-----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, Cdi5RMswJ1/+xUUI5MwZl2/FvaOKrDt5FU72YCtlNpysKtJBcE515PpddBnyFOm6 /0BEheCDyPVEd+ilT0XoIA== 0000912057-96-013563.txt : 19960702 0000912057-96-013563.hdr.sgml : 19960702 ACCESSION NUMBER: 0000912057-96-013563 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19960331 FILED AS OF DATE: 19960701 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-17948 FILM NUMBER: 96589370 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-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the Fiscal Year Ended March 31, 1996 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ___ to ___ Commission File No. 0-17948 ELECTRONIC ARTS INC. (Exact name of Registrant as specified in its charter) DELAWARE 94-2838567 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1450 FASHION ISLAND BOULEVARD SAN MATEO, CALIFORNIA 94404 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (415) 571-7171 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock, $.01 par value (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ___ Indicated by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] THE AGGREGATE MARKET VALUE OF THE REGISTRANT'S COMMON STOCK, $.01 PAR VALUE, HELD BY NON-AFFILIATES OF THE REGISTRANT ON JUNE 3, 1996 WAS $1,277,076,666. AS OF JUNE 3, 1996, THERE WERE 53,065,600 SHARES OF REGISTRANT'S COMMON STOCK, $.01 PAR VALUE, OUTSTANDING. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's definitive proxy statement (the "Proxy Statement") for its 1996 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. This report consists of 60 sequentially numbered pages. The Exhibit Index is located at sequentially numbered page 54. Page 1 of 60 ELECTRONIC ARTS INC. 1996 FORM 10-K ANNUAL REPORT Table of Contents PAGE ---- PART I Item 1. Business 3 Item 2. Properties 17 Item 3. Legal Proceedings 18 Item 4. Submission of Matters to a Vote of Security Holders 18 Item 4A. Executive Officers of the Registrant 19 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholders Matters 21 Item 6. Selected Financial Data 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 8. Financial Statements and Supplementary Data 31 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures 45 PART III Item 10. Directors and Executive Officers of the Registrant 46 Item 11. Executive Compensation 46 Item 12. Security Ownership of Certain Beneficial Owners and Management 46 Item 13. Certain Relationships and Related Transactions 46 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 47 Signatures 52 Exhibit Index 54 2 PART I THIS ANNUAL REPORT ON FORM 10-K, INCLUDING ITEM 1 ("BUSINESS") AND ITEM 7 ("MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS") CONTAINS FORWARD LOOKING STATEMENTS REGARDING FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY THAT INVOLVE CERTAIN RISKS AND UNCERTAINTIES DISCUSSED IN "FACTORS AFFECTING FUTURE PERFORMANCE" BELOW AT PAGES 23 TO 24. ACTUAL EVENTS OR THE ACTUAL FUTURE RESULTS OF THE COMPANY MAY DIFFER MATERIALLY FROM ANY FORWARD LOOKING STATEMENT DUE TO SUCH RISKS AND UNCERTAINTIES. ITEM 1: BUSINESS OVERVIEW Electronic Arts' predecessor was incorporated in California in 1982. In September 1991, Electronic Arts was reincorporated under the laws of Delaware. Unless otherwise indicated, the "Company" or "Electronic Arts" refers to Electronic Arts Inc., a Delaware corporation, its California predecessor and its wholly-owned and majority-owned subsidiaries. Electronic Arts' principal executive offices are located at 1450 Fashion Island Boulevard, San Mateo, California 94404. Its telephone number is (415) 571-7171. Electronic Arts creates, markets and distributes interactive entertainment software for a variety of hardware platforms. As of March 31, 1996, the Company marketed approximately 118 titles developed by it and/or published under one of its brand names, including older titles marketed as "Classics" or "Publisher's Choice". The Company also distributed approximately 500 additional titles developed by other software publishers ("Affiliated Labels"), which includes over 100 additional titles distributed under an exclusive distribution agreement to certain key accounts on behalf of other third party publishers. As of March 31, 1996, the Company had developed 79 titles that had each generated life-to-date net revenues in excess of $5,000,000. Since its inception, the Company has developed products for 34 different computer hardware platforms, including the following: IBM personal computer and compatibles, Amiga, 8-bit Nintendo Entertainment System (the "NES"), 16-bit Sega Genesis videogame system (the "Genesis"), 16-bit Super Nintendo Entertainment System (the "SNES"), Sega CD-ROM (Compact Disc-Read Only Memory) peripheral device, IBM PC-CD and compatibles, Macintosh CD, 3DO Interactive Multiplayer, the Sony PlayStation ("PlayStation") and the Sega Saturn ("Saturn"). Substantially all of the Company's products sold during the Company's 1996 fiscal year were developed for 16-bit and 32-bit platforms. The Company is currently also developing software products for use with the new 64-bit Nintendo 64 platform. As of March 31, 1996, the Company was developing products for 8 different hardware platforms. 3 The Company's product development methods and organization are modeled on those used in the entertainment industry, and the Company markets its products with techniques borrowed from other entertainment companies such as record producers, magazine publishers and video distributors. Company employees called "producers", who are each responsible for the development of one or more products, oversee product development and direct teams comprised of both Electronic Arts employees and outside contractors. Electronic Arts' designers regularly work with celebrities and organizations in sports, entertainment and other areas to develop products that provide gaming experiences that are as realistic and interactive as possible. Celebrities and organizations with whom the Company has had contracts include: Mario Andretti, Michael Jordan, Shaquille O'Neal, Road & Track, John Madden, Mark Hamill, the National Basketball Association, the PGA TOUR and the National Hockey League. The Company maintains development studios in California, Texas, Washington, Maryland, Canada, Japan and the United Kingdom. The Company invests in the creation of state-of-the-art software tools and utilities that are then used in product development. These tools, such as the Company's "Artist Workstation," allow for more cost-effective product development and the ability to more efficiently convert products from one hardware platform to another. The Company has also made investments in new facilities and equipment to facilitate the creation and editing of digital forms of video and audio recordings and product development efforts for new hardware platforms. Additionally, the Company produces film, videotape and audio recordings to include in its products. Two of the Company's subsidiaries, Electronic Arts Productions Inc. (d/b/a Crocodile Productions) and Electronic Arts Productions Ltd., have signed agreements with the Screen Actors Guild (SAG) and American Federation of Television and Radio Artists (AFTRA) in the United States and with British Actors Equity Association (Equity) in the UK, respectively, giving the Company access to a wide range of talent for use in Company-produced film and video for inclusion in the Company's products. See FACTORS AFFECTING FUTURE PERFORMANCE - FILM AND VIDEOTAPE at page 24. Electronic Arts distributes its products and those of its Affiliated Labels primarily by direct sales to retail chains and outlets in the United States and Europe. In Japan and the South Asia Pacific region, the Company distributes products both directly to retailers and through third party distributors. In fiscal 1996, the Company signed a distribution agreement with a third party to distribute the Company's products in certain countries in Southeast Asia including Singapore, Malaysia, Hong Kong and Thailand. The Company's products are available in over 50,000 retail locations worldwide. In fiscal 1996, approximately 42% of the Company's net revenues were generated by international operations, compared to 32% and 25% in fiscal 1995 and fiscal 1994, respectively. 4 ACQUISITIONS, INVESTMENTS AND JOINT VENTURES ACQUISITIONS In February 1996, Electronic Arts acquired Manley & Associates, an interactive software developer based in Seattle, Washington. In March 1996, the Company acquired Vision Software, a distributor of interactive software based in Johannesburg, South Africa. These acquisitions have expanded the Company's direct distribution capabilities and its development resources. See Note 12 of the Notes to Consolidated Financial Statements included in Item 8 hereof. INVESTMENTS The Company has made investments as part of its overall strategy and currently holds minority equity interests in several companies, including Novalogic, Inc., Tiburon Entertainment and The 3DO Company ("3DO"). There can be no assurance that the Company will realize long term benefits from any or all of these investments or that it will continue to carry any or all of these investments at their current value. JOINT VENTURES The Company has a majority interest in a joint venture corporation, Electronic Arts Victor, Inc., for the development and distribution of entertainment software products in Japan as well as certain Asian countries. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 hereof. The Company and Capital Cities/ABC, Inc. formed a joint venture company, in December 1994, Creative Wonders, LLC. (formerly ABC/EA Home Software, LLC), to develop and publish children's edutainment and interactive entertainment titles as well as reference products. The Company currently distributes Creative Wonders' products as one of the Company's Affiliated Labels. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 hereof. MARKET Historically, no hardware platform or system has achieved long-term dominance in the interactive entertainment market. This phenomenon has resulted in the Company developing products at one time or another for 34 different hardware platforms. Today, the competition in the market for hardware platforms has intensified, with the introduction of 32-bit videogame systems, planned introduction of the new 64-bit videogame systems and the rising installed base of multimedia-enabled home computers. This multi- platform approach continues to be a cornerstone of the Company's strategy and the Company plans to continue to develop and publish products for multiple platforms. 5 Early generation computer systems for which interactive software products were published such as the Apple II and the Commodore 64 were 8-bit floppy-disk- based personal computers. Several years ago these systems were eclipsed by more powerful personal computer systems based on 16-bit microprocessors, such as the IBM PC and compatibles, the Commodore Amiga and the Apple Macintosh. Current computer systems utilize 32-bit microprocessor technology and typically run CD-ROM based products. In North America, videogame systems have likewise changed significantly over time. In 1986 and 1987, Nintendo Co., Ltd. ("Nintendo") and Sega Enterprises, Ltd. ("Sega"), respectively, introduced 8-bit videogame systems that, compared to existing general-purpose computer systems available at the time, were low in price, easy to use and had more sophisticated audio-video capabilities. In late 1989, Sega began shipping its Genesis system, a more- powerful 16-bit videogame system. In August 1991, Nintendo introduced its 16- bit SNES videogame system. In late 1992, Sega introduced the Sega CD-ROM drive as an add-on peripheral to its Genesis system. The interactive software industry has recently undergone another significant change due in part to the introduction or planned introduction of new hardware platforms, as well as remote and electronic delivery systems. The new generation of systems are based on 32-bit and 64-bit microprocessors that incorporate dedicated graphics chipsets. Many of these systems utilize CD-ROM drives. The Company began development of 32-bit software products over four years ago by creating the original software development system for the first of these advanced products, the 3DO Interactive Multiplayer, which began selling in calendar 1993. Sega and Sony each began distribution of their next generation hardware systems (named the "Saturn" and "PlayStation", respectively) in Japan during the quarter ended December 1994. Sega began limited shipment of the Saturn in North America in May 1995 and Sony commenced shipping the PlayStation in North America in September 1995. Nintendo shipped the Nintendo 64 ("N64") system in Japan in June 1996 and announced plans to begin shipping the N64 in North America in the fall of 1996. In October 1995, The 3DO Company announced an agreement to license its next generation system, the "M2", to Matsushita Electric Industrial Co., Ltd. ("MEI"). New entrants in the interactive entertainment and multimedia industries, such as cable television, telephone and diversified media and entertainment companies, and a proliferation of new technologies, such as on-line networks and the Internet, are making market forecasting and prediction of financial results increasingly difficult for the Company. However, in the near term, the Company expects that the continued transition from 16-bit cartridge-based game machines to the advanced systems described above will continue to adversely affect the near term financial results of the Company. The Company's new product releases in its 1997 fiscal year will be primarily for 32-bit platforms, including the IBM PC-CD and compatibles, the Sony PlayStation and the Sega Saturn, and to a lesser degree 16-bit videogame systems. See FACTORS AFFECTING FUTURE PERFORMANCE -THE INDUSTRY AND COMPETITION at page 23. 6 As the 16-bit cartridge market has matured, related hardware and software sales have declined and are expected to significantly decline further in fiscal 1997. In addition, sales in the 16-bit software market have become more "hits" driven. Fewer products in that market are successful and publishers of these games, including the Company, must incur additional marketing and sales expenses to promote retailers' sales of their 16-bit cartridge products. In fiscal 1996, the Company released fewer titles for these platforms, concentrated releases during the year-end holiday seasons and focused marketing efforts on promoting hit products. In fiscal 1997, the Company plans to follow the same strategy and intends to release even fewer products for these platforms. The Company's total net revenues derived from 16-bit videogames declined in fiscal 1996 and is expected to significantly decline further in fiscal 1997. The Company also believes that investment in products for the 32-bit market, including both Compact Disk personal computer ("PC-CD") and CD- dedicated videogame ("CD-Videogame") platforms, is strategically important and the Company is therefore continuing its aggressive development activities for 32-bit platforms. Though Sega and Sony have announced price reductions of their 32-bit systems, the 32-bit CD-Videogame market may grow at a slower than expected rate. In addition, the Company's revenues and earnings are dependent on its ability to meet its product release schedule and its failure to meet those schedules may result in reduced revenues and earnings for fiscal 1997 and, in particular, in reduced revenues and a net loss in the first fiscal quarter. See FACTORS AFFECTING FUTURE PERFORMANCE - DEVELOPMENT AND PLATFORM CHANGES, respectively, at page 23. COMPETITION See FACTORS AFFECTING FUTURE PERFORMANCE - THE INDUSTRY AND COMPETITION at page 23. 