 Intersegment net revenues 42,251 7,586 486 109 (50,432) - -------- -------- ------- ------ -------- -------- Total net revenues $449,181 $255,565 $34,331 $16,140 $(50,432) $704,785 ======== ======== ======= ======= ========= ======== Operating income (loss) $ 29,689 $ 32,218 $ 7,124 $(5,935) $ - $ 63,096 Three months ended December 31, 1996 Net revenues from unaffiliated customers $162,546 $104,985 $10,025 $13,293 $ - $290,849 Intersegment net revenues 28,185 2,797 - 56 (31,038) - -------- -------- ------- ------ -------- -------- Total net revenues $190,731 $107,782 $10,025 $13,349 $(31,038) $290,849 ======== ======== ======= ======= ========= ======== Operating income (loss) $ 34,970 $ 22,233 $ 2,687 $(1,249) $ - $ 58,641 Identifiable assets $443,522 $150,712 $14,288 $22,529 $ - $631,051 Nine months ended December 31, 1996 Net revenues from unaffiliated customers $301,663 $169,903 $20,998 $24,291 $ - $516,855 Intersegment net revenues 42,952 5,046 - 67 (48,065) - -------- -------- ------- ------ -------- -------- Total net revenues $344,615 $174,949 $20,998 $24,358 $(48,065) $516,855 ======== ======== ======= ======= ========= ======== Operating income (loss) $24,744 $26,125 $4,892 $(5,431) $ - $50,330
8 ELECTRONIC ARTS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 6. FOREIGN CURRENCY The Company utilizes foreign currency forward exchange contracts to hedge foreign currency market exposures of underlying assets, liabilities and other obligations, primarily intercompany receivables that are denominated in foreign currencies. The Company does not use forward exchange contracts for speculative or trading purposes. The Company transacts business in various foreign currencies, including European and Canadian currencies. At December 31, 1997 and March 31, 1997, the Company had foreign exchange contracts, all having maturities of 90 days or less, to purchase and sell approximately $17,520,000 and $27,549,000, respectively, in foreign currencies, primarily German Deutschmarks, Swedish Krona, Netherlands Guilders and British Pounds. Gains and losses on currency forward contracts that are designated and effective as hedges of existing transactions are recognized in income in the same period as losses and gains on the underlying transactions are recognized and generally offset. The difference between the face value and market value of these contracts is not significant. The counterparties to these contracts are substantial and credit worthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts are not considered to be material. NOTE 7. ACQUISITION AND DIVESTITURE In December 1997, the Company completed the sale of Creative Wonders, LLC, a 50% joint venture company formed with the Walt Disney Company for $16,750,000 in cash. The Company recognized a gain of $12,625,000, included in interest and other income. In December 1997, the Company acquired the remaining 35% ownership interest in Electronic Arts Victor, Inc. ("EAV") from Victor Entertainment Industries, Inc. ("VEI") for approximately $3,225,000 in cash. As a result of the acquisition, the joint venture has become a wholly-owned subsidiary of the Company and has been renamed Electronic Arts, K.K. The acquisition was accounted for as a step acquisition purchase and the excess purchase price over fair value of the net tangible assets acquired was allocated to purchased in-process technology, goodwill and other intangible assets. The Company incurred a charge to operations of $1,500,000 for the acquired in-process technology as of the date of the acquisition after concluding that the related technology had no alternative future use after taking into consideration the potential for usage of the software in different products and resale of the software. The goodwill and other intangible assets of approximately $1,700,000 is being amortized over 7 years. The results of operations reflect a minority interest elimination through the date of the acquisition. No minority interest in EAV was recorded for the losses generated in the three months ended December 31, 1997 as VEI's interest in the net equity of EAV had fallen below zero. 9 NOTE 8. EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No 128, "Earnings per Share" (SFAS 128). SFAS 128 requires dual presentation of basic earnings per share ("EPS") and diluted EPS on the face of all statements of earnings for all entities with complex capital structures. Basic EPS is computed as net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock-based compensation plans including stock options, restricted stock awards, warrants and other convertible securities using the treasury stock method. The following summarizes the computation of Basic EPS and Diluted EPS (in thousands except for per share amounts):
Three Months Ended Nine Months Ended December 31, December 31, 1997 1996 1997 1996 ----------- ---------------- --------------- --------------- Net Income $58,620 $38,703 $57,210 $40,710 Shares: Weighted Average Common Shares 58,961 57,800 58,615 57,366 Dilutive Stock Options 2,173 2,189 1,956 2,079 -------- ------ ------ ------ Dilutive Potential Common Shares 61,134 59,989 60,571 59,445 ======== ====== ====== ====== Earnings Per Share: Basic $0.99 $0.67 $0.98 $0.71 Diluted $0.96 $0.65 $0.94 $0.68
10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q and in particular Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward looking statements regarding future events or the future financial performance of the Company that involve certain risks and uncertainties discussed in "Factors Affecting Future Performance" below at pages 23 to 28, as well as in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 1997 as filed with the Securities and Exchange Commission on June 23, 1997 and the Company's Registration Statement on Form S-4 filed with the Commission on June 25, 1997. Actual events or the actual future results of the Company may differ materially from any forward looking statement due to such risks and uncertainties.
Net Revenues December 31, December 31, 1997 1996 % change ------------------- ------------------ ----------------- Consolidated Net Revenues Three Months Ended $391,245,000 $290,849,000 34.5% Nine Months Ended $704,785,000 $516,855,000 36.4% North America Net Revenues Three Months Ended $230,079,000 $162,546,000 41.5% as a percentage of net revenues 58.8% 55.9% Nine Months Ended $406,930,000 $301,663,000 34.9% as a percentage of net revenues 57.7% 58.4% International Net Revenues Three Months Ended $161,166,000 $128,303,000 25.6% as a percentage of net revenues 41.2% 44.1% Nine Months Ended $297,855,000 $215,192,000 38.4% as a percentage of net revenues 42.3% 41.6%
The Company derives revenues from shipments of EA Studio Compact Disk ("CD") products for dedicated entertainment systems ("CD- video games"), EA Studio CD personal computer products ("PC CD") (primarily entertainment software), EA Studio cartridge products, licensing of EA Studio products, distribution of EA Studio and Affiliated Label ("AL") products through hardware companies ("OEMs") and shipments of AL products that are published by third parties. 11 North America net revenues increased $67,533,000, or 41.5%, and $105,267,000, or 34.9%, for the three and nine months ended December 31, 1997, respectively, compared to the same periods last year primarily due to increased sales of Sony PlayStation ("PlayStation") titles; a key release for the Nintendo 64 ("N64") and increased Affiliated Label revenues resulting from the addition of Accolade and key releases of new products from other affiliates. North America PlayStation sales reflected the increase in installed base of these consoles and the release of hit sports titles for this platform. Total North America PlayStation revenue increased $48,126,000 or 108.9% and $88,225,000 or 98.5% for the three and nine month periods, respectively. N64 net revenues in North America were $38,790,000 and $39,426,000 for the three and nine months ended December 31, 1997, respectively, and are primarily comprised of sales of Madden 64 which was released in the quarter ended December 1997. There were no sales of N64 products in the comparable prior year periods. Affiliated Label revenues increased $17,498,000, or 122.1%, and $34,027,000, or 121.0%, for the three and nine months ended December 31, 1997, respectively. For the quarter ended December 1997, Affiliated Label sales increased primarily due to the release of Test Drive 4 published by Accolade, Inc., an affiliate added in the quarter ended March 1997. Accordingly, there were no revenues generated by this affiliate in the prior year. In addition to increased sales of Accolade products, year to date Affiliated Label sales in the North America increased due to the release of The Lost World: Jurassic Park ("Jurassic Park") which was co-published by the Company and Dreamworks Interactive and released in the quarter ended September 1997. The increase in North America net revenues was partially offset by a decrease in net revenues from the sales of 16-bit cartridge products and, to a lesser degree, from Sega Saturn ("Saturn") sales. 16-bit revenues decreased $36,529,000, or 89.2%, and $50,336,000, or 85.0%, compared to the prior year three and nine month periods due to the completed transition of 16-bit cartridge platforms to 32-bit and 64-bit video games. Sales of Saturn titles decreased $4,169,000 and $6,879,000 for the three and nine months ended December 31, 1997, respectively, as this platform has not achieved the level of market acceptance as compared to other next generation platforms. Though North America net revenues are expected to continue to grow in fiscal 1998, they may not grow at as high a rate as compared to this quarter. International net revenues increased $32,863,000, or 25.6%, and $82,663,000, or 38.4%, for the three and nine months ended December 31, 1997 compared to the same periods last year. The increase in international revenues for these periods was primarily due to growth in European net revenues consisting of higher sales of AL and PlayStation products, and to a lesser degree, N64 and PC CD sales. Total net revenues in Europe were $140,778,000 for the three months ended December 31, 1997 compared to $104,985,000 in the same period last year, while revenues for the nine month period were $247,979,000 compared to $169,903,000 in the same period last year. European AL sales increased $20,989,000 for the three months and $40,794,000 for the nine months ended December 31, 1997 compared to the prior year due to the third quarter release of Croc - Legend of Gobbos ("Croc"), published by Twentieth Century Fox Home Entertainment ("Fox"), Test Drive 4 published by Accolade and continued distribution under an exclusive international agreement with Fox and other affiliates. In addition, AL sales for the nine month period increased due to the worldwide release of Jurassic Park, as noted above. 12 European PlayStation sales increased $18,501,000, or 60.2%, and $33,181,000, or 72.8%, for the three and nine months ended December 31, 1997, respectively, reflecting the worldwide growth in installed base of this platform. European N64 sales were $8,306,000 and $10,269,000 for the three and nine month periods ended December 1997 due to the release of FIFA: Road to the World Cup in the third fiscal quarter. There were no sales of N64 products in Europe in the comparable prior year periods. European PC CD sales increased $5,467,000, or 16.5%, and $15,526,000, or 27.9%, for the three and nine months ended December 31, 1997, respectively, primarily due to growth of this platform in Europe and as a result of strong sales of Dungeon Keeper, which was released in the first fiscal quarter of 1998. Overall European sales were offset by a decrease in 16-bit revenues of $13,191,000 and $16,502,000, for the three and nine months ended December 31, 1997, respectively, attributable to the transition to 32-bit and 64-bit video games. Sales in the South Asia Pacific region increased by 50.3% to $15,070,000 for the three months ended December 31, 1997 compared to $10,025,000 in the prior year while revenues for the nine month period were $33,845,000 compared to $20,998,000 in the prior year. The increase is attributable to increased sales of Affiliated Label, PC CD and PlayStation titles resulting from both the increase in installed base of these platforms and the growth in sales offices throughout the region, including China, Singapore, New Zealand and Hong Kong. Revenues from the sale of Affiliated Label titles for the three month period increased $2,561,000 to $5,048,000 as a result of key releases from certain affiliates and continued distribution of Fox titles, as noted above. AL revenues for the nine months ended December 31, 1997 were $11,624,000 compared to $3,983,000 in the prior year. For the three and nine months ended December 31, 1997, PC CD net revenues increased $1,325,000 and $2,684,000, respectively, while PlayStation net revenues increased $1,361,000 and $2,885,000, respectively. Net revenues in Japan for the third fiscal quarter of 1998 were $5,318,000 compared to $13,293,000 for the corresponding period in the prior year while year to date revenues were $16,031,000 versus $24,291,000 for the comparable period last year. The decrease in revenues was due primarily to the lack of locally developed titles in this market, primarily for the PlayStation, and the significant decline in sales of Saturn products, which represented 29% of third quarter sales last year, offset by additional sales of PC CD titles. In the quarter ended December 31, 1997, the Company released no original titles for the PlayStation compared to one in the comparable prior year period. 13 EA STUDIO NET REVENUES: - ---------------------- 32-BIT VIDEO GAME PRODUCT NET REVENUES
December 31, December 31, 1997 1996 % change ----------------- ------------------- ------------- Three Months Ended $152,021,000 $96,352,000 57.8% as a percentage of net revenues 38.9% 33.1% Nine Months Ended $286,108,000 $179,250,000 59.6% as a percentage of net revenues 40.6% 34.7%
The Company released seven 32-bit CD-video game products during the third quarter of fiscal 1998 comprised of four for the PlayStation, including NBA Live 98, FIFA: Road To The World Cup 98 and MotoRacer, and three for the Saturn, including NASCAR 98. The increase in sales for the three and nine months ended December 31, 1997 compared to the prior year periods is attributable to the greater installed base of PlayStation consoles and the related release of key titles for this platform during the quarter offset by a decline in Saturn revenues. For the three months ended December 31, 1997, the majority of the 32-bit videogame revenue increase was attributable to PlayStation sales which were $146,526,000, compared to $82,502,000 for the three months ended December 31, 1996. For the nine months ended December 31, 1997 and 1996, PlayStation revenues were $271,188,000 and $152,934,000, respectively. The Company expects revenues from PlayStation products to continue to grow in fiscal 1998, but as revenues for these products increase, the Company does not expect to maintain these growth rates. Net revenue from the sale of other 32-bit products, primarily from sales of products for the Saturn, were $5,495,000 for the quarter ended December 31, 1997 compared to $13,850,000 for the same period in the prior year. For the nine months ended December 31, 1997 and 1996 other 32-bit revenues were $14,920,000 and $26,316,000, respectively. As the installed base of Saturn consoles has not achieved the growth rates of PlayStation consoles, the Company's revenues from sales of Saturn products have declined and are expected to decline further in future years. The Company plans fewer releases of Saturn products in fiscal 1998 than fiscal 1997 and currently plans to release one Saturn product after the quarter ending December 31, 1997. Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994 (the "Sony Agreement"), as amended, the Company is authorized to develop and distribute CD-based software products compatible with the PlayStation. Pursuant to the Sony Agreement, the Company engages Sony to supply PlayStation CDs for distribution by the Company. Accordingly, the Company has limited ability to control its supply of PlayStation CD products or the timing of their delivery. See Hardware Companies, below. 14 Under the terms of a licensing agreement entered into with Sega Enterprises, Ltd. in January 1995 (the "Sega Saturn Agreement"), the Company is authorized to develop and distribute CD-based software products compatible with the Sega Saturn. Pursuant to the Sega Saturn Agreement, the Company engages various third party manufacturers approved by Sega to supply its Saturn CDs for distribution. Accordingly, the Company has limited ability to control its supply of Saturn CD products or the timing of their delivery. See Hardware Companies, below. PERSONAL COMPUTER CD PRODUCT NET REVENUES
December 31, December 31, 1997 1996 % change ------------------ ------------------- ------------- Three Months Ended $101,054,000 $90,374,000 11.8% as a percentage of net revenues 25.8% 31.1% Nine Months Ended $188,474,000 $166,481,000 13.2% as a percentage of net revenues 26.7% 32.2%
The Company released thirteen PC CD titles in the third quarter of the current fiscal year for the IBM personal computer and compatibles including Wing Commander Prophecy and Nuclear Strike, compared to thirteen for the same period last year. The increase in sales of PC CD products for the nine months ended December 31, 1997 is attributable to growth in the PC CD market worldwide and expansion of the Company's direct worldwide distribution. Year to date PC CD sales also increased due to the worldwide release of Dungeon Keeper during the first quarter. The growth in PC CD sales for the three and nine month periods ended December 31, 1997 was partially offset by a decline in titles published by Maxis. Maxis revenues for the three and nine months ended December 31, 1997, decreased $10,285,000, or 59.7%, and $11,409,000, or 42.1%, respectively. Though PC CD revenues are expected to continue to grow in fiscal 1998, they may not grow at as high a rate as in prior periods. 64-BIT VIDEO GAME PRODUCT NET REVENUES
December 31, December 31, 1997 1996 % change ------------------ ------------------- ------------- Three Months Ended $47,514,000 $ - N/M as a percent of net revenues 12.1% N/A Nine Months Ended $50,547,000 $ - N/M as a percent of net revenues 7.2% N/A
The Company released two N64 titles, Madden 64 and FIFA: Road to the World Cup 98, in the quarter ended December 31, 1997. The Company had its initial release of a title for the N64 in the quarter ended March 31, 1997 and accordingly there were no revenues from the sales of N64 titles in the comparable three and nine month periods. In March 1997, the Company signed a licensing agreement with Nintendo to develop, publish and market certain sports products for the N64. Due to the development time necessary for these products, the Company does not anticipate shipping any additional products for the N64 in the fiscal year ending March 31, 1998. 15 Under the terms of its licensing agreement with Nintendo, the Company engages Nintendo to manufacture its N64 cartridges for distribution. Accordingly, the Company has little ability to control its supply of cartridges or the timing of their delivery. A shortage of microchips or other factors outside the control of the Company could impair the Company's ability to obtain an adequate supply of cartridges. In connection with the Company's purchases of N64 cartridges for distribution in North America, Nintendo requires that the Company provide it irrevocable letters of credit prior to Nintendo's acceptance of purchase orders from the Company for purchases of these cartridges. For purchases of N64 cartridges for distribution in Japan and Europe, Nintendo requires the Company to make cash deposits. Furthermore, Nintendo maintains a policy of not accepting returns. Because of these and other factors, the carrying of an inventory of cartridges entails significant investment and risk. See Hardware Companies, below. LICENSE/OEM NET REVENUES
December 31, December 31, 1997 1996 % change ----------------- ------------------- ------------- Three Months Ended $3,466,000 $8,897,000 (61.0%) as a percentage of net revenues 0.9% 3.1% Nine Months Ended $11,320,000 $20,102,000 (43.7%) as a percentage of net revenues 1.6% 3.9%
The decrease in license/OEM net revenues for the three and nine months ended December 31, 1997 compared to the same period last year was primarily a result of a decrease in the licensing of Maxis products in Europe and Japan and of EA products in Europe.