7 RELATIONSHIPS WITH SIGNIFICANT HARDWARE PLATFORM COMPANIES SEGA Under the terms of a licensing agreement entered into with Sega in July 1992, as amended (the "16-bit Sega Agreement"), the Company is authorized to develop and manufacture ROM-cartridge software products compatible with the Sega Genesis system through December 1997 and to distribute those cartridges through June 1998. In addition, the Company is authorized to develop and distribute CD-ROM software products compatible with the Sega CD add-on drive for the Genesis through December 1996. Genesis cartridges are manufactured by the Company in Puerto Rico under the 16-bit Sega Agreement. Genesis CD-ROM products are manufactured by third party manufacturers. A shortage of components, or other factors outside the control of the Company could impair the Company's ability to obtain an adequate supply of cartridges or CD-ROMs. The Company currently derives a significant portion of its revenues from products developed for the Sega Genesis. In the fiscal year ended March 31, 1996, approximately 26% of the Company's net revenue came from sales of Sega Genesis products compared to 43% in fiscal 1995. During fiscal 1996, the Company released ten Genesis games compared to seventeen in fiscal 1995. Among these releases were MADDEN FOOTBALL '96, NBA LIVE '96, NHL HOCKEY '96, FIFA SOCCER '96 and COLLEGE FOOTBALL '96. The volume of sales of Sega Genesis products significantly declined in fiscal 1996 and is expected to decline significantly further in fiscal 1997. The Company plans to continue to develop and distribute titles for the Sega Genesis, though on a more limited scale than in the past, throughout fiscal 1997. Under the terms of a licensing agreement entered into with Sega 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. During the third quarter of fiscal 1996, the Company had its initial release of products for the Sega Saturn. During fiscal 1996, the Company released four Saturn products. 8 NINTENDO The Company released five SNES games in fiscal 1996 compared to six games in fiscal 1995. Among these releases were JOHN MADDEN FOOTBALL '96, NBA LIVE '96, FIFA SOCCER '96, AND NHL HOCKEY '96. In fiscal 1996, approximately 12% of the Company's net revenues were derived from sales of software for the SNES platform compared to 14% in fiscal 1995. During fiscal 1996 the Company sold SNES products in Europe, while in fiscal 1995 the Company licensed its products for publication in Europe on SNES to a third party. Accordingly, the Company's net revenues from SNES products attributable to Europe was significantly higher in fiscal 1996 than in fiscal 1995. Worldwide, the volume of sales of SNES products declined in fiscal 1996 and is expected to significantly decline in fiscal 1997. Under the terms of its licensing agreement with Nintendo, the Company engages Nintendo to manufacture its SNES cartridges. 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 Nintendo cartridges to be distributed in North America, Nintendo requires that the Company provide it with irrevocable letters of credit prior to Nintendo's acceptance of purchase orders from the Company. For purchases of Nintendo 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 FACTORS AFFECTING FUTURE PERFORMANCE - HARDWARE COMPANIES at page 24. SONY In fiscal 1996, approximately 9% of the Company's net revenues were derived from sales of software for the PlayStation. PlayStation products were first released during the second quarter of fiscal 1996. During fiscal 1996, the Company released thirteen PlayStation games. Among these releases were FIFA SOCCER '96, PGA TOUR GOLF '96, THEME PARK, ROAD RASH, AND THE NEED FOR SPEED. 9 Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994 ( the "Sony Agreement"), the Company is authorized to develop and distribute CD based software products compatible with the Sony PlayStation. Pursuant to the Sony Agreement, the Company engages Sony to supply its PlayStation CDs for distribution by the Company. Accordingly the Company has limited ability to control its supply of PlayStation CD products or the timing of their delivery. See FACTORS AFFECTING FUTURE PERFORMANCE - HARDWARE COMPANIES at page 24. In connection with the Company's purchases of Sony products to be distributed in Japan, Sony of Japan requires cash deposits totaling one-third of the purchase orders. At March 31, 1996, the Company had $197,000 of cash deposits to Sony. EAV utilizes a line of credit to fund these deposits. At March 31, 1996, EAV had an outstanding balance on this line of approximately $1,900,000. 3DO One of the advanced 32-bit platforms supported by the Company is the 3DO Interactive Multiplayer. At March 31, 1996, the Company owned approximately 12% of the common stock of 3DO. See Note 3 of the Notes to the Consolidated Financial Statements included in Item 8 hereof. During fiscal 1996, the Company released eight 3DO games, including WING COMMANDER 3. The Company released eight 3DO games in fiscal 1995. As discussed above, The 3DO Company announced that it has licensed the technology for the "M2" system - the next generation platform to the 3DO Interactive Multiplayer to MEI and thus 3DO will become primarily a software publishing company competing directly with the Company on multiple platforms. The Company currently has no planned releases of 3DO games in fiscal 1997. There can be no assurance that 3DO as a company will be successful. Because of the Company's equity stake in and historical association with 3DO, a material adverse effect on the business or prospects of 3DO or a substantial adverse change in the stock price of 3DO could have a material adverse effect on the Company's stock price. 10 PRODUCTS AND PRODUCT DEVELOPMENT In fiscal 1996, the Company generated approximately three-quarters of its revenues from products released during the year. See FACTORS AFFECTING FUTURE PERFORMANCE - PRODUCTS at page 23. As of March 31, 1996, Electronic Arts was actively marketing approximately 118 titles, comprising approximately 224 stock keeping units ("sku's"), that were published by the Company's development divisions and subsidiaries ("EA Studios"). During fiscal 1996, the Company introduced over 22 EA Studios titles, representing over 64 sku's, compared to 51 EA Studio titles, comprising over 85 sku's, in fiscal 1995. From the inception of the Company through March 31, 1996, the EA Studios organization had created and published 79 titles that have each generated more than $5,000,000 in life-to-date net revenues for the Company. The products published by EA Studios are designed and created by its in- house designers and artists and by independent software developers ("independent artists"). The Company typically pays the independent artists royalties ranging from 4% to 15% of net revenues, as defined in the related independent artist agreements. For fiscal 1996, the Company had one title, FIFA SOCCER '96, published on six platforms, represented 11% of the total 1996 net revenues. No one title accounted for more than 10% of the Company's net revenues for fiscal 1995. For fiscal 1994, the Company had two titles, JOHN MADDEN FOOTBALL '94, published on three platforms, and NHL HOCKEY '94, published on four platforms, which represented approximately 13% and 11%, respectively, of the total 1994 net revenues. The Company publishes products in a number of categories such as sports, action and interactive movies, strategy, simulations, role playing and adventure, each of which is becoming increasingly competitive. The Company's sports-related products, marketed under the EA Sports brand name, accounted for a significant percentage of net revenues in fiscal years 1996 and 1995. There can be no assurance that the Company will be able to maintain its market share in the sports category. See FACTORS AFFECTING FUTURE PERFORMANCE -THE INDUSTRY AND COMPETITION at page 23. The retail selling prices in North America of the Company's products, excluding older titles (marketed as "Classics" and "Publisher's Choice"), typically range from $35.00 to $70.00. "Classics" and "Publisher's Choice" titles have retail selling prices that range from $15.00 to $20.00. The retail selling prices of EA titles outside of North America vary based on local market conditions. 11 The Company currently develops or publishes products for 8 different hardware platforms and has from time to time developed and marketed products on 34 different and incompatible platforms in the past. The Company's current and planned product introductions are predominantly for 32-bit platforms such as the IBM PC and compatibles, the Sony PlayStation and the Sega Saturn and to a lesser degree 16-bit platforms, the Genesis videogame system and SNES. See FACTORS AFFECTING FUTURE PERFORMANCE - DEVELOPMENT AND PLATFORM CHANGES, respectively, at page 23. As compact discs have emerged as the preferred medium for interactive entertainment, education, and information software, the Company continued its investment in the development of CD-ROM tools and technologies in fiscal 1996 and currently has more than 60 products in development for new CD-ROM platforms, including the IBM PC and compatibles, the Sony PlayStation and the Sega Saturn. Most of these products will be convertible for use on multiple advanced hardware systems. During the fiscal years 1996, 1995 and 1994, the Company had research and development expenditures of $99.6 million, $73.9 million, and $62.6 million, respectively. See FACTORS AFFECTING FUTURE PERFORMANCE - DEVELOPMENT at page 23. Additionally, 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. With extensive use of video in some of the Company's products, particularly its products in the interactive movie category, there can be no assurance that the significantly higher sales levels required to make these products profitable will be achieved. The Company expects to release one product with significant video content during fiscal 1997. See FACTORS AFFECTING FUTURE PERFORMANCE - FILM AND VIDEOTAPE at page 24. MARKETING AND DISTRIBUTION The Company distributes both EA Studio products and products developed and published by other software publishers known as "Affiliated Labels". In most cases, Affiliated Label products are delivered to the Company as completed products. As of March 31, 1996, the Company distributed approximately 500 Affiliated Label titles. During fiscal 1996 the Company introduced over 600 Affiliated Label titles, as compared to more than 130 titles in fiscal 1995. The increase in the number of Affiliated Label titles marketed and released was primarily due to the acquisition of Kingsoft GmbH in Germany at the end of fiscal 1995. Starting in fiscal 1996, the Company began to derive revenues from the exclusive distribution of PC entertainment and 3DO products to key accounts on behalf of other third party publishers. No single Affiliated Label has accounted for more than 10% of the Company's net revenue in any of the last three fiscal years. 12 The Company generated approximately 84% of its North American net revenues from direct sales through a field sales organization of professionals and a group of telephone sales representatives. The remaining 16% of its North American sales were made through a limited number of specialized and regional distributors and rack jobbers in markets where the Company believes direct sales would not be economical. The Company had no customers accounting for more than 10% of total net revenues for the years ended March 31, 1996 and 1995. The Company had sales to one customer which represented 10.8% of total net revenues for fiscal 1994. As discussed above, (See MARKET above) the 16-bit videogame business has become increasingly "hits" driven, requiring significantly greater expenditures for advertising, particularly for television advertising. There can be no assurance that the Company will continue to produce hit products or that advertising expenditures will increase sales sufficiently to recoup the advertising expenditures. The Company has stock-balancing programs for its personal computer products (whether provided on floppy-disk or CD-ROM) 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 16-bit and 32-bit videogame 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. The risk of price protection requirements is increasing as a result of the maturing and the increasingly hit-based nature of the 16-bit video cartridge market. 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 the foreseeable future. However, there can be no assurance that actual returns or price protection will not exceed the Company's reserves. See FACTORS AFFECTING FUTURE PERFORMANCE - REVENUES AND EXPENSES at page 24. The Company also has a fulfillment group that sells product directly to consumers through a toll-free number listed in advertising by the Company and its Affiliated Labels. This group is also responsible for targeted direct mail marketing and sells product upgrades, backups and accessories to registered customers. 13 The distribution channels through which consumer software products are sold have been characterized by change, including consolidations and financial difficulties of certain distributors and retailers and the emergence of new retailers such as general mass merchandisers. The development of remote and electronic delivery systems will create further changes. The bankruptcy or other business difficulties of a distributor or retailer could render Electronic Arts' accounts receivable from such entity uncollectible, which could have an adverse effect on the operating results and financial condition of the Company. Uncollectible receivables from certain accounts in Japan resulted in an increase in bad debt reserves in fiscal 1995. In addition, an increasing number of companies are competing for access to these channels. Electronic Arts' arrangements with its distributors and retailers may be terminated by either party at any time without cause. Distributors and retailers often carry products that compete with those of the Company. Retailers of Electronic Arts' products typically have a limited amount of shelf space and promotional resources for which there is intense competition. There can be no assurance that distributors and retailers will continue to purchase Electronic Arts' products or provide Electronic Arts' products with adequate levels of shelf space and promotional support. INTERNATIONAL OPERATIONS The Company has wholly-owned subsidiaries in the United Kingdom, France, Spain, Germany, Australia, Canada, South Africa, Singapore, Sweden and Puerto Rico as well as a majority-owned subsidiary in Japan. The amounts of net revenues, operating profit and identifiable assets attributable to each of the Company's geographic regions for each of the last three fiscal years are set forth in Note 16 of the Notes to the Consolidated Financial Statements included in Item 8 hereof. In comparison to fiscal 1995, international net revenues increased by 43% due primarily to the increase in sales of PC-CD and Sony products together with increased SNES sales in Europe. These increases were offset by reduced Sega and floppy revenue. 14 In fiscal 1996, net revenues from Europe increased by 40% to $157,999,000 compared to $112,907,000 in fiscal 1995. The increase was due mainly to higher revenues generated by Kingsoft GmbH in Germany and DROSoft in Spain. Europe also implemented a pan-European distribution network that resulted in a significant portion of products being distributed directly to retailers. During fiscal 1996, Electronic Arts opened EA Nordic in Stockholm, Sweden to distribute the Company's products in Sweden, Norway, Finland, Denmark and Iceland. In March 1996, Electronic Arts acquired Vision Software, a distributor of interactive software based in Johannesburg, South Africa. In fiscal 1996, Japan net revenues increased by 43% to $45,865,000 compared to $31,997,000 in fiscal 1995. The increase was due to an increase in net revenues derived from a higher volume of CD based products (PC-CD and CD- Videogames) and Affiliated Label products. In fiscal 1996, net revenues from South Asia Pacific increased by 66% to $21,794,000 compared to $13,139,000 in fiscal 1995. As mentioned earlier, Electronic Arts signed a distribution agreement with a third party to distribute the Company's products in certain countries in Southeast Asia. The increase in net revenues was due mainly to sales in new markets, including Singapore and Malaysia. Though international revenues are expected to grow in fiscal 1997, international revenues may not grow at as high a rate as in prior years. MANUFACTURING The Company's Genesis cartridge products are manufactured by the Company in Puerto Rico under the terms of a manufacturing license agreement with Sega. The assembly of the final packaged product is performed by outside organizations under the supervision of the Company's operations organization. The Company's SNES products are purchased as finished goods from Nintendo. Manufacturing and assembly of floppy-disk and CD products is performed by outside organizations under the supervision of the Company's operations organization. The manufacturing process for all software involves the duplication of software code onto floppy diskettes, ROM chips, or CD's, printing of packaging and documentation, and assembly of the final packaged product. Quality control tests are performed on all products by Company employees, and the products are then warehoused and shipped to customers by the Company. In many instances, the Company is able to acquire materials on a volume- discount basis. The Company has multiple potential sources of supply for most materials. Except with respect to its SNES and Sony products, the Company also has alternate sources for the manufacture and assembly of most of its products. To date, the Company has not experienced any material difficulties or delays in production of its software and related documentation and packaging. However, a shortage of components or other factors beyond the control of the Company could impair the Company's ability to manufacture, or have manufactured, its products. SEE FACTORS AFFECTING FUTURE PERFORMANCE - HARDWARE COMPANIES at page 24. 