16-BIT VIDEO GAME PRODUCT NET REVENUES December 31, December 31, 1997 1996 % change ----------------- ------------------- ------------- Three Months Ended $6,368,000 $56,769,000 (88.8%) as a percentage of net revenues 1.6% 19.5% Nine Months Ended $13,959,000 $81,703,000 (82.9%) as a percentage of net revenues 2.0% 15.8%
The Company released no new 16-bit video games for the Sega Genesis ("Genesis") or the Super Nintendo Entertainment System ("SNES") during the three and nine months ended December 31, 1997. 16-bit revenues for the quarter ended December 31, 1997 were primarily attributable to the sales of the Company's 16-bit products published under a licensing arrangement with a third party. As the 16-bit video game market has made the transition to next generation 32-bit and 64-bit systems, the Company does not expect to release any new 16-bit titles in fiscal 1998 and revenues from the sales of 16-bit products in fiscal 1998 are not expected to be significant. 16 AFFILIATED LABEL NET REVENUES
December 31, December 31, 1997 1996 % change ----------------- ------------------- ------------- Three Months Ended $79,027,000 $38,337,000 106.1% as a percentage of net revenues 20.2% 13.2% Nine Months Ended $150,923,000 $68,943,000 118.9% as a percentage of net revenues 21.4% 13.3%
The increase in Affiliated Label net revenues for the three and nine months ended December 31, 1997 compared to the prior year periods was due to higher sales of Affiliated Label products in Europe, North America and South Asia Pacific. The increase for the quarter ended December 31, 1997 is due primarily to the release of Test Drive 4 published by Accolade, which was added as a worldwide affiliate in the quarter ended March 1997, and Croc published by Fox and distributed outside of North America. The increase for the nine months ended December 31, 1997 is due to the release of Croc, the addition of Accolade, Inc. as noted above, the continued distribution under an exclusive international agreement with Fox, and the release of Jurassic Park in the second fiscal quarter. COST OF GOODS SOLD
December 31, December 31, 1997 1996 % change ----------------- -------------------- -------------- Three Months Ended $210,799,000 $142,655,000 47.8% as a percentage of net revenues 53.9% 49.0% Nine Months Ended $376,752,000 $253,142,000 48.8% as a percentage of net revenues 53.5% 49.0%
The increase in costs of goods sold as a percentage of net revenues for the three and nine months ended December 31, 1997 compared to the same periods last year was primarily due to increased sales of lower margin affiliated label and N64 titles, the decrease in PC CD sales as a proportion of total net revenues and higher professional, celebrity and manufacturing royalties on CD-video and PC CD game titles. 17 MARKETING AND SALES
December 31, December 31, 1997 1996 % change ------------------ ------------------- -------------- Three Months Ended $45,027,000 $38,886,000 15.8% as a percentage of net revenues 11.5% 13.4% Nine Months Ended $100,695,000 $79,377,000 26.9% as a percentage of net revenues 14.3% 15.4%
The increase in marketing and sales expenses for the three and nine months ended December 31, 1997 was primarily attributable to increased television and print advertising worldwide to support new releases and increased cooperative advertising associated with higher revenues as compared to the prior year periods. Marketing and sales expenses also increased due to additional headcount related to the continued expansion of the Company's worldwide distribution business and increased trade show expenses. Increases were partially offset by savings attributable to the integration of Maxis in July, 1997. GENERAL AND ADMINISTRATIVE
December 31, December 31, 1997 1996 % change ------------------ ------------------- -------------- Three Months Ended $17,578,000 $13,614,000 29.1% as a percentage of net revenues 4.5% 4.7% Nine Months Ended $42,658,000 $37,028,000 15.2% as a percentage of net revenues 6.1% 7.2%
The increase in general and administrative expenses for the three months ended December 31, 1997 was due primarily to an increase in payroll and occupancy costs due to the opening of additional international offices and additional depreciation related to the installation of new management information systems worldwide partially offset by savings attributable to the integration of Maxis in the second quarter of fiscal 1998. The increase for the nine months ended December 31, 1997 was due to the factors noted above offset by lower bad debt expenses related to additional bad debt reserves taken in the prior year. RESEARCH AND DEVELOPMENT
December 31, December 31, 1997 1996 % change ------------------ ------------------- -------------- Three Months Ended $45,358,000 $37,053,000 22.4% as a percentage of net revenues 11.6% 12.7% Nine Months Ended $109,292,000 $96,978,000 12.7% as a percentage of net revenues 15.5% 18.8%
The increase in research and development expenses for the three and nine months ended December 31, 1997 was due to additional headcount related expenses attributable to increased in-house development capacity, higher development costs per title and additional depreciation of computer equipment. 18 CHARGE FOR ACQUIRED IN-PROCESS TECHNOLOGY
December 31, December 31, 1997 1996 % change ------------------ ------------------- -------------- Three Months Ended $1,500,000 $ - N/M as a percentage of net revenues 0.4% N/A Nine Months Ended $1,500,000 $ - N/M as a percentage of net revenues 0.2% N/A
In connection with the acquisition of the remaining 35% minority ownership interest in Electronic Arts Victor, Inc. in December 1997, the Company incurred a charge of $1,500,000 for acquired in-process technology. This charge was made after the Company concluded that the in-process technology had no alternative future use after taking into consideration the potential for usage of the software in different products and resale of the software. OPERATING INCOME
December 31, December 31, 1997 1996 % change ------------------ ------------------- -------------- Three Months Ended $70,983,000 $58,641,000 21.0% as a percentage of net revenues 18.1% 20.2% Nine Months Ended $63,096,000 $50,330,000 25.4% as a percentage of net revenues 9.0% 9.7%
Operating income was higher for the three and nine months ended December 31, 1997 compared to the same periods last year due to increased revenue and related gross profit margins partially offset by increased operating expenses including the charge for acquired in-process technology as discussed in Note 7, above. The increase for the nine months ended December 31, 1997 was partially offset by merger costs related to the acquisition of Maxis. INTEREST AND OTHER INCOME, NET
December 31 December 31, 1997 1996 % change ----------------- ------------------- -------------- Three Months Ended $16,558,000 $1,343,000 N/M as a percentage of net revenues 4.2% 0.5% Nine Months Ended $22,250,000 $10,147,000 119.3% as a percentage of net revenues 3.2% 2.0%
Interest and other income, net, increased for the three and nine months ended December 31, 1997 compared to the same periods last year primarily due to higher interest income attributable to higher cash balances as compared to the prior year periods and the sale of the Company's 50% ownership interest in Creative Wonders LLC as discussed in Note 7 in December 1997. The sale resulted in a gain of $12,625,000. 19 INCOME TAXES
December 31, December 31, 1997 1996 % change ----------------- ------------------- -------------- Three Months Ended $28,921,000 $21,281,000 35.9% effective tax rate 33.0% 35.5% Nine Months Ended $28,164,000 $21,058,000 33.7% effective tax rate 33.0% 34.8%
The Company's effective tax rate for the three and nine months ended December 31, 1997 was lower than the comparable prior year periods as a result of the higher proportion of international income subject to a lower foreign effective tax rate as compared to prior comparable periods and the reinstatement of the federal research and development tax credit in fiscal 1998. MINORITY INTEREST IN CONSOLIDATED JOINT VENTURE
December 31, December 31, 1997 1996 % change ------------------ ------------------- -------------- Three Months Ended $ - $ - 0.0% as a percentage of net revenues N/A N/A Nine Months Ended $28,000 $1,291,000 (97.8%) as a percentage of net revenues 0.0% 0.3%
As discussed in Note 7, the Company acquired the remaining 35% minority ownership interest in EAV held by VEI in December 1997. Prior to the acquisition, EAV was sixty-five percent owned by the Company and thirty-five percent owned by VEI, (formerly Victor Musical Industries, Inc.) a wholly owned subsidiary of Victor Company of Japan, Limited. No minority interest in EAV was recorded for the losses generated in the three months ended December 31, 1997 as VEI's interest in the net equity of EAV prior to the acquisition had fallen below zero. Minority interest for the nine months ended December 31, 1997 reflects only a portion of reported losses for EAV as the net equity of EAV fell below zero in the first quarter of fiscal 1998. 20 NET INCOME
December 31, December 31, 1997 1996 % change ----------------- ------------------- -------------- Three Months Ended $58,620,000 $38,703,000 51.5% as a percentage of net revenues 15.0% 13.3% Nine Months Ended $57,210,000 $40,710,000 40.5% as a percentage of net revenues 8.1% 7.9%