15 BACKLOG The Company normally ships product within a few days after receipt of an order. However, a backlog may occur for EA Studios and Affiliated Label products that have been announced for release but not yet shipped. The Company does not consider backlog to be an indicator of future performance. SEASONALITY The Company's business is highly seasonal. The Company typically experiences its highest revenues and profits in the calendar year-end holiday season and a seasonal low in revenues and profits in the quarter ending in June. In its 1997 fiscal year, and particularly in the June and September quarters, the Company expects these seasonal trends to be magnified by general economic and industry factors, including the continued transition from 16-bit cartridge-based game machines to the new 32-bit systems and the concentration of the Company's product releases in the second half of fiscal 1997. EMPLOYEES As of March 31, 1996, the Company employed approximately 1,500 people, of whom over 700 were outside the United States. The Company believes that its ability to attract and retain qualified employees is an important factor in its growth and development and that its future success will depend, in large measure, on its ability to continue to attract and retain qualified employees. To date, the Company has been successful in recruiting and retaining sufficient numbers of qualified personnel to conduct its business successfully. See FACTORS AFFECTING FUTURE PERFORMANCE - EMPLOYEES at page 24. 16 ITEM 2: PROPERTIES The Company's principal administrative, sales and marketing, research and development, and support facility is located in four modern buildings in San Mateo, California, 15 miles south of San Francisco. The Company presently occupies approximately 196,000 square feet in these buildings, under leases that expire at various times between August 1998 and April 1999. In addition, the Company leases and occupies a 54,000 square foot facility, used as an office and warehouse in Hayward, California, and a 120,000 sq. ft. warehouse facility in Louisville, Kentucky. The Company also occupies sales offices in the metropolitan areas of Toronto, Chicago, Dallas and New York. The Company's North American research and development activities are supported by a 69,000 square foot development facility in Burnaby, British Columbia, Canada. The Company also owns a 178,000 square foot development facility in Austin, Texas and leases a 5,000 sq. ft. development facility in Baltimore, Maryland. The Company's United Kingdom subsidiary occupies administrative, sales, and distribution facilities in Langley, England, under a long-term lease for a total of 66,000 square feet as well as 10,500 square foot development facility in Surrey, England. In Europe, the Company also leases two administrative, sales and distribution facilities in Germany, one for 1,000 square feet and another for 78,000 square feet, as well as sales and distribution facilities in Madrid, Spain, Lyon, France, and a sales office in Stockholm, Sweden. The Company also maintains an 8,000 square foot sales and distribution facility in Brisbane, Australia, a 10,000 square foot sales, distribution and development facility in Tokyo, Japan, a representative office in Beijing, China, and a manufacturing facility in San Juan, Puerto Rico. See Notes 4 and 9 to Notes to Consolidated Financial Statements included in Item 8 hereof. In February 1995, the Company entered into a master operating lease for land and a building to be constructed in Redwood City, California. The facility is to be used as a corporate headquarters for EA. The above mentioned rental space EA currently occupies is expected to be vacated upon the completion of the new corporate headquarters. The square footage of the new facilities is expected to be approximately 375,000. In connection with its fiscal 1996 acquisitions (See ACQUISITIONS, INVESTMENTS AND JOINT VENTURES above), the Company assumed leases for 7,000 square feet of sales and distribution facilities in Johannesburg, South Africa and 10,000 square feet of development facilities in Seattle, Washington. The Company believes that these facilities are adequate for its current needs. The Company believes that suitable additional or substitute space will be available as needed to accommodate the Company's future needs. 17 ITEM 3: LEGAL PROCEEDINGS The Company is subject to a number of routine pending litigation matters. Management, after review and consultation with counsel, considers that any liability from the disposition of such matters would not have a material adverse effect upon the financial condition or results of operations of the Company. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the quarter ended March 31, 1996. 18 ITEM 4A: EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company, who are chosen by and serve at the discretion of the Board of Directors, are as follows: Name Age Position ---- --- -------- Lawrence F. Probst III 46 Chairman of the Board of Directors and Chief Executive Officer William Bingham Gordon 46 Executive Vice President, Marketing Monty Finefrock 47 Senior Vice President, San Mateo Studios Mark S. Lewis 46 Senior Vice President, International E. Stanton McKee, Jr. 51 Senior Vice President, Chief Financial and Administrative Officer Donald A. Mattrick 32 Senior Vice President, North American Studios Nancy L. Smith 43 Senior Vice President, North American Sales and Distribution David L. Carbone 45 Vice President, Finance Ruth A. Kennedy 41 Vice President, General Counsel and Secretary MR. PROBST has been a director of the Company since January 1991 and currently serves as Chairman of the Board of Directors, and Chief Executive Officer. He was elected as Chairman in July 1994. Mr. Probst served as Senior Vice President of EA Distribution, the Company's distribution division, from January 1987 to January 1991, and from September 1984, when he joined the Company, until December 1986, served as Vice President of Sales. Mr. Probst holds a B.S. degree from the University of Delaware. MR. GORDON has served as Executive Vice President, Marketing since October 1995. From August 1993 to October 1995, he served as Executive Vice President of EA Studios. Prior to this, he served as Senior Vice President of Entertainment Production since February 1992. From December 1989 to January 1992, he served as the Senior Vice President of Marketing. He also served as General Manager of EA Studios, as Vice President of Marketing, Director of Advertising and Vice President of the Company's former entertainment division while employed by the Company. Mr. Gordon holds a B.A. degree from Yale University and an M.B.A. degree from Stanford University. 19 MR. FINEFROCK has served as Senior Vice President, San Mateo Studios since October 1995. Prior to this he served as Senior Vice President and General Manager of the EA Entertainment division since March 1994. From February 1992 to March 1994, he served as Vice President of EA Studio Operations and Development. From July 1989 to February 1992, Mr. Finefrock served as Vice President of Studio Operations. Mr. Finefrock joined the Company in April 1983. He holds a B.S. degree in Business Administration from the University of Redlands. MR. LEWIS has served as Senior Vice President of International since July 1993. From August 1991 to July 1993, he served as President of Electronic Arts, Limited, a wholly-owned subsidiary of the Company which serves the European market from its base in Langley, England. He has also served as Managing Director of Electronic Arts, Ltd., Director of European Publishing, and as a Producer and Manager of Product Support and Acquisitions during his tenure with the Company. He has been employed by the Company since 1984. Mr. Lewis is a graduate of Yale University. MR. MCKEE joined the Company as Senior Vice President and Chief Financial and Administrative Officer in March 1989. Mr. McKee holds B.A. and M.B.A. degrees from Stanford University and is also a Certified Public Accountant. MR. MATTRICK has served as Senior Vice President, North American Studios, since October 1995. From July 1991 to October 1995 he served as Vice President of Electronic Arts and Executive Vice President/General Manager for EA Canada. Mr. Mattrick was founder and former chairman of Distinctive Software Inc. from 1982 until it was acquired by the Company in 1991. MS. SMITH has served as Senior Vice President of North American Sales and Distribution since July 1993 and as Vice President of Sales from 1988 to 1993. Ms. Smith has also served as Western Regional Sales Manager and National Sales Manager since she joined the Company in 1984. Ms. Smith holds a B.S. degree in management and organizational behavior from the University of San Francisco. MR. CARBONE has been with the Company since February 1991 as Vice President, Finance. He was elected Assistant Secretary of the Company in March 1991. Prior to joining the Company, Mr. Carbone served as Controller for Magnetic Pulse, Inc., a privately held designer of tools for hydrocarbon exploration, and was previously employed as Vice President of Finance for Vicom Systems Inc., a supplier of high-end graphics and imaging systems, from August 1989 to February 1990. Mr. Carbone holds a B.S. degree in accounting from King's College and is a Certified Public Accountant. MS. KENNEDY has been employed by the Company since February 1990. She served as Corporate Counsel until March 1991 and is currently Vice President, General Counsel and Secretary. Ms. Kennedy was elected Secretary in September 1994. Ms. Kennedy is a member of the State Bars of California and New York and received her B.A. degree from William Smith College and her Juris Doctor from the State University of New York. 20 PART II ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the National Market under the symbol "ERTS". The following table sets forth the quarterly high and low closing sales prices of the Company's Common Stock from April 1, 1994 through March 31, 1996. Such prices represent prices between dealers and does not include retail mark-ups, mark-downs or commissions and may not represent actual transactions. Closing Sales Prices -------------------- High Low ---- --- Fiscal Year Ended March 31, 1995: First Quarter $25.75 $13.00 Second Quarter 18.75 13.50 Third Quarter 22.50 17.50 Fourth Quarter 25.75 16.75 Fiscal Year Ended March 31, 1996: First Quarter $30.00 $20.13 Second Quarter 41.75 27.13 Third Quarter 38.75 23.13 Fourth Quarter 28.50 22.13 There were approximately 2,085 holders of record of the Company's Common Stock as of June 3, 1996. The Company believes that a significant number of beneficial owners of its Common Stock hold their shares in street names. DIVIDEND POLICY The Company has not paid any cash dividends and does not anticipate paying cash dividends in the foreseeable future. 21 ITEM 6: SELECTED FINANCIAL DATA ELECTRONIC ARTS SELECTED FIVE-YEAR FINANCIAL DATA Year Ended March 31, (In thousands, except per share data)
INCOME STATEMENT DATA 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------------------ Net revenues $531,887 $493,346 $418,289 $298,386 $175,094 Cost of goods sold 273,594 263,357 224,606 160,578 90,915 --------------------------------------------------------------------------- Gross profit 258,293 229,989 193,683 137,808 84,179 Operating expenses: Marketing and sales 72,928 61,951 46,847 38,465 22,679 General and administrative 32,207 29,308 23,767 20,713 13,962 Research and development 99,627 73,902 62,570 37,451 21,533 --------------------------------------------------------------------------- Total operating expenses 204,762 165,161 133,184 96,629 58,174 --------------------------------------------------------------------------- Operating income 53,531 64,828 60,499 41,179 26,005 Interest and other income, net 6,021 13,250 3,782 2,537 1,522 --------------------------------------------------------------------------- Income before provision for income taxes and minority interest 59,552 78,078 64,281 43,716 27,527 Provision for income taxes 18,759 24,980 19,450 13,421 8,839 --------------------------------------------------------------------------- Income before minority interest 40,793 53,098 44,831 30,295 18,688 Minority interest in consolidated joint venture (304) 2,620 (94) 563 - --------------------------------------------------------------------------- Net income $ 40,489 $ 55,718 $ 44,737 $ 30,858 $ 18,688 --------------------------------------------------------------------------- --------------------------------------------------------------------------- Net income per share $ 0.75 $ 1.07 $ 0.86 $ 0.62 $ 0.40 --------------------------------------------------------------------------- --------------------------------------------------------------------------- Number of shares used in computation 54,163 52,297 52,286 49,992 47,165 --------------------------------------------------------------------------- ---------------------------------------------------------------------------
BALANCE SHEET DATA AT FISCAL YEAR END - ------------------------------------------------------------------------------------------------------------------------------ Cash and short-term investments $147,983 $174,121 $130,318 $ 98,029 $ 59,053 Marketable securities 37,869 10,725 11,931 -- Working capital 199,713 168,742 135,741 85,094 57,375 Long-term investments 24,200 14,200 - - - Total assets 424,219 341,239 273,651 181,257 105,773 Total liabilities 100,625 103,018 97,988 67,687 37,764 Minority interest 1,277 1,148 3,485 2,999 - Total stockholders' equity 322,317 237,073 172,178 110,571 68,009