The increase in net income for the three months ended December 31, 1997, before the gain on sale of Creative Wonders, LLC and charge for acquired in-process technology discussed above, as compared to the prior year period was primarily related to higher revenues, gross profits, offset by higher operating expenses. Net income for the nine months ended December 31, 1997 increased due to the growth in revenues and gross margins offset by higher operating expenses. The impact of the gain on sale of Creative Wonders, LLC of $12,625,000, before income taxes, was offset by the charge for acquired in-process technology and merger costs of $10,792,000, before income taxes, incurred in the second quarter of fiscal 1998. 21 LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, the Company's working capital was $373,652,000 compared to $284,863,000 at March 31, 1997. Cash and short term investments increased by approximately $19,672,000 during the nine months ended December 31, 1997 as the Company used $1,039,000 of cash in operations and $25,358,000 in capital expenditures offset by proceeds from the Company's employee stock programs, proceeds from the sale of Creative Wonders, LLC and from sales of securities. Reserves for bad debts and sales returns increased from $43,268,000 at March 31, 1997 to $68,935,000 at December 31, 1997. Reserves have been charged for returns of product and price protection credits issued for products sold in prior periods. Management believes these reserves are adequate based on historical experience and its current estimate of potential returns and allowances. Inventory levels at December 31, 1997 increased compared to March 31, 1997 due mainly to increases of AL inventories in Europe to support the growth of the business related to the opening of multiple new distribution facilities in Europe to support the Company's direct distribution effort. In connection with the Company's purchases of Sony products to be distributed in Japan, Sony of Japan requires cash deposits totaling one-third of purchase orders. Additionally, Nintendo of Japan requires cash deposits on all orders of N64 cartridge products in Japan. In lieu of letters of credit, EA Japan utilizes a line of credit to fund these deposits for purchases of Sony and Nintendo products in Japan and for other operating requirements. At December 31, 1997, EA Japan had approximately $3,800,000 outstanding on this line. The Company's principal source of liquidity is $287,813,000 in cash and short-term investments. Management believes the existing cash, cash equivalents, short-term investments, marketable securities and cash generated from operations will be sufficient to meet cash and investment requirements for the foreseeable future. 22 FACTORS AFFECTING FUTURE PERFORMANCE Future operating results of the Company depend upon many factors and are subject to various risks and uncertainties. Some of those important risks and uncertainties which may cause the Company's operating results to vary or which may materially and adversely affect the Company's operating results are as follows: THE INDUSTRY AND COMPETITION. The interactive software business has historically been a volatile and highly dynamic industry affected by changing technology, limited hardware platform life cycles, hit products, competition, component supplies, seasonality, consumer spending and other economic trends. The business is also intensely competitive. A variety of companies offer products that compete directly with one or more of the Company's products. These direct competitors vary in size from very small companies to companies with financial, managerial and technical resources comparable to or greater than those of the Company. Typically, the Company's chief competitor on dedicated game platforms is the hardware manufacturer/licensor itself, to which the Company must pay royalties, and in the case of Sony and Nintendo, manufacturing charges. For example, Sony has aggressively launched sports product lines that directly compete with the Company's sports products on the PlayStation. In addition, competition for creative talent has intensified, and the attraction and retention of key personnel by the Company is increasingly difficult. PRODUCTS. Interactive entertainment software products typically have life spans of only 3 to 12 months. In addition, the market is crowded with a large number of titles competing for limited shelf space at retail. The Company's future success will depend in large part on its ability to develop and introduce new competitive products on a timely basis and to get those products distributed widely at retail. To compete successfully, new products must adapt to new hardware platforms and emerging industry standards, provide additional functionality and be successfully distributed in numerous changing worldwide markets. If the Company were unable, due to resource constraints or technological or other reasons, to successfully develop and distribute such products in a timely manner, this inability would have a material adverse effect on its operating results and financial condition. DEVELOPMENT. Product development schedules, particularly for new hardware platforms and high-end multimedia PCs are difficult to predict because they involve creative processes, use of new development tools for new platforms and the learning process, research and experimentation associated with development for new technologies. New CD-ROM product releases are frequently including more content and are more complex, time-consuming and costly to develop and, accordingly, cause additional development and scheduling risk. For example, Dungeon Keeper for PC CD, originally scheduled to ship in the quarter ended June 1996, shipped in the quarter ended June 1997. In addition Populous 3 for PC CD and PlayStation were scheduled for shipment in the fiscal year ended March 31, 1998 are now expected to ship in the fiscal year ending March 31, 1999. Also, SimCity 3000, the follow on product to SimCity 2000, was scheduled to ship in October 1997 at the time of the merger with Maxis. Due to additional development delays, it is anticipated that this product will ship during the first half of the fiscal year ending March 31, 1999. Additionally, development risks for CD-ROM products can cause particular difficulties in predicting quarterly results because brief manufacturing lead times allow finalizing products and projected release dates late in a quarter. Manufacturing lead times during the year for CD-based products have been as brief as 23 one to three weeks; cartridge products more typically have had a six to twelve week lead time for manufacture. The Company's revenues and earnings are dependent on its ability to meet its product release schedule and its failure to meet those schedules could result in revenues and earnings which fall short of analysts' expectations for any individual quarter and the fiscal year. PLATFORM CHANGES. A large portion of the Company's revenues are derived from the sale of products designed to be played on proprietary video game platforms such as the PlayStation and the N64. The interdependent nature of the Company's business and that of its hardware licensors brings significant risks to the Company's business. The success of the Company's products is significantly affected by market acceptance of the new video game hardware systems and the life span of older hardware platforms, and the Company's ability to accurately predict these factors with respect to each platform. In many cases, the Company will have expended a large amount of development and marketing resources on products designed for new video game systems (such as the new 32-bit systems) that have not yet achieved large installed bases or will have continued product development for older hardware platforms that may have shorter life cycles than the Company expected. Conversely, if the Company does not choose to develop for a platform that achieves significant market acceptance, or discontinues development for a platform that has a longer life cycle than expected, the Company's revenue growth may be adversely affected. For example, the Company signed an agreement with Nintendo to develop and publish a line of EA SPORTS products for the N64 in March of 1997, nearly seven months after introduction of that platform in North America. Due to long development times associated with this platform, the Company will not ship more than two N64 products under this agreement in significant quantities during the fiscal year ending March 31, 1998. The Company believes that investment in products for the 32-bit market, including both PCCD and CD-video game platforms (particularly the PlayStation) has been strategically important in positioning the Company for the now completed transition to 32-bit machines. The Company continues to believe that such investment is important and will continue its aggressive development activities for 32-bit platforms. Although the PlayStation has achieved significant market acceptance in all geographic territories, there can be no assurance that its growth will continue at the present rates, particularly with the introduction of the N64 by Nintendo. The market acceptance of the N64, particularly in North America and Europe, may adversely affect the growth rate of the 32-bit CD-platforms. While the Company has a broad range of products available and under development for the PlayStation and for PCCD, the Company will not ship more than two products for the N64 in any significant quantities until calendar year 1998, as noted above. HARDWARE COMPANIES. The Company's contracts with hardware licensors, which are also some of the Company's chief competitors, often grant significant control to the licensor over the manufacturing of the Company's products. This fact could, in certain circumstances, leave the Company unable to get its products manufactured and shipped to customers. In most events, control of the manufacturing process by hardware companies increases both the manufacturing lead times and the expense to the Company as compared to the lead times and costs that the Company can achieve independently. For example, the Company, in prior years, experienced delays in the manufacturing of PlayStation products which caused delays in shipping those products. The results of future periods may be affected by similar delays. Finally, the Company's contracts with 24 its hardware licensors often require the Company to take significant risks in