22 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FACTORS AFFECTING FUTURE PERFORMANCE 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/ licenser 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 PC's are difficult to predict because they involve creative processes, use of new development tools for new platforms and the learning process, research and experimentation associated with development for new technologies. CD-ROM products frequently include more content and are more complex, time-consuming and costly to develop than cartridge products and, accordingly, cause additional development and scheduling risk. For example, WING COMMANDER IV, a major product scheduled to ship for the PC platform in the December quarter, did not ship until February, 1996, due to delays in the final editing and testing process. Similarly, JOHN MADDEN FOOTBALL 96 and NHL HOCKEY 96 for the Sony PlayStation did not ship at all due to significant delays in development that made the delayed completion date untimely for these products. Because of the increased cost of compact disk product development, write-offs of advance payments made to outside artists for discontinued or unsuccessful products have and may continue to increase. In addition, 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 one to three weeks; cartridge products more typically have had a six to twelve week lead time for manufacture. PLATFORM CHANGES. A large portion of the Company's revenues are derived from the sale of products designed to be played on proprietary videogame platforms such as the Sony PlayStation, Sega Saturn, Super Nintendo Entertainment System and Sega Genesis. The interdependent nature of the Company's business and that of its hardware licensers brings significant risks to the Company's business. The success of the Company's products is significantly affected by market acceptance of the new videogame 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 videogame systems (such as the new 32-bit systems) that have not yet achieved large installed bases or 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. 23 HARDWARE COMPANIES. The Company's contracts with hardware licensers, which are also some of the Company's chief competitors, often grant significant control to the licenser 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 Company over the lead times and costs that the Company can achieve independently. In fiscal 1996, for example, the Company experienced delays in the manufacturing of Sony PlayStation products which caused delays in shipping those products. The results of future periods may be affected by similar delays. Finally, the Company's contracts with its hardware licensers often require the Company to take significant risks in holding or prepaying for its inventory of products. 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. 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. In addition, due in part to the volume of products introduced into the market and the short shelf life of most products, there is increasing pressure from retailers to offer price protection and accept returns of retailers' excess inventory. 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. For example, the film component of WING COMMANDER IV cost approximately $8.0 million. Accordingly, more units of such products must be sold to recoup the development and production costs. While WING COMMANDER IV has sold sufficient units to recoup the full costs of development, there can be no assurances that other products including significant film or videotape components 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 assurances that the Company will be able to renegotiate favorable terms. 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 severe. 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 on-line business areas offer significant potential equity gains which are difficult for more mature companies like the Company to match without significant shareholder dilution. In the last eighteen (18) months, three of the Company's executive officers have resigned to work with small start-up ventures, and virtually all of the executives are under intense recruiting pressure. There can be no assurances that the Company will be able to continue to attract and retain enough qualified employees in the future. None of the Company's employees is subject to a collective bargaining agreement, and the Company believes that its employee relations are excellent. FLUCTUATIONS IN STOCK PRICE. Due to analysts' expectations of continued growth and other factors, any shortfall in earnings could have an immediate and significant adverse effect on the trading price of the Company's common stock in any given period. As a result of the factors discussed in this annual report and other factors that may arise in the future, the market price of the Company's common stock may 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. 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. 24 RESULTS OF OPERATIONS Comparison of Fiscal 1996 to 1995 1996 1995 % change - -------------------------------------------------------------------------------- Net revenues $531,887,000 $493,346,000 7.8 - -------------------------------------------------------------------------------- The Company derives revenues from shipments of EA Studio cartridge products, EA Studio Compact Disk ("CD") personal computer products ("PC-CD") and floppy-disk personal computer products (primarily entertainment software), EA Studio CD products for dedicated entertainment systems ("CD-Videogame"), licensing of EA Studio products, distribution of EA Studio products through hardware companies ("OEMs") all of which comprise its "published revenues" and shipments of Affiliated Label CD and floppy-disk products that are created by third parties. Total net revenues increased compared to the prior year primarily due to an increase in net revenues derived from a higher volume of CD based products (PC- CD and CD-Videogames), and Affiliated Label products. This was partially offset by a decrease in sales of 16-bit Sega Genesis Videogame Cartridges ("Genesis") and EA floppy-disk products. Net revenues generated by 16-bit videogame cartridge based products were $202,599,000 or 38% of consolidated net revenues in fiscal 1996 compared to $281,933,000 or 57% of net revenues in fiscal 1995. The mix of net revenue in fiscal 1996 reflects the continued impact of the transition from the mature 16- bit cartridge based market to the emerging CD based market. As the 16-bit market has matured, sales of hardware and software have declined and are expected to significantly decline further in fiscal 1997. During fiscal 1996, the Company released fewer titles for these platforms and intends significantly fewer releases in fiscal 1997. Sales of EA Studio Genesis cartridge products in fiscal 1996 declined to $138,643,000, or 26% of total revenue, compared to $213,471,000, or 43% of total revenue in fiscal 1995. The Company released 10 new Genesis titles in fiscal 1996 compared to 17 in fiscal 1995. Net revenues derived from cartridge products for the Super Nintendo Entertainment System ("Super NES") were $63,956,000, or 12% of total revenue, in fiscal 1996 compared to $68,462,000, or 14% of total revenue in fiscal 1995. The Company released five new titles for the Super NES in fiscal 1996 compared to six in fiscal 1995. Net revenues from PC-CD products increased to $140,594,000 in fiscal 1996, representing 26% of total net revenues, from $72,227,000, or 15% of total net revenues in fiscal 1995. The Company released 22 PC-CD titles in fiscal 1996 compared to 30 in fiscal 1995. The Company expects revenues from PC-CD products to continue to grow, but as revenues for PC-CD products increase, the Company does not expect to maintain these growth rates. CD-Videogame products, primarily the Sony PlayStation in fiscal 1996 and the 3DO Interactive Multiplayer in fiscal 1995, generated net revenues of $76,523,000 in fiscal 1996, representing 14% of the total net revenues compared to $27,230,000, or 6% of total net revenues in fiscal 1995. The Company released 25 CD-Videogame titles in fiscal 1996 compared to eight in fiscal 1995. Licensing of EA Studio products generated $27,018,000 in fiscal 1996, compared to $21,001,000 in fiscal 1995. The increase primarily resulted from increased distribution of EA's products through OEMs. Net revenues from shipments of Affiliated Label products in fiscal 1996 increased to $76,302,000 from $48,480,000 in fiscal 1995. The increase was primarily attributable to revenues from the exclusive distribution of certain PC entertainment and 3DO products to key accounts on behalf of other third party publishers which began in fiscal 1996. Additionally , the Company had increased Affiliated Label net revenues in Japan and Europe due to higher sales from several new and existing affiliates. Affiliated Label CD based products represented 96% of total Affiliated Label net revenues in fiscal 1996, compared to 59% in fiscal 1995. The Company's revenues from floppy-disk products, hand-held cartridge products and products from the Sega 32X platform decreased to $8,851,000 or 2% of the total in 1996 from $42,475,000 or 9% in fiscal 1995. Results continue to reflect the rapid market shift away from these products to CD based products. The Company produced no new games for these platforms in fiscal 1996 and does not expect to release any new titles in fiscal 1997. In fiscal 1995, the Company released 14 floppy-disk titles. On a geographic basis, the revenue mix reflects the Company's growth in worldwide operations. International net revenues increased by 43% to $225,658,000 or 42% of consolidated 1996 net revenues compared to $158,043,000 or 32% of the 1995 total. The increase in international revenues was attributable to higher worldwide sales of CD based products, primarily PC-CD and Sony PlayStation together with an increase in sales of Super NES products in Europe, which were licensed in 1995. This was partially offset by a decrease in floppy-disk and Genesis products. North American net revenues totaled $306,229,000 in fiscal 1996, representing a decrease of 9% over the $335,303,000 generated in fiscal 1995. The decrease was attributable to the decline in 16-bit cartridge revenues partially offset by the increase in shipments of PC-CD products and CD-Videogames. 25 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1996 1995 % change - -------------------------------------------------------------------------------- Cost of goods sold $273,594,000 $263,357,000 3.9 As a percentage of net revenues 51.4% 53.4% - -------------------------------------------------------------------------------- Cost of goods sold as a percentage of revenues in fiscal 1996 reflects lower product costs associated with CD based products offset by higher production costs for multimedia releases, higher professional and celebrity royalties, higher distribution and manufacturing expenses for the operations in Europe and growth in the lower margin distribution business. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- OPERATING EXPENSES 1996 1995 % change - -------------------------------------------------------------------------------- Marketing and sales $72,928,000 $61,951,000 17.7 As a percentage of net revenues 13.7% 12.6% - -------------------------------------------------------------------------------- General and administrative $32,207,000 $29,308,000 9.9 As a percentage of net revenues 6.1% 5.9% - -------------------------------------------------------------------------------- Research and development $99,627,000 $73,902,000 34.8 As a percentage of net revenues 18.7% 15.0% - -------------------------------------------------------------------------------- The increase in marketing and sales expenses was affected by higher trade show expenses and higher co-op advertising expenses associated with higher revenues. Additionally, marketing and sales expenses, along with general and administrative expenses, increased due to additional headcount and higher facility expenses related to the prior year acquisitions and the opening of new sales offices in International markets. Increases in general and administrative expenses were partially offset by a decrease in bad debt expenses in Japan as compared to fiscal 1995. The increase in research and development expenses was primarily due to additional headcount relating to increased in-house development capacity, higher average development costs for CD based products than for cartridge products, increased reserves against artist advances due to product delays, primarily on CD-Videogame platforms, and the acquisition of Manley & Associates, a Seattle based development company in 1996. The Company released a total of 64 new products in fiscal 1996 compared to 86 in fiscal 1995. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1996 1995 % change - -------------------------------------------------------------------------------- Operating income $53,531,000 $64,828,000 (17.4) As a percentage of net revenue 10.1% 13.1% - -------------------------------------------------------------------------------- The decrease in operating income was primarily due to higher operating expenses partially offset by an increase in net revenues. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1996 1995 % change - -------------------------------------------------------------------------------- Interest and other income, net $6,021,000 $13,250,000 (54.6) As a percentage of net revenues 1.1% 2.7% - -------------------------------------------------------------------------------- The decrease in other income was primarily due to a one-time payment of $10,000,000 from Broderbund Software, Inc. ("Broderbund"), offset by costs of $1,400,000 incurred by the Company, associated with the termination of the merger agreement between the Company and Broderbund in fiscal 1995. In fiscal 1996, the Company also had higher interest income related to higher average cash balances and interest rates worldwide together with gains on the sales of marketable securities and fixed assets. These gains were substantially offset by losses and write-offs of certain investments in affiliates. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1996 1995 % change - ------------------------------------------------------------------------------- Income taxes $18,759,000 $24,980,000 (24.9) Effective tax rate 31.5% 32.0% - ------------------------------------------------------------------------------- The effective tax rate for fiscal 1996 decreased over the prior year primarily as a result of the fiscal 1995 impact of the operating loss reported by Electronic Arts Victor ("EAV") and the use of those losses to offset EAV's profits in 1996. Tax benefits from the Company's Puerto Rico operations were lower in the current year as a result of lower sales of cartridge products. 26 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1996 1995 % change - -------------------------------------------------------------------------------- Minority interest in consolidated joint venture $(304,000) $2,620,000 N/M As a percentage of net revenues (0.1%) 0.5% - -------------------------------------------------------------------------------- EAV is sixty-five percent owned by the Company and thirty-five percent owned by Victor Entertainment Industries, Inc. ("VEI"), a wholly owned subsidiary of Victor Company of Japan, Limited. Minority interest for fiscal 1996 represents VEI's pro rata share of net income from EAV's operations. Conversely, the fiscal 1995 minority interest represents VEI's pro rata share of EAV's net loss for that period. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1996 1995 % change - -------------------------------------------------------------------------------- Net income $40,489,000 $55,718,000 (27.3) As a percentage of net revenues 7.6% 11.3% - -------------------------------------------------------------------------------- The decrease in net income was due to higher operating expenses partially reduced by higher revenue combined with the prior year impact of the after-tax net gain of approximately $5,800,000 from the one-time payment of a merger termination fee. 27 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- RESULT OF OPERATIONS Comparison of Fiscal 1995 to 1994 1995 1994 % change - -------------------------------------------------------------------------------- Net revenues $493,346,000 $418,289,000 17.9 - -------------------------------------------------------------------------------- Total fiscal 1995 net revenues increased compared to fiscal 1994 primarily due to increased net revenues derived from a higher volume of CD based products (PC- CD and 3DO Interactive Multiplayer), EA License/OEM products and Affiliated Label products. This was partially offset by decreased sales of 16-bit Super Nintendo Entertainment System ("Super NES") and EA floppy-disk products. Net revenues generated by 16-bit cartridge based products were $281,933,000 or 57% of consolidated net revenues in fiscal 1995 compared to $309,929,000 or 74% of net revenues in fiscal 1994. The mix of net revenue in fiscal 1995 reflected the impact of the transition from the mature 16-bit cartridge based market to the emerging 32-bit CD- Videogame market. Additionally, as the 16-bit market has become more "hits-driven", the Company released fewer titles for these platforms in fiscal 1995. Sales of EA Studio Sega Genesis ("Genesis") cartridge products in fiscal 1995 declined to $213,471,000, or 43% of total revenue, compared to $220,327,000, or 53% of total revenue in fiscal 1994. The Company released 17 new Genesis titles in fiscal 1995 compared to 24 in fiscal 1994. Net revenues derived from cartridge products for the Super NES were $68,462,000, or 14% of total revenue, in fiscal 1995 compared to $89,602,000, or 21% of total revenue in fiscal 1994. The Company released six new titles for the Super NES in fiscal 1995 compared to eight in fiscal 1994. Net revenues from PC-CD products increased to $72,227,000 in fiscal 1995, representing 15% of total net revenues, from $4,968,000, or 1% of total net revenues in fiscal 1994. The Company released 30 PC-CD titles in fiscal 1995 compared to eight in fiscal 1994. CD-Videogame products, primarily the 3DO Interactive Multiplayer, generated net revenues of $27,230,000 in fiscal 1995, representing 6% of the total net revenues compared to $8,676,000, or 2% of total net revenues in fiscal 1994. The Company released eight of these titles in fiscal 1995 compared to seven in fiscal 1994. Net revenues from floppy-disk based products decreased to $26,631,000, or 5% of the total in fiscal 1995, from $50,998,000, or 12 % in fiscal 1994. Results reflected the rapid market shift from floppy-disk based personal computer products to PC-CD products. In fiscal 1995, the Company released 14 floppy disk titles, compared to 35 in fiscal 1994. Licensing of EA Studio products generated $21,001,000 in fiscal 1995, compared to $8,495,000 in fiscal 1994. The increase primarily resulted from the licensing of the Company's Super NES products to a third party in Europe and increased distribution of its products through OEMs. Net revenues from shipments of Affiliated Label products in fiscal 1995 increased to $48,480,000 from $33,216,000 in fiscal 1994. The increase, primarily attributable to higher net revenues for PC-CD products, was partially offset by decreased net revenues derived from floppy-disk based computer products. Affiliated Label PC-CD products represented 59% of total Affiliated Label net revenues in fiscal 1995, compared to 32% in fiscal 1994. Net revenues generated by hand-held cartridge and other products were $15,844,000 for fiscal 1995 compared to $2,007,000 in fiscal 1994. North American net revenue totaled $335,303,000 in fiscal 1995, representing an increase of 7% over the $311,986,000 in net revenue generated in fiscal 1994. The increase was primarily due to the significant increase in PC-CD and CD- Videogame product sales. This increase was offset by the decreased volume of sales in the mature 16-bit cartridge market in North America. International net revenues increased 49% to $158,043,000 in fiscal 1995 from $106,303,000 in fiscal 1994. The increase in international revenues was due primarily to the sale of PC-CD products, together with increased licensing activities in Europe. This was partially offset by reduced Super NES revenue in Europe and Japan. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1995 1994 % change - -------------------------------------------------------------------------------- Cost of goods sold $263,357,000 $224,606,000 17.3 As a percentage of net revenues 53.4% 53.7% - -------------------------------------------------------------------------------- Cost of goods sold as a percentage of revenues in fiscal 1995 reflected the higher margin associated with CD based products offset by the higher cartridge costs on Genesis and Super NES products, which resulted from larger cartridge configurations, as well as higher professional and celebrity royalties. 28 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- OPERATING EXPENSES 1995 1994 % change - -------------------------------------------------------------------------------- Marketing and sales $61,951,000 $46,847,000 32.2 As a percentage of net revenues 12.6% 11.2% - -------------------------------------------------------------------------------- General and administrative $29,308,000 $23,767,000 23.3 As a percentage of net revenues 5.9% 5.7% - -------------------------------------------------------------------------------- Research and development $73,902,000 $62,570,000 18.1 As a percentage of net revenues 15.0% 15.0% - -------------------------------------------------------------------------------- The increase in marketing and sales expenses was primarily attributable to increased television advertising oriented to the "hits-driven" 16-bit cartridge business during the holiday season and increased cooperative advertising to support the 16-bit cartridge market. General and administrative expenses increased due to bad debts incurred in the joint venture in Japan and legal costs associated with business development activities in Europe. The increase in research and development expenses was primarily due to the increased number of products under development, higher average development costs for CD based products than for cartridge products, continued investment in new technologies for next generation systems and the acquisition of Bullfrog Productions Ltd., a United Kingdom based development company. The Company released a total of 86 new products in fiscal 1995 compared to 82 in fiscal 1994. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1995 1994 % change - -------------------------------------------------------------------------------- Operating income $64,828,000 $60,499,000 7.2 As a percentage of net revenues 13.1% 14.5% - -------------------------------------------------------------------------------- The increase in operating income in fiscal 1995 was primarily due to higher net revenues, reduced by an increase in operating expenses. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1995 1994 % change - -------------------------------------------------------------------------------- Interest and other income, net $13,250,000 $3,782,000 250.3 As a percentage of net revenues 2.7% 0.9% - -------------------------------------------------------------------------------- Other income increased in fiscal 1995 over fiscal 1994 primarily due to a one- time payment of $10,000,000 from Broderbund Software, Inc. ("Broderbund"), offset by costs of $1,400,000 incurred by the Company, associated with the termination of the merger agreement between the Company and Broderbund. Additionally, interest income was higher in fiscal 1995 due to higher average cash balances together with higher average interest rates. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1995 1994 % change - -------------------------------------------------------------------------------- Income taxes $24,980,000 $19,450,000 28.4 Effective tax rate 32.0% 30.3% - -------------------------------------------------------------------------------- The effective tax rate for fiscal 1995 increased over the prior year primarily due to the impact of the current year operating loss reported by Electronic Arts Victor ("EAV"). - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1995 1994 % change - -------------------------------------------------------------------------------- Minority interest in consolidated joint venture $2,620,000 $(94,000) N/M As a percentage of net revenues 0.5% - - -------------------------------------------------------------------------------- Minority interest for fiscal 1995 represents VEI's pro rata share of net loss from EAV's operations compared to pro-rata share of net income in fiscal 1994. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1995 1994 % change - -------------------------------------------------------------------------------- Net income $55,718,000 $44,737,000 24.5 As a percentage of net revenues 11.3% 10.7% - -------------------------------------------------------------------------------- The increase in net income was due to the after-tax net gain of approximately $5,800,000 from the one-time merger termination fee as well as higher revenues, partially offset by higher operating expenses and the impact of the higher effective tax rate. 29 LIQUIDITY AND CAPITAL RESOURCES As of March 31, 1996, the Company's working capital was $199,713,000 compared to $168,742,000 at March 31, 1995. Cash and short-term investments decreased by approximately $26,138,000 in fiscal 1996. The Company generated $6,930,000 of cash from operations in fiscal 1996. In addition, $21,678,000 was provided through the sale of equity securities under the Company's employee stock plans. Reserves for bad debts and sales returns decreased from $33,567,000 at March 31, 1995 to $27,569,000 at March 31, 1996. Reserves have been charged for returns of product and price protection credits issued for products sold in prior periods. Management believes these reserves are adequate based on historical experience and its current estimate of potential returns and allowances. During fiscal 1996 the Company invested approximately $25,000,000 relating to computer hardware and software purchases required to support the Company's development efforts and new management information systems worldwide. The Company also invested $21,200,000 in the purchase of land and buildings to expand its Texas-based development group. Inventory levels at March 31, 1996 increased compared to March 31, 1995 to support the Company's expanded international distribution network in Germany, Spain, South Africa and Southeast Asia. In March 1996, the Company made an additional $10,000,000 long-term investment to enable it to take advantage of certain tax exemptions in its Puerto Rico operation. The Company's principal source of liquidity is $147,983,000 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. 30 ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The report of Independent Auditors', Consolidated Financial Statements and Notes to Consolidated Financial Statements follow below on pages 31 through 44. INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Electronic Arts and Subsidiaries: We have audited the accompanying consolidated balance sheets of Electronic Arts and subsidiaries as of March 31, 1996 and 1995 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended March 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Electronic Arts and subsidiaries at March 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 1996, in conformity with generally accepted accounting principles. Palo Alto, California May 2, 1996 KPMG Peat Marwick LLP 31 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(In thousands, except share data) March 31, 1996 1995 - --------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and short-term investments $147,983 $174,121 Marketable securities 37,869 10,725 Receivables, less allowances of $27,569 and $33,567, respectively 73,075 56,389 Inventories 14,704 12,358 Prepaid royalties 14,519 8,318 Deferred income taxes - 3,142 Other current assets 12,188 6,707 ---------------------------- Total current assets 300,338 271,760 Property and equipment, net 70,062 30,528 Prepaid royalties 11,030 6,633 Long-term investments 24,200 14,200 Investment in affiliates 15,952 13,397 Deferred income taxes - 77 Other assets 2,637 4,644 ---------------------------- $424,219 $341,239 ---------------------------- ---------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $37,019 $ 34,247 Accrued liabilities 63,606 68,771 ---------------------------- Total current liabilities 100,625 103,018 Minority interest in consolidated joint venture 1,277 1,148 Stockholders' equity: Preferred stock, $0.01 par value. Authorized 1,000,000 shares - - Common stock, $0.01 par value. Authorized 70,000,000 shares; issued and outstanding 52,741,572 and 50,928,103 shares, respectively 527 509 Paid-in capital 108,078 77,144 Retained earnings 199,523 161,512 Unrealized appreciation (depreciation) of investments 16,266 (1,206) Translation adjustment (2,077) (886) ---------------------------- Total stockholders' equity 322,317 237,073 ---------------------------- $424,219 $341,239 ---------------------------- ----------------------------
See accompanying notes to consolidated financial statements. 32 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data) Years Ended March 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- Net revenues $531,887 $493,346 $418,289 Cost of goods sold 273,594 263,357 224,606 -------------------------------------- Gross profit 258,293 229,989 193,683 Operating expenses: Marketing and sales 72,928 61,951 46,847 General and administrative 32,207 29,308 23,767 Research and development 99,627 73,902 62,570 -------------------------------------- Total operating expenses 204,762 165,161 133,184 -------------------------------------- Operating income 53,531 64,828 60,499 Interest and other income, net 6,021 13,250 3,782 -------------------------------------- Income before provision for income taxes and minority interest 59,552 78,078 64,281 Provision for income taxes 18,759 24,980 19,450 -------------------------------------- Income before minority interest 40,793 53,098 44,831 Minority interest in consolidated joint venture (304) 2,620 (94) -------------------------------------- Net income $ 40,489 $ 55,718 $ 44,737 -------------------------------------- -------------------------------------- Net income per share $ 0.75 $ 1.07 $ 0.86 -------------------------------------- -------------------------------------- Number of shares used in computation 54,163 52,297 52,286 -------------------------------------- --------------------------------------
See accompanying notes to consolidated financial statements. 33 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended March 31, 1996, 1995 and 1994 Common Stock ------------------ (In thousands) Unrealized Appreciation Paid-In Retained (Depreciation) Translation Shares Amount Capital Earnings of Investments Adjustment Total - ----------------------------------------------------------------------------------------------------------------------------- Balances at March 31, 1993 48,502 $ 462 $49,770 $64,141 $ 0 $ (3,802) $110,571 Proceeds from sales of shares through employee stock plans and other plans 1,472 15 9,845 9,860 Tax benefit related to stock options 6,062 6,062 Translation adjustment 948 948 Net income 44,737 44,737 --------------------------------------------------------------------------------- Balances at March 31, 1994 49,974 477 65,677 108,878 0 (2,854) 172,178 Proceeds from sales of shares through employee stock plans and other plans 954 10 7,210 7,220 Tax benefit related to stock options 4,242 4,242 Adjustment effect of poolings on prior periods 22 15 (1,698) (1,661) Adjustment for change in Kingsoft, GmbH fiscal year end (1,386) (1,386) Unrealized loss on investments (1,206) (1,206) Translation adjustment 1,968 1,968 Net income 55,718 55,718 --------------------------------------------------------------------------------- Balances at March 31, 1995 50,928 509 77,144 161,512 (1,206) (886) 237,073 Proceeds from sales of shares through employee stock plans and other plans 1,814 17 21,661 21,678 Tax benefit related to stock options 9,170 9,170 Adjustment effect of immaterial pooling 1 103 (177) (73) Adjustment for change in Manley & Associates fiscal year end (2,301) (2,301) Unrealized gain on investments 17,472 17,472 Translation adjustment (1,191) (1,191) Net income 40,489 40,489 --------------------------------------------------------------------------------- Balances at March 31, 1996 52,742 $ 527 $108,078 $199,523 $ 16,266 $ (2,077) 322,317 --------------------------------------------------------------------------------- ---------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 34 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended March 31 (In thousands) 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 40,489 $ 55,718 $ 44,737 Adjustments to reconcile net income to net cash provided by operating activities: Minority interest in consolidated joint venture 304 (2,620) 94 Depreciation and amortization 15,859 10,763 7,865 Loss (gain) on sale of fixed assets (2,044) 76 28 Gain on sale of marketable securities (4,879) - - Deferred rent (87) 160 26 Adjustment for change in fiscal year end for pooled subsidiaries (2,301) (1,386) - Change in assets and liabilities: Receivables (16,686) 8,726 (38,733) Inventories (2,346) (2,887) 2,887 Prepaid royalties (10,598) (5,120) (5,804) Other assets (4,214) (11,306) 2,616 Accounts payable 2,772 (1,605) 2,081 Accrued liabilities (12,558) 6,475 21,173 Deferred income taxes 3,219 6,803 3,857 -------------------------------------- Net cash provided by operating activities 6,930 63,797 40,827 -------------------------------------- INVESTING ACTIVITIES: Proceeds from sale of property and equipment 4,221 527 93 Proceeds from sale of marketable securities 5,273 - - Capital expenditures (56,830) (16,503) (13,962) Investment in affiliates (4,641) (472) - Short-term investments (11,655) 5,700 (36,831) Long-term investments (10,000) (14,200) - Acquisition of DROsoft - (1,397) - Acquisition of Vision Software (500) - - Adjustment for effect of poolings on prior periods (73) (1,661) - -------------------------------------- Net cash used in investing activities (74,205) (28,006) (50,700) -------------------------------------- FINANCING ACTIVITIES: Proceeds from sales of shares through employee stock plans and other plans 21,678 7,220 9,860 Tax benefit from stock option exercises 9,170 4,242 6,062 -------------------------------------- Net cash provided by financing activities 30,848 11,462 15,922 -------------------------------------- Translation adjustment (1,191) 1,968 948 Minority interest on translation adjustment (175) 282 392 -------------------------------------- Increase (decrease) in cash and cash equivalents (37,793) 49,503 7,389 Beginning cash and cash equivalents 143,421 93,918 86,529 -------------------------------------- Ending cash and cash equivalents 105,628 143,421 93,918 Short-term investments 42,355 30,700 36,400 -------------------------------------- Ending cash and short-term investments $147,983 $ 174,121 $ 130,318 -------------------------------------- -------------------------------------- SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the year for income taxes $ 9,570 $ 6,390 $ 4,815 -------------------------------------- -------------------------------------- NON-CASH INVESTING ACTIVITIES: Unrealized gain (loss) on investments $ 24,952 $ (1,206) $ - Transfer of assets at net book value to affiliated company - 6,003 - -------------------------------------- --------------------------------------