holding or prepaying for its inventory of products. In particular, the Company's agreement with Nintendo for N64 products requires prepayment of costly cartridge-based inventory, minimum orders and no rights of return. REVENUE AND EXPENSES. A substantial majority of the revenue of the Company in any quarter typically results from orders received in that quarter and products introduced in that quarter. The Company's expenses are based, in part, on development of products to be released in the future. Certain overhead and product development expenses do not vary directly in relation to revenues. This trend is increasing as the Company increases the proportion of products developed internally. As a result, the Company's quarterly results of operations are difficult to predict, and small delays in product deliveries may cause quarterly revenues, operating results and net income to fall significantly below anticipated levels. The Company typically receives orders shortly before shipments, making backlog an unreliable indicator of quarterly results. A shortfall in shipments at the end of any particular quarter may cause the results of that quarter to fall significantly short of anticipated levels. FILM AND VIDEOTAPE. The Company produces film and videotape to include in certain products pursuant to agreements between certain of the Company's subsidiaries with SAG, AFTRA and Equity. However, the costs of video production are significantly higher than for software production, and for products which include a substantial amount of video such as certain interactive movies, the costs of producing the video component is significantly higher than the cost of developing the software component. Accordingly, more units of such products must be sold to recoup the development and production costs. There can be no assurance that these products which include significant film or videotape components will be commercially successful enough to recoup development costs. In addition, the Company's agreements with SAG and AFTRA expire during the current calendar year, and there can be no assurance that the Company will be able to renegotiate favorable terms. GROSS MARGINS. Gross margins as a percent of net revenues for the three and nine months ended December 31, 1997 decreased compared to the comparable prior year periods. The decrease was mainly due to increases in the mix of lower margin Affiliated Label revenues due to the expansion of distribution worldwide and releases of major titles by key affiliates, increased sales of N64 products and the lower proportion of revenues associated with sales of higher margin PC CD products to total revenues. The mix in sales of the Company's products have a significant effect on gross margins as a percentage of net revenues. If the proportion of PC CD net revenues increase in relation to AL revenues, margins may increase. Conversely, if AL revenues as a proportion of total revenues increase, overall margins may continue to decrease. In addition, as the Company begins to ship N64 products in significant quantities, margins may decline due to the higher cost of goods associated with this cartridge-based platform. Further, gross margins continue to be affected by increases in professional and celebrity royalties. Also, while the costs of development of new products for 32- and 64-bit systems have increased, overall cost of goods are not declining. For products on platforms for which the Company is required to purchase its goods from the hardware companies, the Company is unable to achieve cost reductions through manufacturing efficiencies, and in addition have to pay manufacturing royalties to hardware companies. Additionally, higher distribution expenses for operations in Europe and North America continue to put 25 pressure on margins and retailers also continue to require significant price protection for products. With an increasing number of titles available for advanced platforms, such requirements for price protection may increase. The Company also anticipates that retail and wholesale prices for interactive entertainment products may decrease and gross margins may be further adversely affected. MARKETING AND DISTRIBUTION. Both the video game and PC businesses have become increasingly "hits" driven. Additional marketing and advertising funds are required to drive and support "hit" products, particularly television advertising. There can be no assurance that the Company will continue to produce "hit" titles, or that advertising for any product will increase sales sufficiently to recoup those advertising expenses. The Company has stock-balancing programs for its personal computer products that, under certain circumstances and up to a specified amount, allow for the exchange of personal computer products by resellers. The Company also typically provides for price protection for its personal computer and video game system products that, under certain conditions, allows the reseller a price reduction from the Company for unsold products. The Company maintains a policy of exchanging products or giving credits, but does not give cash refunds. Moreover, the risk of product returns may increase as new hardware platforms become more popular or market factors force the Company to make changes in its distribution system. The Company monitors and manages the volume of its sales to retailers and distributors and their inventories as substantial overstocking in the distribution channel can result in high returns or the requirement for substantial price protection in subsequent periods. The Company believes that it provides adequate reserves for returns and price protection which are based on estimated future returns of products, taking into account promotional activities, the timing of new product introductions, distributor and retailer inventories of the Company's products and other factors, and that its current reserves will be sufficient to meet return and price protection requirements for current in-channel inventory. However, there can be no assurance that actual returns or price protection will not exceed the Company's reserves. See Revenue and Expenses, above. The distribution channels through which consumer software products are sold have been characterized by change, including consolidations and financial difficulties of certain distributors and retailers and the emergence of new retailers such as general mass merchandisers. The development of remote and electronic delivery systems will create further changes. The bankruptcy or other business difficulties of a distributor or retailer could render the Company's accounts receivable from such entity uncollectible, which could have an adverse effect on the operating results and financial condition of the Company. In the quarter ended September 1996, the Company recorded $2,300,000 in bad debt expenses related to potentially uncollectible receivables from a customer who filed for bankruptcy. In addition, an increasing number of companies are competing for access to these channels. The Company's arrangements with its distributors and retailers may be terminated by either party at any time without cause. Distributors and retailers often carry products that compete with those of the Company. Retailers of the Company's products typically have a limited amount of shelf space and promotional resources for which there is intense competition. There can be no assurance that distributors and retailers will continue to purchase the Company's products or provide the Company's products with adequate levels of shelf space and promotional support. 26 EMPLOYEES. Competition for employees in the interactive software business is intense and increasing as competition in the industry increases. In the last fiscal year, recruiting of the Company's employees generally, and its executive officers in particular, has been intense. Large software and media companies frequently offer significantly larger cash compensation than does the Company, placing pressure on the Company's base salary and cash bonus compensation. Small start-up companies such as those proliferating in the online business areas offer significant potential equity gains which are difficult for more mature companies like the Company to match without significant stockholder dilution. While executive turnover has decreased in fiscal 1998 as compared to prior years, virtually all of the executives continue to experience intense recruiting pressure. There can be no assurance that the Company will be able to continue to attract and retain enough qualified employees in the future. FOREIGN SALES AND CURRENCY FLUCTUATIONS. For the nine months ended December 31, 1997 and for the fiscal year ended March 31, 1997, international net revenues comprised 42% and 45% of total consolidated net revenues, respectively. The Company expects foreign sales to continue to account for a significant and growing portion of the Company's revenues. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies which may fluctuate. As a result of current economic conditions in Asia, the Company is subject to additional foreign currency risk. Though the Company does not currently derive a significant portion of revenues and operating profits from sales in Asia and other developing countries, the Company's foreign currency exposure may increase as the Company's operations in these countries grow and if current economic trends in Asia continue. There can be no assurance that these or other factors will not have an adverse effect on the Company's future operating results. INVESTMENTS IN AFFILIATES AND MARKETABLE SECURITIES. The Company has a number of equity investments in affiliates, including small developers, such as Firaxis; other publishers, such as Accolade, Inc. and Stormfront; and new ventures such as Mpath Interactive. Additionally, the Company has an equity investment in the 3DO Company. These companies are generally small and without significant financial resources. Financial difficulties for any of these companies could cause a reduction in the value of the Company's investment. For example, in fiscal 1996 the Company wrote off its investment in SportsLab in its entirety. FLUCTUATIONS IN STOCK PRICE. Due to analysts' expectations of continued growth and other factors, any shortfall in earnings could have an immediate and significant adverse effect on the trading price of the Company's Common Stock in any given period. As a result of the factors discussed in this quarterly report and other factors that may arise in the future, the market price of the Company's Common Stock historically has been, and may continue to be subject to significant fluctuations over a short period of time. These fluctuations may be due to factors specific to the Company, to changes in analysts' earnings estimates, or to factors affecting the computer, software, entertainment, media or electronics industries or the securities markets in general. For example, during the most recently completed fiscal year, the price per share of the Company's common stock ranged from $24.75 to $39.13 and in the first nine months of the current fiscal year ranged from $20.13 to $39.56. 27 SEASONALITY. The Company's business is highly seasonal. The Company typically experiences its highest revenues and profits in the calendar year-end holiday season and a seasonal low in revenues and profits in the quarter ending in June. Because of the foregoing factors, as well as other factors affecting the Company's operating results and financial condition, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. 28 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is subject to pending claims. Management, after review and consultation with counsel, considers that any liability from the disposition of such lawsuits in the aggregate would not have a material adverse effect upon the consolidated financial position or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - The following exhibits are filed as part of this report: 10.39 Employment Agreement by and between the Registrant and John Riccitiello dated August 29, 1997. 10.40 Lease Agreement by and between Registrant and John Riccitiello dated August 29, 1997. (b) Reports on Form 8-K: None 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ELECTRONIC ARTS INC. (Registrant) /s/E. STANTON MCKEE ------------------- DATED: E. STANTON MCKEE February 13, 1998 Executive Vice President and Chief Financial and Administrative Officer (Duly authorized officer) 30 ELECTRONIC ARTS INC. AND SUBSIDIARIES FORM 10-Q QUARTERLY REPORT FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1997 EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT TITLE PAGE - ------ ------------- ---- 10.39 Employment Agreement by and between 32 the Registrant and John Riccitiello dated August 29, 1997. 10.40 Lease Agreement by and between 34 Registrant and John Riccitiello dated August 29, 1997. 27 Financial Data Schedule 44 31 EX-10.39 2 EMPLYMNT AGRMNT BY & BTWN REGISTRANT & JOHN RICCITIELLO 8/29/97 EXHIBIT 10.39 [LETTERHEAD OF ELECTRONIC ARTS APPEARS HERE] August 29, 1997 John Riccitiello 20 East Cedar Street, 14A Chicago, IL 60611 Dear John, I am pleased to offer you a regular full-time position with Electronic Arts as President and COO reporting to me. Your salary will be $33,333.33 per month. A one time signing bonus of $250,000 will be provided. Your effective date of employment is on or about October 15, 1997. I will recommend to the Board of Directors that you be granted a Non-qualified Option to purchase 150,000 shares of Electronic Arts common stock in accordance with our Stock Option Plan. You will receive a second grant of 150,000 shares which will vest in full five years from the original date of the grant. In addition to the benefits described in the EA Playbook, you will also be eligible to participate in our bonus program at a 75% target. You will receive six months bonus guaranteed at the end of EA's fiscal year 1998. Electronic Arts will allow you to lease the property at 45 Robles Drive, Woodside, California for $7,500.00 per month, for a period of five years if still employed by EA. At your option, you may purchase the property at EA's acquisition cost after March 31, 2000, with the condition that you continue to be employed in good standing by Electronic Arts. Prior to March 31, 2000 the property can only be sold at EA's option. EA will reimburse you for all normal and reasonable relocation costs associated with moving to this property. Your employment with Electronic Arts is for an indefinite term. In other words, the employment relationship is "at will" and you have the right to terminate that employment relationship at any time. Also, although I hope that you will remain with us and be successful here, Electronic Arts must, and does retain the right to terminate the employment relationship at any time. Should you be terminated without cause prior to March 31, 1998, you will receive three years salary as severance. If this should occur in the period 4/1/98 to 3/31/99, you will receive two years salary as severance, and if in the period 4/1/99 to 3/31/00, one year's salary will be provided. 32 John Riccitiello August 29, 1997 Page 2 of 2 This offer assumes that you have the legal right to work in the United States and can submit appropriate proof. If you accept the offer, please so indicate by signing this letter where indicated and returning it to my attention. Electronic Arts' mission is to make fun software for consumers and to help interactive entertainment become a part of everyday life. To play a leading role in this new industry, EA needs a dedicated team of pioneers with vision, a passion for quality, a willingness to innovate and a desire to achieve great things while vigilantly maintaining our integrity. We are delighted to have you join us. Sincerely, /s/ Larry Probst ------------------------------------------ Larry Probst CEO/Chairman Electronic Arts Accepted: /s/ John Riccitiello Date: -------------------------------- -------------- 33 EX-10.40 3 LEASE AGRMNT BY & BTWN REGISTRANT & JOHN RICCITIELLO 8/29/97 EXHIBIT 10.40 LEASE AGREEMENT --------------- THIS LEASE AGREEMENT ("Lease") is made as of the 13th day of October, 1997 ("Effective Date") by and between ELECTRONIC ARTS INC., a Delaware corporation ("Landlord"), and John Riccitiello ("Tenant"). ARTICLE 1: PREMISES -------------------- 1.1 Premises. The "Premises" consist of that single family residence -------- located at 45 Robles Drive in Woodside, California and the associated real property shown more particularly on Exhibit A attached hereto. --------- ARTICLE 2: TERM ---------------- 2.1 Term. The term ("Term") of this Lease shall commence on the Effective ---- Date and shall terminate on October 31, 2002 ("The Expiration Date"), unless sooner terminated as provided for elsewhere herein. ARTICLE 3: RENT ---------------- 3.1 Rent. Tenant shall pay to Landlord rent ("Rent") in the amount of ---- Seven Thousand Five Hundred and No/100 Dollars ($7,500.00) per month in advance, without notice, demand, offset or deduction, on the first day of each calendar month, commencing November 1, 1997. 3.2 Late Charge and Interest. The late payment by Tenant of the Rent will ------------------------ cause Landlord to incur additional costs, including, without limitation, administration and collection costs and processing and accounting expenses and additional increased debt service. If Landlord has not received any installment of the Rent on the date such amount is due, Tenant shall immediately pay Landlord a late charge of five percent (5%) of the delinquent amount, which is agreed to represent a reasonable estimate of the costs incurred by Landlord. In addition, all such delinquent amounts shall bear interest from the date such amount was due until paid in full at a rate per annum equal to ten percent (10%) ("Interest Rate") per annum; provided, in no event shall the interest due hereunder exceed the maximum interest rate permitted by law which may be charged under such circumstances. ARTICLE 4: REAL PROPERTY TAXES ------------------------------ 4.1 Real Property Taxes. Landlord shall pay as and when due any and all ------------------- real property taxes, levies and charges assessed against the Premises and coming due during the Term of this Lease. Tenant agrees to promptly provide Landlord with copies of any real property tax bills for the Premises received by Tenant during the Term hereof. 34 ARTICLE 5: SECURITY DEPOSIT ---------------------------- 5.1 Security Deposit. Upon the request of Landlord at any time during the ---------------- Term, Tenant shall deposit with Landlord the sum of Seven Thousand Five Hundred and No/100 Dollars ($7,500.00) as a security deposit ("Security Deposit") to secure performance of Tenant's obligations hereunder. If Tenant fails to pay Rent or fails to perform an obligation under this Lease, Landlord may apply the Security Deposit to the payment of Rent or any other sum which Landlord may become obligated to pay by reason of Tenant's failure to perform any obligation under this Lease, or to compensate Landlord for any reasonable loss or damage or costs for repair and clean up which Landlord may suffer by reason of such failure. If Landlord so applies the Security Deposit, Tenant shall, within five (5) days after written demand, deposit with Landlord an amount sufficient to restore the Security Deposit to its full, original amount. Landlord shall not be required to keep the Security Deposit separate from its general accounts or to pay interest thereon to Tenant. Upon expiration of the Term or, if later vacation of the Premises by Tenant, Landlord shall pay to Tenant the amount of the Security Deposit then remaining. ARTICLE 6: MAINTENANCE AND REPAIR ---------------------------------- 6.1 Tenant's Representations. Tenant represents to Landlord that he has ------------------------ had the opportunity to and has inspected the Premises. Excepting only those conditions reported to Landlord prior to execution hereof, Tenant accepts the Premises "as is". 