See accompanying notes to consolidated financial statements. 35 ELECTRONIC ARTS AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1996, 1995 AND 1994 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The accompanying consolidated financial statements include the accounts of Electronic Arts, Inc. and its wholly owned subsidiaries (the "Company") and its majority owned subsidiary Electronic Arts Victor, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements of the Company follows: (a) FISCAL YEAR The Company's fiscal year is reported on a 52/53-week period that ends on the Saturday nearest to March 31 in each year. The results of operations for fiscal 1996 contains 53 weeks. Since the results of an additional week are not material, and for clarity of presentation herein, all fiscal periods are treated as ending on a calendar month end. (b) REVENUE RECOGNITION Product Sales: Revenue is recognized when the product is shipped. Subject to certain limitations, the Company permits customers to obtain exchanges within certain specified periods, and provides price protection on certain unsold merchandise. Revenue is reflected net of an allowance for returns and price protection. Software Licenses: For those agreements which provide the customers the right to multiple copies in exchange for guaranteed amounts, revenue is recognized at delivery of the product master or the first copy. Per copy royalties on sales that exceed the guarantee are recognized as earned. Revenue from the licensing of software was $27,018,000, $21,001,000 and $8,495,000 for the fiscal years ended March 31, 1996, 1995 and 1994, respectively. (c) CASH AND SHORT-TERM INVESTMENTS Cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase. Short-term investments include securities with maturities greater than three months and less than one year, except for certain investments with stated maturities greater than one year. The Company accounts for investments under Statement of Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, ("SFAS 115"). SFAS 115 requires that investments in equity and debt securities be classified and accounted for in one of three categories. The Company has classified short-term investments as "available-for-sale" and applicable investments are stated at fair value which approximates cost. The cost of securities sold is based upon the specific identification method. (d) PREPAID ROYALTIES Prepaid royalties represent prepayments made to independent software developers under development agreements. 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 research and development expense any amounts that management deems unlikely to be amortized at the contract royalty rate through product sales. Royalty advances are classified as current and noncurrent assets based upon estimated net product sales within the next year. (e) SOFTWARE DEVELOPMENT COSTS Statement of Financial Accounting Standards No. 86 provides for the capitalization of certain software development costs once technological feasibility is established. The capitalized costs are then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues, whichever is greater. No software development costs have been capitalized to date as the impact on the financial statements for all periods presented is immaterial. (f) INVENTORIES Inventories are stated at the lower of average cost or market. Inventories at March 31, 1996 and 1995 consisted of:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------- (in thousands) Raw materials and work in process $ 2,160 $ 2,799 Finished goods 12,544 9,559 - ------------------------------------------------------------------------------- $ 14,704 $ 12,358 - -------------------------------------------------------------------------------
(g) OUTSIDE PRODUCTION COSTS The Company defers the outside production costs of the film content of its products. Such costs are expensed as cost of goods sold based on actual net product sales. Film costs deferred as of March 31, 1996 and 1995 were $5,500,000, and $2,200,000, respectively. (h) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation of furniture and equipment is computed using the declining balance method over the estimated useful lives of the respective assets, which range from three to seven years. The building is being depreciated using the straight line method over 20 years. Amortization of leasehold improvements is computed using the declining balance method over the lesser of the lease terms or the estimated useful lives of the improvements. 36 (i) INTANGIBLE ASSETS Intangible assets net of amortization at March 31, 1996 and 1995 of $1,752,000, and $2,340,000 are included in other current and noncurrent assets and include costs of obtaining product technology and noncompete covenants which are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically no more than five years, and goodwill resulting from the purchase of DROSoft (now known as EA Spain) in November 1994 and Vision Software in March 1996. Amortization expense for fiscal years ended March 31, 1996, 1995 and 1994 was $740,000, $337,000, and $318,000, respectively. (j) INCOME TAXES Income tax expense is based on reported earnings before income taxes. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. (k) FOREIGN CURRENCY TRANSLATION For each of the Company's foreign subsidiaries the functional currency is its local currency. Assets and liabilities of foreign operations are translated into U.S. dollars using current exchange rates, and revenues and expenses are translated into U.S. dollars using average exchange rates. The effects of foreign currency translation adjustments are deferred and included as a component of stockholders' equity. Foreign currency transaction gains and losses are a result of the effect of exchange rate changes on transactions denominated in currencies other than the functional currency. Included in interest and other income in the statements of income are foreign currency transaction gains of $433,000, $785,000, and $1,418,000 for the fiscal years ended March 31, 1996, 1995 and 1994, respectively. (l) NET INCOME PER SHARE Net income per share is based on the weighted average number of common stock and common stock equivalents from stock options outstanding during the period. There is no significant difference between primary and fully diluted earnings per share. (m) EMPLOYEE BENEFITS The Company has deferred savings and profit sharing plans for its employees. The Profit Sharing Plan was terminated effective March 31, 1995 and all employee account balances transferred to employees' accounts in the 401(k) Plan. There were no contributions to the Profit Sharing Plan for the fiscal year ended March 31, 1995 compared to $615,000 for the fiscal year ended March 31, 1994. The 401(k) Plan permits the Company to make discretionary contributions to employees' accounts based on the Company's financial performance. In fiscal 1996, $279,000 was accrued for contributions to the Plan. No such contributions were made during fiscal year 1995 and 1994. (n) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of ("SFAS 121"). SFAS 121 requires that impairment losses to be recorded on long- lived assets and certain identifiable intangibles when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. SFAS 121 also addresses the accounting for long lived assets that are expected to be disposed of. The Company will adopt SFAS 121 effective April 1, 1996 and, based on current circumstances, does not believe the effect of adoption will be material. In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for the Stock-Based Compensation" ("SFAS 123"), which establishes a fair value based method of accounting for stock based compensation plans. The Company intends to continue to account for employee stock options under APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123 is effective for fiscal years beginning after December 15, 1995 and will require certain additional disclosures in the fiscal 1997 financial statements. (o) USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include provisions for doubtful accounts, sales returns and allowances, warranty provisions, and estimates regarding the recoverability of prepaid royalty advances and inventory. Actual results could differ from those estimates. (p) RECLASSIFICATIONS Certain amounts have been reclassified to conform to fiscal 1996 presentation. 37 (2) CASH AND INVESTMENTS
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------- (in thousands) Cash and equivalents: Cash $ 28,078 $ 21,023 Municipal securities 13,885 42,813 Money market funds 37,843 25,437 Commercial paper 25,822 54,148 - ------------------------------------------------------------------------------- Cash and equivalents 105,628 143,421 - ------------------------------------------------------------------------------- Short-term investments: Commercial paper 2,805 - Municipal securities 5,600 8,500 Money market preferreds 33,950 22,200 - ------------------------------------------------------------------------------- Short-term investments 42,355 30,700 - ------------------------------------------------------------------------------- Cash and short-term investments $147,983 $174,121 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Long-term investments $ 24,200 $ 14,200 - -------------------------------------------------------------------------------
Long-term investments are in the form of commercial notes with maturities of five to eight years secured by U.S. Treasury Notes. Such investments enable the Company to take advantage of certain tax incentives in its Puerto Rico operation and are treated as held to maturity for financial reporting purposes. (3) MARKETABLE SECURITIES Marketable securities are comprised of equity securities. The Company has accounted for investments in equity securities as "available-for-sale" and has stated applicable investments at fair value, with net unrealized gains (losses) reported as a separate component of stockholders' equity. Marketable securities had an aggregate cost of $14,123,000 and $11,931,000 at March 31, 1996 and 1995, respectively. At March 31, 1996 marketable securities included gross unrealized gains of $27,334,000 and gross unrealized losses of $3,588,000. At March 31, 1995, there was a gross unrealized loss of $1,206,000. At March 31, 1995, the Company owned 4,218,168 shares or approximately 18% ownership interest in The 3DO Company ("3DO"). During Fiscal 1996, the Company sold 982,500 shares of 3DO reducing its ownership interest to 3,235,668 shares or approximately 12% of the outstanding shares of 3DO as of March 31, 1996. Accordingly, the investment in 3DO was reclassified to Marketable Securities and accounted for as "available-for-sale". At March 31, 1995, the Company's ownership interest in 3DO was accounted for under the equity method and included in "Investment in affiliates." For the year ended March 31, 1996, the fair value of 3DO stock that was sold was $9,783,000. The gross realized gains from these sales totaled $9,112,000. There were no gains or losses from sales of marketable securities during 1995. The gain on sale of investments is based on the specific identification method. (4) COMMITMENTS LEASE OBLIGATIONS The Company leases its current facilities and certain equipment under non- cancelable operating lease agreements. The Company is required to pay property taxes, insurance and normal maintenance costs for certain of its facilities and will be required to pay any increases over the base year of these expenses on the remainder of the Company's facilities. In February 1995, the Company entered into a master operating lease for land and a building to be constructed in Redwood City, California. The initial term of the lease is for a period of three years from the date of completion of construction. Monthly lease payments are based upon the London Interbank Offered Rate. The Company has the option to purchase the property for the unamortized financed balance at any time after the non-cancelable lease term, or it may terminate the lease at any time after the non-cancelable term by arranging a third party sale or by making a termination payment. Should the Company elect to terminate the lease, it will guarantee a residual value of up to 85% of the unamortized value of the property. As part of the agreement, the Company must also comply with certain financial covenants. Total future minimum lease commitments as of March 31, 1996 are:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Year Ending: (in thousands) 1997 $ 8,405 1998 7,780 1999 4,632 2000 1,174 2001 745 Thereafter 9,489 - ------------------------------------------------------------------------------- $ 32,225 - -------------------------------------------------------------------------------
Total rent expense for all operating leases was $7,631,000, $6,451,000, and $5,558,000 for the fiscal years ended March 31, 1996, 1995 and 1994, respectively. The current portion of deferred rent of $823,000 and $736,000 at March 31, 1996 and 1995, respectively, represents the obligation accrued for rent, calculated on the straight-line method over the lease term and is included in accrued liabilities. (5) MAJOR CUSTOMER The Company had no sales to any one customer in excess of 10% of total net revenues for the years ended March 31, 1996 and 1995. For the fiscal year ended March 31, 1994, the Company had sales to one customer which represented 10.8% of total net revenues. 38 (6) LITIGATION The Company is subject to pending claims and litigation. Management, after review and consultation with counsel, considers that any liability from the disposition of such lawsuits would not have a material adverse effect upon the consolidated financial condition of the Company. (7) PREFERRED STOCK At March 31, 1996 and 1995, the Company had 1,000,000 shares of Preferred Stock authorized but unissued. The rights, preferences, and restrictions of the Preferred Stock may be designated by the Board of Directors without further action by the Company's stockholders. (8) STOCK PLANS (a) EMPLOYEE STOCK PURCHASE PLAN The Company has an Employee Stock Purchase Plan whereby eligible employees may authorize payroll deductions of up to 10% of their compensation to purchase shares at 85% of the lower of the fair market value of the Common Stock on the date of commencement of the offering or on the last day of the six-month purchase period. The Plan commenced in September 1991. In fiscal 1996, 154,516 shares were purchased by employees at prices ranging from $15.09 to $21.57. In fiscal 1995, 169,187 shares were purchased by employees at prices ranging from $15.09 to $15.51 per share. In fiscal 1994, 164,456 shares were purchased by employees at prices ranging from $11.37 to $21.46. At March 1996, the Company had 313,234 shares of its Common Stock reserved for future issuance under the Plan. (b) STOCK OPTION PLANS The Company's 1991 Stock Option Plan and Directors' Plan provide stock options for employees, officers and independent contractors, and for directors, respectively. Pursuant to these Option Plans, the Board of Directors may grant non-qualified and incentive stock options to employees and officers and non- qualified options to independent contractors and directors, at not less than the fair market value on the date of grant. The Company's 1982 Stock Option Plan ("1982 Plan") expired in September 1992. The options generally expire ten years from the date of grant and are generally exercisable in monthly increments over 50 months. At March 31, 1996, 3,301,613 shares of the outstanding options were exercisable at prices ranging from $1.938 to $35.375. At March 31, 1995, 3,497,818 shares of the outstanding options were exercisable at prices ranging from $1.938 to $34.750. At March 31, 1994, 2,145,214 shares of the outstanding options were exercisable at prices ranging from $1.594 to $39.000. 39 The following summarizes the activity under the Company's stock option plans during the fiscal years ended March 31, 1996, 1995 and 1994:
------------------------------------------------------------ ------------------------------------------------------------ Options -------------------------------------------- Available Options Outstanding for Grant Shares Price Per Share ------------------------------------------------------------ Balance at March 31, 1993 1,115,308 7,144,482 $ 1.219 - 29.000 Additional authorized options 2,000,000 - - Options: Granted (1,212,400) 1,212,400 24.250 - 39.000 Canceled - 1982 Plan - (93,802) 1.594 - 13.750 Canceled - other plans 375,805 (375,805) 4.469 - 34.750 Exercised - (1,306,478) 1.219 - 33.250 ------------------------------------------------------------ Balance at March 31, 1994 2,278,713 6,580,797 $ 1.594 - 39.000 Additional authorized options 2,350,000 - - Options: Granted (3,173,931) 3,173,931 13.500 - 25.750 Canceled - 1982 Plan - (54,115) 1.594 - 13.625 Canceled - other plans 1,541,503 (1,541,503) 4.469 - 39.000 Exercised - (810,673) 1.594 - 24.125 ------------------------------------------------------------ Balance at March 31, 1995 2,996,285 7,348,437 $ 1.938 - 34.750 Additional authorized options 1,852,175 - - Options: Granted (4,312,249) 4,312,249 22.250 - 37.875 Canceled - 1982 Plan - (4,480) 4.094 - 13.625 Canceled - other plans 2,316,692 (2,316,692) 4.469 - 37.875 Exercised - (1,658,953) 2.031 - 35.375 ------------------------------------------------------------ Balance at March 31, 1996 2,852,903 7,680,561 $ 1.938 - 37.375 ------------------------------------------------------------ ------------------------------------------------------------
40 (9) PROPERTY AND EQUIPMENT Property and equipment at March 31, 1996 and 1995 consisted of:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------- (in thousands) Computer equipment $61,391 $36,123 Building 18,921 1,446 Office equipment, furniture and fixtures 10,913 6,915 Leasehold improvements 7,594 6,365 Land 4,766 770 Warehouse equipment and other 5,227 3,043 - ------------------------------------------------------------------------------- 108,812 54,662 Less accumulated depreciation and amortization (38,750) (24,134) - ------------------------------------------------------------------------------- $70,062 $30,528 - -------------------------------------------------------------------------------
Depreciation and amortization expenses associated with property and equipment amounted to $15,119,000, $9,339,000, and $7,589,000 for the fiscal years ended March 31, 1996, 1995 and 1994, respectively. (10) ACCRUED LIABILITIES Accrued liabilities at March 31, 1996 and 1995 consisted of:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1996 1995 - ------------------------------------------------------------------------------- (in thousands) Accrued expenses $18,203 $22,878 Accrued royalties 16,889 16,040 Accrued compensation and benefits 11,480 10,524 Accrued income taxes 10,477 16,069 Deferred income taxes 5,878 1,840 Deferred revenue 679 1,420 - ------------------------------------------------------------------------------- $63,606 $68,771 - -------------------------------------------------------------------------------
(11) JOINT VENTURES (a) ELECTRONIC ARTS VICTOR, INC. The Company has a majority interest in a joint venture corporation, Electronic Arts Victor, Inc. ("EAV"), for the development and distribution of entertainment software products in Japan as well as certain Asian countries. EAV is sixty- five percent owned by the Company and thirty-five percent owned by Victor Entertainment Industries, Inc. ("VEI"), (formerly Victor Musical Industries, Inc.) a wholly owned subsidiary of Victor Company of Japan, Limited. The Company has consolidated 100% of the assets, liabilities and results of operations for EAV. VEI's 35% interest in EAV and the profits or losses therefrom has been reflected as "Minority interest in consolidated joint venture" on the Company's Consolidated Financial Statements. (b) CREATIVE WONDERS, INC. In December 1994, the Company and Capital Cities/ABC, Inc. formed Creative Wonders, Inc. (formerly ABC/EA Home Software, Inc.), a joint venture company, to publish children's edutainment and interactive entertainment multimedia titles as well as reference products for personal computers and new generation entertainment machines. Each company has a 50% ownership interest in the joint venture company. The investment is accounted for under the equity method. The Company distributes interactive titles sold by the joint venture into the retail channel. (12) BUSINESS COMBINATIONS ACQUISITION OF MANLEY & ASSOCIATES AND VISION SOFTWARE In February 1996, the Company issued approximately 65,000 shares of common stock in exchange for all of the outstanding common stock of Manley & Associates ("Manley"), an interactive software developer based in Seattle, Washington. The acquisition has been accounted for under the pooling of interests method. Manley had a December 31 year end. Accordingly, the Company's financial statements have been restated to include the accounts and operations of Manley for the year ended December 31, 1995. Separate and combined results for the Company and Manley for the twelve months ended March 31, 1996 are as follows:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Year-Ended March 31, 1996 (in thousands) - ------------------------------------------------------------------------------- Electronic Arts Manley Adjustments Combined - ------------------------------------------------------------------------------- Net revenues $530,253 $2,628 ($994) $531,887 - ------------------------------------------------------------------------------- Net income $40,705 $88 ($304) $40,489 - -------------------------------------------------------------------------------
The adjustments impacting net income were the elimination of intercompany revenues and royalties and the related impact on the provision for income taxes. 41 Effective March 31, 1996, Manley changed its fiscal year end from December 31 to March 31. As a result, Manley's results of operations for the three months ended March 31, 1996 are not reflected in the consolidated statements of income but were charged directly to retained earnings. Manley's revenues, operating loss and net loss for the three month period ending March 31, 1996 were $11,000, $2,302,000 and $2,301,000, respectively. In March 1996, the Company paid $500,000 to acquire Vision Software, an independent distributor of entertainment software, headquartered in Johannesburg, South Africa. The acquisition has been accounted for under the purchase method. The $152,000 excess of the purchase price over the estimated fair value of net assets acquired has been recorded as goodwill and is being amortized over five years. (13) INCOME TAXES The Company's pretax income from operations for the fiscal years ended March 31, 1996, 1995 and 1994 consisted of the following components:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - ------------------------------------------------------------------------------- Domestic $14,722 $41,330 $41,156 Foreign 44,830 36,748 23,125 - ------------------------------------------------------------------------------- Total pretax income $59,552 $78,078 $64,281 - -------------------------------------------------------------------------------
Income tax expense (benefit) for the fiscal years ended March 31, 1996, 1995 and 1994 consisted of:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (in thousands) Current Deferred Total - ------------------------------------------------------------------------------- 1996: Federal $(6,075) $2,094 $(3,981) State (523) 395 (128) Foreign 13,980 (282) 13,698 Charge in lieu of taxes from employee stock plans 9,170 - 9,170 - ------------------------------------------------------------------------------- $16,552 $2,207 $18,759 - ------------------------------------------------------------------------------- 1995: Federal $ 3,676 $5,955 $9,631 State 353 2,688 3,041 Foreign 8,066 - 8,066 Charge in lieu of taxes from employee stock plans 4,242 - 4,242 - ------------------------------------------------------------------------------- $16,337 $8,643 $24,980 - ------------------------------------------------------------------------------- 1994: Federal $ 2,597 $3,690 $6,287 State 140 167 307 Foreign 6,794 - 6,794 Charge in lieu of taxes from employee stock plans 6,062 - 6,062 - ------------------------------------------------------------------------------- $15,593 $3,857 $19,450 - -------------------------------------------------------------------------------
The components of the net deferred tax assets as of March 31, 1996 and 1995 consist of:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (in thousands) 1996 1995 - ------------------------------------------------------------------------------- Deferred tax assets: Accruals, reserves and other expenses $23,415 $15,369 Federal and State loss carryforwards 1,553 - Foreign loss and credit carryforwards 8,321 7,178 - ------------------------------------------------------------------------------- Total gross deferred tax assets 33,289 22,547 Less: valuation allowance (8,321) (7,178) - ------------------------------------------------------------------------------- Net deferred tax assets 24,968 15,369 - ------------------------------------------------------------------------------- Deferred tax liabilities: Undistributed earnings of DISC (2,378) (2,527) Prepaid royalty expenses (20,988) (11,463) Unrealized gains on marketable securities (7,480) - - ------------------------------------------------------------------------------- Total gross deferred tax liabilities (30,846) (13,990) - ------------------------------------------------------------------------------- Net deferred tax asset (liability) $(5,878) $ 1,379 - -------------------------------------------------------------------------------
The valuation allowance relates solely to the foreign loss and foreign credit carryforwards, for which the utilization is uncertain in future periods. At March 31, 1996, for Federal income tax purposes, the Company has a net operating loss carryforward of approximately $3,000,000 which expires in the year 2012. For California income tax purposes, as of March 31, 1996, the Company has a net operating loss carryforward of approximately $5,000,000 which expires in the year 2002. 42 The differences between the statutory income tax rate and the Company's effective tax rate, expressed as a percentage of income before provision for income taxes, for the years ended March 31, 1996, 1995 and 1994 were as follows:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------- Statutory Federal tax rate 35.0% 35.0% 35.0% State taxes, net of Federal benefit 0.5 2.9 5.3 Differences between statutory rate and foreign effective tax rate (3.0) (1.8) (0.4) Foreign loss without tax benefit - 3.4 - Research and development credits - (1.2) (4.5) Tax exemptions on Puerto Rico operation (0.7) (5.0) (4.7) Other (0.3) (1.3) (0.4) - ------------------------------------------------------------------------------- 31.5% 32.0% 30.3% - -------------------------------------------------------------------------------
The Company does not provide for U.S. taxes on undistributed earnings of its foreign subsidiaries. At March 31, 1996, the undistributed foreign earnings of the foreign subsidiaries amounted to approximately $50,000,000. If these earnings were distributed to the parent company, foreign tax credits available under current law would substantially eliminate the resulting Federal tax liability. The Company's manufacturing subsidiary in Puerto Rico operates under a Puerto Rican tax incentive program which grants the Company certain percentage exemptions from Puerto Rican income, property and municipal taxes for a period of 20 years from the date of the commencement of operations. The U.S. tax benefit derived for the year-ended March 31, 1996, 1995 and 1994 was approximately $411,000, $3,886,000 and $2,687,000, respectively. Long-term reinvestment in Puerto Rico of the undistributed earnings of the Puerto Rico subsidiary enables the Company to take advantage of certain tax incentives. In addition, the Company has applied for an amendment to expand its exemption for certain additional operations. (14) INTEREST AND OTHER INCOME, NET Interest and other income, net for the years ended March 31, 1996, 1995 and 1994 consisted of:
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - ------------------------------------------------------------------------------- Interest income $ 6,444 $ 4,748 $ 3,042 Interest expense (141) (51) (52) Merger-related fee - 8,600 - Gain on sale of marketable securities 4,879 - - Gain (loss) on sale of property and equipment 2,044 (76) (28) Impairment of investment in affiliates (4,700) - - Equity in net loss of affiliates (1,746) - - Other income (expense), net (759) 29 820 - ------------------------------------------------------------------------------- $ 6,021 $13,250 $3,782 - -------------------------------------------------------------------------------
(15) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: CASH, SHORT-TERM INVESTMENTS, RECEIVABLES, ACCOUNTS PAYABLE AND ACCRUED LIABILITIES - the carrying amount approximates fair value because of the short maturity of these instruments. MARKETABLE SECURITIES - fair value is based on quoted market prices. 43 (16) OPERATIONS BY GEOGRAPHIC AREAS The Company operates in one industry segment. Information about the Company's operations in the United States and foreign areas for the fiscal years ended March 31, 1996, 1995 and 1994 is presented below:
North South Asia (in thousands) America Europe Pacific Japan Eliminations Total ----------------------------------------------------------------------------------- FISCAL 1996: Net revenues from unaffiliated customers $306,229 $157,999 $21,794 $45,865 $ - $531,887 Intersegment sales 49,975 9,801 54 100 (59,930) - ----------------------------------------------------------------------------------- Total net revenues $356,204 $167,800 $21,848 $45,965 $ (59,930) $531,887 ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- Operating income $ 14,409 $ 33,126 $ 5,114 $ 882 $ - $ 53,531 Identifiable assets $309,308 $ 88,446 $ 8,469 $17,996 $ - $424,219 FISCAL 1995: Net revenues from unaffiliated customers $335,303 $112,907 $13,139 $31,997 $ - $493,346 Intersegment sales 55,444 3,850 101 34 (59,429) - ----------------------------------------------------------------------------------- Total net revenues $390,747 $116,757 $13,240 $32,031 $ (59,429) $493,346 ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- Operating income (loss) $ 44,276 $ 25,997 $ 2,123 $ (7,568) $ - $ 64,828 Identifiable assets $272,577 $ 50,910 $ 6,268 $ 11,484 $ - $341,239 FISCAL 1994: Net revenues from unaffiliated customers $311,986 $71,105 $ 6,879 $ 28,319 $ - $418,289 Intersegment sales 35,508 2,855 51 - (38,414) - ----------------------------------------------------------------------------------- Total net revenues $347,494 $73,960 $ 6,930 $ 28,319 $ (38,414) $418,289 ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- Operating income (loss) $ 47,883 $11,792 $ 994 $ (170) $ - $ 60,499 Identifiable assets $195,849 $47,801 $ 6,498 $ 23,503 $ - $273,651