6.2 Landlord's Obligations. Landlord shall have no obligation to perform ---------------------- or pay for ordinary maintenance of or repairs to the Premises. Repair of damage to the Premises from causes for which Landlord is required to maintain insurance pursuant to Section 9.3 below shall be made by Landlord and the deductible amounts, if any, for such repairs shall be paid by Landlord. 6.3 Tenant's Obligations. Tenant, at Tenant's expense, shall maintain the -------------------- Premises and every part thereof in good order, condition and repair. In connection therewith, Tenant shall, throughout the Term of this Lease, maintain at Tenant's expense, maintenance contracts reasonably satisfactory to Landlord for the pool, lawn and landscaping on the Premises. If Tenant fails to perform Tenant's obligations under this Paragraph 6.3, Landlord may enter upon the Premises after thirty (30) days' prior written notice to Tenant (except in the case of emergency, in which case no notice shall be required) and perform such obligations on Tenant's behalf; the cost thereof, together with interest thereon at the Interest Rate, shall be due and payable to Landlord with the Rent installment next due. ARTICLE 7: SECURITY MEASURES ----------------------------- 7.1 Security Measures. Landlord shall have no obligation whatsoever to ----------------- provide security measures for the benefit of the Premises. Tenant assumes all responsibility for the protection of Tenant and his invitees and the property of Tenant and his invitees against acts of third parties. 35 ARTICLE 8: ALTERATIONS ----------------------- 8.1 Alterations. The term "Alterations" means alterations, improvements, ----------- additions, removals of such alterations, improvements or additions, including but not limited to temporary structures, but excluding personal property of Tenant. "Alterations" shall exclude cosmetic changes to the interior of the Premises without regard to cost. 8.2 Alterations by Tenant. Tenant shall not make any Alterations to the --------------------- Premises that are structural in nature, that change the cosmetic image of the exterior of the Premises or that cost more than Five Thousand Dollars ($5,000.00) each without Landlord's prior written consent. Such Alternations approved by Landlord are hereinafter referred to as "Approved Alterations". Alterations made by Tenant that have not been approved as provided herein are hereinafter referred to as "Unapproved Alterations." All Alterations shall become the property of Landlord when installed. Landlord may, at the expiration or termination of the Term and unless Tenant has exercised the Option described in Section 15 below, require Tenant, at Tenant's expense, to remove immediately any and all Unapproved Alterations made by Tenant without Landlord's prior approval and to restore the premises to their condition prior to the making of such Unapproved Alterations. Unapproved Alterations shall, upon termination of this Lease, be subject to Paragraph 13. In the event that Tenant does not exercise the Option described in Article 15 below or in the event that such Option terminates, Landlord shall reimburse Tenant for the lesser of the amounts actually approved by Landlord for such Approved Alterations or the actual costs to Tenant of such Approved Alterations. ARTICLE 9: LIABILITY AND INSURANCE ----------------------------------- 9.1 Liability. Tenant shall indemnify, defend and hold Landlord harmless --------- from and against all losses, claims, suits, judgments, liabilities, damages, costs and expenses, including without limitation reasonable attorneys' and experts' fees and expenses and court costs (collectively, "Liabilities"), which arise directly and indirectly out of Tenant's use of the Premises, any breach of or any default in the performance of Tenant's obligations under this Lease or the breach of any representation or warranty made by Tenant in connection with this Lease, any discharge, leakage, spillage, emission or pollution of any type (including gasoline) upon or from the Premises or on any other property arising out of or in any way connected with Tenant's use or occupancy of the Premises, or any act or omission of Tenant or any of Tenant's invitees; provided, however, that Tenant shall not be liable for Liabilities caused by the sole, active negligence or willful misconduct of Landlord. Upon notice from Landlord, Tenant shall defend Landlord against Liabilities at Tenant's expense by counsel reasonably satisfactory to Landlord and Landlord shall cooperate with Tenant in such defense. TENANT HEREBY ASSUMES ALL RISK, WAIVES ANY CLAIMS AGAINST AND RELEASES LANDLORD FROM LIABILITY, AND AGREES THAT LANDLORD SHALL NOT BE LIABLE TO TENANT FOR CONSEQUENTIAL DAMAGES OR FOR DAMAGE TO THE PROPERTY OF TENANT, TENANT'S INVITEES OR OF THIRD PARTIES OR FOR INJURY TO OR THE DEATH OF TENANT, ANY OF TENANT'S INVITEES OR ANY OTHER PERSON IN OR ABOUT THE PREMISES UNLESS CAUSED BY THE SOLE, ACTIVE NEGLIGENCE OR WILLFUL MISCONDUCT OF LANDLORD. 36 9.2 Insurance to be Maintained by Tenant. Tenant shall, at Tenant's ------------------------------------ expense, obtain and keep in force the following: (i) A policy of comprehensive general liability insurance, having a combined single limit of not less than One Million Dollars ($1,000,000) per occurrence, from an insurance company acceptable to Landlord; and (ii) A policy or policies, including the basic form, broad form and special form of coverage, including vandalism and malicious mischief, theft, sprinkler leakage and water damage coverage in an amount equal to the full replacement value, new without deduction for depreciation, of all Landlord's fixtures, furniture and equipment in the Premises, and all Alterations to the Premises installed on the Premises. The policies shall name landlord as an additional insured. Tenant shall deliver to Landlord for Landlord's approval certificates of such insurance no later than seven (7) days prior to the Commencement Date (or date of possession of the Premises if earlier). The limits of such insurance shall not limit the liability of Tenant hereunder. 9.3 Insurance to be Maintained by Landlord. Landlord shall, at Landlord's -------------------------------------- expense, obtain and keep in force a policy or policies, including the basic form, broad form and special form of coverage including vandalism and malicious mischief, theft, sprinkler leakage and water damage coverage in an amount equal to the full replacement value, new without deduction for depreciation, of the residence located on the Premises. ARTICLE 10: ASSIGNMENT AND SUBLEASING -------------------------------------- 10.1 Personal Nature of Lease. This Lease is personal to Tenant. As ------------------------ such, Tenant has no right to assign or permit any other person or entity to use this Lease in whole or in part. Notwithstanding the foregoing, in the event of the death of Tenant during the Term hereof, Tenant's spouse may occupy the Premises subject to the terms of this Lease Agreement for the period referred to in Section 11.3 and may exercise the Option to purchase the Premises on the basis of the terms of and applicable to Section 15. ARTICLE 11: DEFAULT AND REMEDIES --------------------------------- 11.1 Default. The occurrence of any one or more of the following events ------- shall constitute a material default of this Lease by Tenant. (a) The failure by Tenant to make any payment of Rent or any other payment required to be made by Tenant hereunder within (5) days of receipt of written notice from Landlord therefor; or (b) Except as otherwise provided in this Lease, the failure by Tenant to observe or perform any of Tenant's obligations under this Lease, other than described in paragraph (a) above, where such failure shall continue for a period of ten (10) days after delivery of written notice of demand therefor from Landlord to Tenant; provided, however, that 37 if the nature of Tenant's noncompliance is such that more than ten (10) days are reasonably required for its cure, then Tenant shall not be deemed to be in default hereof if Tenant, in good faith, has commenced such cure within said ten (10) day period and thereafter diligently prosecutes such cure to completion. 11.2 Remedies. In the event of a default by Tenant, Landlord may, at any -------- time thereafter, exercise any right or remedy Landlord may have at law or equity. 11.3 Termination of Employment. Notwithstanding anything to the contrary ------------------------- herein, in the event of any termination of Landlord's employment of Tenant, this Lease shall terminate, and Tenant shall surrender the Premises to Landlord in the condition required hereunder within: (a) four (4) months of the effective date of the termination of Tenant's employment, if such employment is terminated for any reason by Tenant, and (b) six (6) months of the effective date of the termination of Tenant's employment if such employment is terminated for any reason by Landlord. In the event that the period described in this Section 11.3 shall extend beyond the Termination Date, then the Term shall be deemed extended for such period, and of the rights and obligations of the parties set forth herein, including Tenant's obligations to pay Rent, shall continue for such period. ARTICLE 12: LANDLORD'S ENTRY ----------------------------- 12.1 Landlord's Access. Upon twenty-four (24) hours notice to the Tenant, ----------------- Landlord shall have the right to enter the Premises at reasonable times for the purpose of inspecting the same, showing the same to prospective purchasers, lenders or others (during the last sixty (60) days of the Lease, if Tenant has not exercised the Option only), or exercising any of Landlord's rights hereunder. In the event of an emergency, Landlord shall have the right to perform all such actions as Landlord shall deem necessary on the Premises at any time. All activities of the Landlord undertaken pursuant to this paragraph shall not grant to Tenant, and Tenant hereby waives, any right of abatement of the Rent or other claim for liability against Landlord. ARTICLE 13: SURRENDER ---------------------- 13.1 Return of Premises. Landlord, may, by delivery of written notice to ------------------ Tenant no later than ten (10) days prior to the date of expiration or earlier termination of this Lease, require Tenant to remove, at Tenant's expense and on or before the expiration or earlier termination of this Lease, any or all Unapproved Alterations made to the Premises by Tenant. ARTICLE 14: TRANSFER OF PREMISES --------------------------------- 14.1 Transfer of Premises. In the event of a transfer of Landlord's title -------------------- or interest in the Premises, then, provided the transferee agrees to be bound by the terms of this Lease 38 Agreement, including the Option to purchase, from and after the date of such transfer, Landlord herein named (or, in case of any subsequent transfers, the then grantor) shall be relieved of all liability as respects Landlord's obligations thereafter to be performed, provided that any funds held by Landlord (or the then grantor) in which Tenant has an interest shall be delivered to the grantee. Subject to the foregoing, the obligations to be performed herein by Landlord shall be binding on Landlord and Landlord's successors and assigns only during their respective periods of ownership of the Premises. ARTICLE 15: OPTION TO PURCHASE ------------------------------- 15.1 Option. Provided that (i) Tenant is not then in default hereunder, ------ and (ii) Tenant is residing in and has not vacated the Premises, Tenant shall have an exclusive option (the "Option") to purchase the Premises during the time period commencing on April 1, 2000 and ending on the Expiration Date by providing Landlord with written notice thereof at least thirty (30) days (and no more than sixty (60) days) in advance. Upon Tenant's giving such written notice to Landlord, this Option shall become a contract for the purchase and sale of the Premises, and Landlord shall thereupon sell the Property including all Alterations to Tenant at a purchase price equal to the price for which Landlord purchased the Premises, plus the cost of any capital improvements made to the Premises at any time by Landlord (together "Costs"). Landlord shall pay the costs of title insurance, real property taxes accrued to the date of closing, and repairs required as a condition to closing by law or by a third party, and Tenant shall pay any and all other expenses associated with such purchase and sale of the Premises, including but not limited to escrow fees, transfer taxes and recording fees. Upon completion of the purchase and sale, all obligations of the Tenant for Rent, except for arrears for any period preceding the completion date, shall terminate. ARTICLE 16: DAMAGE OR DESTRUCTION OF PREMISES ----------- --------------------------------- 16.1. Termination Upon Damage or Destruction. In the event that the -------------------------------------- Premises or any substantial part thereof shall during the Term be damaged or destroyed by fire, earthquake or flood or otherwise damaged so as to render the same unfit for the purposes of habitation then, upon written notice from Tenant to Landlord, this Lease Agreement shall immediately terminate without further liability of Tenant to pay future Rent owing. ARTICLE 17: MISCELLANEOUS -------------------------- 17.1 Attorney's Fees. If either party shall bring an action or proceeding --------------- against the other party to enforce the terms of this Lease or to declare their respective right hereunder, the losing party shall pay the reasonable attorneys' and experts' fees and expenses and court costs of the party prevailing in the such action, proceeding, or trial or appeal thereof. 17.2 Notices. All notices shall be in writing and shall be deemed to have ------- been given when delivered personally or deposited in the United States mail, registered or certified, postage prepaid, and addressed as follows: 39 To Landlord: To Tenant: Electronic Arts Inc. 45 Robles Drive 1450 Fashion Island Boulevard Woodside, California 94062 San Mateo, California 94404 Attention: Vice President, Finance Either party may change the address for notices or Landlord may change the address for payments by giving the other party notice to that effect. 17.3 No Waiver. No waiver by Landlord or Tenant of any provision hereof --------- shall be deemed a waiver of any other provision hereof or of any subsequent breach by Tenant or Landlord, as the case may be, of the same or any other provision, nor shall any custom or practice which may grow up between Landlord and Tenant in the administration of this Lease be construed to waive or to lessen the right of Landlord or Tenant to insist upon the performance by Landlord or Tenant in strict accordance with this Lease. Landlord's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Landlord's consent to, or approval of, any subsequent act by Tenant. The acceptance of the Rent hereunder by Landlord shall not be deemed a waiver of any preceding breach by Tenant of any provision hereof, other than the failure of Tenant to pay the particular payment of the Rent so accepted, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such Rent. 17.4 Severability. The invalidity of the Lease as determined by a court ------------ of competent jurisdiction, shall in no way affect the validity of any other provision hereof. 17.5 Time of Essence. Time is of the essence with respect to the --------------- obligations to be performed under this Lease. 17.6 Incorporation of Prior Agreements; Amendments; No Representations and --------------------------------------------------------------------- Warranties. This Lease contains all the agreements of the parties with respect - ---------- to any matter mentioned herein. No prior or contemporaneous agreement or understanding pertaining to any such matter shall be effective. This Lease may be modified only by written instrument signed by the parties. Except as otherwise stated in this Lease, Tenant hereby acknowledges that no real estate broker nor Landlord nor any agent or employee of either has made any oral or written warranties or representations to Tenant about the condition of the Premises or the present or future suitability of the Premises for the conduct of Tenant's business and Tenant's intended use. 17.7 Binding Effect. Subject to Article 10, this Lease shall be binding -------------- on and insure to the benefit of the successors and assigns of the parties hereto. 17.8 Choice of Law: Venue. The Lease shall be governed by the laws of -------------------- California. Any litigation concerning this Lease between the parties hereto shall be initiated in the county where the Premises are located. 40 17.9 Captions. The captions on this Lease are for convenience only and in -------- no way define, limit or otherwise describe the scope or intent of this Lease, or any provision hereof, or in any way affect the interpretation of this Lease. 17.10 Recording. Tenant shall not record this Lease or a memorandum of --------- "Short Form" thereof. 17.11 Authority: Joint and Several Liability. Each individual executing --------------------------------------- this Lease on behalf of Tenant represents and warrants that he or she is duly authorized to execute and deliver this Lease on behalf of Tenant and that such execution is binding upon Tenant. Tenant shall deliver to Landlord evidence of such authority satisfactory to Landlord prior to Tenant's occupancy of the Premises. The individuals executing this Lease on behalf of Landlord represent and warrant to Tenant that they are duly authorized to execute this Lease on behalf of Landlord and that such execution is binding upon all parties holding an ownership interest in the Premises. Where a party consists of more than one person, firm or corporations, each such person, firm or corporation shall be jointly and severally liable for performance of such party's obligations hereunder. IN WITNESS WHEREOF, the parties have executed this Lease in duplicate as of the Effective Date. Landlord Tenant ELECTRONIC ARTS INC., /s/ JOHN RICCITIELLO a Delaware corporation --------------------------- JOHN RICCITIELLO By: /s/ Ruth A. Kennedy --------------------------- Name: Ruth A. Kennedy -------------------------- Title: Sr VP ------------------------- 41 EXHIBIT A THE PREMISES THE LAND REFERRED TO HEREIN IS SITUATED IN THE STATE OF CALIFORNIA, COUNTY OF SAN MATEO, TOWN OF WOODSIDE, described as follows: PARCEL I: LOT 13, BLOCK 1, AS DESIGNATED ON THAT CERTAIN MAP ENTITLED, "TRACT NO. 106 LOS ROBLES, TOWN OF WOODSIDE, SAN MATEO COUNTY, CALIFORNIA," WHICH MAP WAS FILED IN THE OFFICE OF THE RECORDER OF THE COUNTY OF SAN MATEO, STATE OF CALIFORNIA ON JULY 13, 1960, IN BOOK 53 OF MAPS AT PAGES 40, 41 AND 42. PARCEL II: NON-EXCLUSIVE EASEMENT FOR INGRESS AND EGRESS OVER SO MUCH OF THE HEREIN DESCRIBED PROPERTY, AS LIES WITHIN ROBLES DRIVE, AS SAID DRIVE IS SHOWN UPON THE MAP HEREIN MENTIONED. 42 [MAP OF THE SUBJECT PROPERTY APPEARS HERE] The information on these plat is provided for your convenience as a guide to the general location of the subject property. The accuracy of this plat is not guaranteed, nor is it a part of any policy, report or guarantee to which it may be attached. 43 EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS MAR-31-1998 APR-01-1997 DEC-31-1997 287,813 3,128 342,192 68,935 32,259 629,848 112,763 19,662 780,777 256,196 0 0 0 592 523,989 780,777 704,785 704,785 376,752 376,752 264,937 4,061 204 85,346 28,164 57,182 0 0 0 57,210 0.98 0.94
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