44 ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES During the Company's last two fiscal years, there have been no changes in independent accountants nor disagreements with such accountants as to accounting and financial disclosures of the type required to be disclosed in Item 9. 45 PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information regarding directors who are nominated for re-election required by Item 10 is incorporated herein by reference to the information in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders (the "Proxy Statement") under the caption "Proposal No. 1 - Election of Directors." The information regarding executive officers required by Item 10 is included in Item 4A hereof. ITEM 11: EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference to the information in the Proxy Statement under the caption "Director and Executive Officer Compensation" specifically excluding the "Compensation Committee Report on Executive Compensation," and "Stock Option Plan." ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 is incorporated herein by reference to the information in the Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management." ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference to the information in the Proxy Statement under the caption "Certain Transactions." 46 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K (a) DOCUMENTS FILED AS PART OF THIS REPORT: 1. INDEX TO FINANCIAL STATEMENTS. Page(s) in Form 10-K Independent Auditors' Report 31 Consolidated Balance Sheets as of March 31, 1996 and 1995 32 Consolidated Statements of Income for the Years Ended March 31, 1996, 1995 and 1994 33 Consolidated Statements of Stockholders' Equity for the Years Ended March 31, 1996, 1995 and 1994 34 Consolidated Statements of Cash Flows for the Years Ended March 31, 1996, 1995 and 1994 35 Notes to Consolidated Financial Statements for the Years Ended March 31, 1996, 1995 and 1994 36 2. FINANCIAL STATEMENT SCHEDULE. The following financial statement schedule of Electronic Arts for the years ended March 31, 1996, 1995 and 1994 are filed as part of this report and should be read in conjunction with the Consolidated Financial Statements of Electronic Arts. Schedule II - Valuation and Qualifying Accounts Other financial statement schedules are omitted because the information called for is not required or is shown either in the Consolidated Financial Statements or the notes thereto. 3. EXHIBITS. The following exhibits are filed as part of, or incorporated by reference into, this report: Number Exhibit Title ------ ------------- 3.01 Registrant's Certificate of Incorporation, as amended to December 1, 1992. (1) 3.02 Registrant's Certificate of Amendment of Certificate of Incorporation. (2) 3.03 Registrant's By-Laws, as amended to date. (3) 4.01 Specimen Certificate of Registrant's Common Stock. (4) 10.01 Registrant's 1982 Stock Option Plan, as amended to date, and related documents. (5)(6) 10.02 Registrant's Directors Stock Option Plan and related documents. (6)(7) 10.03 Description of Registrant's FY 1997 Executive Bonus Plan. (6) 10.04 Directors and Officers and Company Reimbursement Indemnity Policy by and between Registrant and certain underwriters at Lloyd's, London and Continental Insurance Company, dated June 20, 1992. (8) 10.05 Lease by and between Registrant, Electronic Arts Limited and Allied Dunbar Assurance PLC, dated June 24, 1987, for the Registrant's U.K. facilities. (9) 47 Number Exhibit Title ------ ------------- 10.06 Lease by and between Registrant and H.G.C. Associates, dated June 24, 1992, for the Registrant's warehouse and production facilities. (10) 10.07 Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated March 22, 1991. (11) 10.08 Registrants' 1991 Stock Option Plan and related documents as amended. (6)(12) 10.09 Form of Indemnity Agreement with Directors. (13) 10.10 Registrants' Employee Stock Purchase Plan and related documents as amended. (6)(14) 10.11 Lease Agreement by and between Registrant and The Canada Life Assurance Company, dated December 20, 1991, for the Registrant's Canadian facilities. (15) 10.13 Amendment to Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated March 22, 1991. (17) 10.14 Agreement between Registrant and Sega Enterprises, Ltd., dated July 14, 1992. (18) (19) 10.15 Lease Agreement by and between Registrant and Century Centre II Associates, dated July 27, 1992. (19) 10.16 Amendment to Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated October 1, 1992. (19) 10.17 Amendment to Lease Agreement by and between Registrant and Century Centre II Associates, dated February 2, 1993. (19) 10.18 Amendment to Lease Agreement by and between Registrant and Century Centre II Associates, dated February 22, 1993. (19) 10.19 Directors and Officers and Company Reimbursement Indemnity Policy by and between Registrant and certain underwriters at Lloyd's, London and Continental Insurance Company, dated June 20, 1993. (19) 10.20 Lease by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated August 27, 1992 for additional space at corporate headquarters. (10) 10.21 Lease by and between Registrant and Sowa Urban Development Co., Ltd. (Sowa Toshi Kaihatsu K.K.), dated October 1, 1992 for the Registrant's Japan facilities. (10) 10.22 Lease by and between Registrant, Electronic Arts Limited and Heron Slough Limited, dated June 12, 1992, for the Registrant's U.K. facilities. (20) 10.23 Lease by and between Registrant and the Travelers Insurance Company, dated April 14, 1993, for the Registrant's production facilities. (21) 10.24 Amendment to Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated June 1, 1993. (22) 10.25 Amendment to Lease Agreement by and between Registrant and the Travelers Insurance Company, dated November 30, 1993. (23) 10.26 Amendment to Lease Agreement by and between Registrant and the Travelers Insurance Company, dated November 30, 1993. (23) 10.27 Lease Agreement by and between Registrant and Arthur J. Rogers & Co., dated January 14, 1994. (24) 10.28 Lease Agreement by and between Registrant and the Prudential Insurance Company of America, dated January 10, 1994. (24) 10.29 Agreement for Lease between Flatirons Funding, LP and Electronic Arts Redwood, Inc. dated February 14, 1995. (25) 10.30 Guarantee from Electronic Arts Inc. to Flatirons Funding, LP dated February 14, 1995. (25) 48 Number Exhibit Title ------ ------------- 10.31 Lease Agreement by and between Registrant and Dixie Warehouse & Cartage Co., dated April 10, 1995. (25) 10.32 Commercial Earnest Money Contract between Novell, Inc. and ORIGIN Systems, Inc. dated April 13, 1995. (26) 10.33 First Amendment to Commercial Earnest Money Contract between Novell, Inc. and ORIGIN Systems, Inc. dated June 1, 1995. (27) 10.34 Amendment No. 1 to Agreement between Registrant and Sega Enterprises, Inc. effective December 31, 1995. 11.01 Computation of Per Share Earnings. 21.01 Subsidiaries of the Registrant. 23.01 Report on Financial Statement Schedule and Consent of Independent Auditors. --------- (1) Incorporated by reference to Exhibit 3.01 to Registrant's Current Report on Form 8-K filed on October 16, 1991. (2) Incorporated by reference to Exhibit 4.01 to Registrant's Registration Statement on Form S-8 filed on December 1, 1992 (File No. 33-55212) (the "1992 Form S-8"). (3) Incorporated by reference to Exhibit 3.02 to Registrant's Current Report on Form 8-K filed on October 16, 1991. (4) Incorporated by reference to Exhibit 4.01 to Registrant's Registration Statement on Form S-4 filed on March 3, 1994 (File No. 33-75892). (5) Incorporated by reference to Exhibit 4.03 to Post-Effective Amendment No. 2 to Registrant's Registration Statement on Form S-8 filed on November 6, 1991 (File No. 33-32616) ("S-8 Amendment No. 2"). (6) Management contract or compensatory plan or arrangement. (7) Incorporated by reference to Exhibit 4.04 to S-8 Amendment No. 2. (8) Incorporated by reference to Exhibit 10.08 to Registrant's Annual Report on Form 10-K for the year ended March 31, 1992 (the "1992 Form 10-K"). (9) Incorporated by reference to Exhibit 10.07 to the Registrant's Registration Statement on Form S-1 filed on September 20, 1989, and all amendments thereto (File No. 33-30346) (the "Form S-1"). (10) Incorporated by reference to similarly numbered exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992. (11) Incorporated by reference to Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended March 31, 1991. 49 (12) Incorporated by reference to Exhibit 4.01 to the Registrant's Registration Statement on Form S-8 filed on July 29, 1993 (File No. 33-66836) (the "1993 Form S-8"). (13) Incorporated by reference to Exhibit 10.09 to the Form S-1. (14) Incorporated by reference to Exhibit 4.02 to 1993 Form S-8. (15) Incorporated by reference to Exhibit 10.16 to the 1992 Form 10-K. (16) Not Used. (17) Incorporated by reference to Exhibit 10.18 to the 1992 Form 10-K. (18) Confidential treatment has been granted with respect to certain portions of this document. (19) Incorporated by reference to similarly numbered exhibits to Registrants Annual Report on Form 10-K for the year ended March 31, 1993. (20) Incorporated by reference to Exhibit 19.01 of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992. (21) Incorporated by reference to Exhibit 10.23 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993. (22) Incorporated by reference to Exhibit 10.24 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993. (23) Incorporated by reference to similarly numbered exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1993. (24) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 1994 (the "1994 Form 10-K"). (25) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 1995 (the "1995 Form 10-K"). (26) Incorporated by reference to Exhibit 10.01 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995. (27) Incorporated by references to Exhibit 10.02 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995. (b) REPORTS ON FORM 8-K: No reports on Form 8-K were filed during the quarter ended March 31, 1996. 50 (c) EXHIBITS: The Registrant hereby files as part of this Form 10-K the exhibits listed in Item 14(a)3, as set forth above. (d) FINANCIAL STATEMENT SCHEDULE: The Registrant hereby files as part of this Form 10-K the financial statement schedule listed in Item 14(a)2, as set forth on page 53. 51 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ELECTRONIC ARTS By: /s/ Lawrence F. Probst III --------------------------------- (Lawrence F. Probst III, Chairman of the Board and Chief Executive Officer) Date: June 27, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, on behalf of the Registrant in the capacities indicated and on the 27th of June 1996. Name Title ---- ----- /s/ Lawrence F. Probst III Chairman of the Board - --------------------------------- and Chief Executive Officer (Lawrence F. Probst III) /s/ E. Stanton McKee, Jr. Senior Vice President and Chief - --------------------------------- Financial and Administrative Officer (E. Stanton McKee, Jr.) /s/ David L. Carbone Vice President Finance - --------------------------------- (David L. Carbone) Directors: /s/ M. Richard Asher Director - ----------------------------------- (M. Richard Asher) /s/ William J. Byron Director - ----------------------------------- (William J. Byron) /s/ Daniel H. Case III Director - ----------------------------------- (Daniel H. Case III) /s/ Gary M. Kusin Director - ----------------------------------- (Gary M. Kusin) /s/ Timothy J. Mott Director - ----------------------------------- (Timothy J. Mott) 52 ELECTRONIC ARTS INC. AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED MARCH 31, 1996, 1995 AND 1994 (IN THOUSANDS)
Balance at Charged to Charged to Balance Beginning Costs and Other at End Description of Period Expenses Accounts(1) Deductions of Period - ----------- --------- -------- ----------- ---------- --------- Year Ended March 31, 1996 Allowance for doubtful accounts and returns $33,567 $45,346 $ (461) $50,883 $27,569 ------- ------- -------- ------- ------- ------- ------- -------- ------- ------- Year Ended March 31, 1995 Allowance for doubtful accounts and returns $29,113 $56,371 $ 2,540 $54,457 $33,567 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Year Ended March 31, 1994 Allowance for doubtful accounts and returns $18,653 $31,539 $ 314 $21,393 $29,113 ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(1) Primarily the translation effect of using the average exchange rate for expense items and the year-ended exchange rate for the balance sheet item (allowance account). 53 ELECTRONIC ARTS INC. 1996 FORM 10-K ANNUAL REPORT EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT TITLE PAGE - ------ ------------- ---- 10.03 Description of Registrant's FY 1997 Executive Bonus Plan. 55 10.34 Amendment No. 1 to Agreement between Registrant and Sega Enterprises, Inc. effective December 31, 1995. 56 11.01 Computation of Per Share Earnings. 58 21.01 Subsidiaries of the Registrant. 59 23.01 Report on Financial Statement Schedule and Consent of Independent Auditors. 60 - ---------- 54 EX-10.3 2 EXH 10.03 EXHIBIT 10.03 ELECTRONIC ARTS INC. AND SUBSIDIARIES DESCRIPTION OF REGISTRANT'S FISCAL YEAR 1997 EXECUTIVE BONUS PLAN Target annual bonuses are set for each executive based upon a percentage of salary. Bonuses are paid in six parts, five of which relate only to the Company's earnings results: one part measured against the Company's performance in each fiscal quarter for a total of four parts, and one part measured against the Company's performance for the fiscal year. The sixth part is discretionary and is measured against each individual executive's contributions. Bonuses are paid quarterly for the prior quarter, and after the end of the fiscal year for those portions based on fiscal year performance and individual contributions. If profits in any period are less than 90% of plan, no bonus based on the Company's performance is paid for that period. If profits exceed plan by up to 20% during a period, the bonus rate is doubled for the incremental profits above plan. If profits exceed plan by more than 20%, the bonus rate is tripled for profits in excess of 120% of plan. 55 EX-10.34 3 EXH 10.34 EXHIBIT 10.34 AMENDMENT NO. 1 TO AGREEMENT This AMENDMENT is entered into as of December 31, 1995 by and between SEGA ENTERPRISES LTD., a Japanese company with principal offices at 2-12, Haneda 1- chome, Ohta-ku, Tokyo, Japan (hereinafter "SEGA") and ELECTRONIC ARTS INC., a Delaware corporation with principal offices at 1450 Fashion Island Blvd., San Mateo, California, 94404, USA (hereinafter "EA"). A. Sega and EA have previously entered into an Agreement dated as of July 14, 1992 (the "AGREEMENT") in which Sega licenses to EA the right to publish interactive entertainment software products compatible with the Sega Genesis System (as defined in the Agreement). B. According to Section 2.2 of the Agreement, the Agreement will expire on December 31, 1995, unless the term of the Agreement is renewed or extended by written agreement of the parties. C. Section 10.9 of the Agreement allows the modification of any provision of the Agreement, provided that such amendment is evidenced by a writing signed by both parties. D. Sega and EA each wish to extend the term of the Agreement and to continue to operate under the provisions thereof. NOW, THEREFORE, the parties hereto have agreed as follows: 1. EXTENSION OF TERM. Section 2.2 of the Agreement shall be amended and restated in its entirety as follows: "2.2 TERM OF LICENSE. The term of the license granted by Sega in Subsection 2.1, above, shall commence upon January 1, 1993, and, unless sooner terminated in accordance with the provisions of Section 8, below, shall continue in full force and effect until December 31, 1997 (the "Term"). Following the expiration of this Agreement, EA shall nevertheless be entitled to sell-off any units of EA's Genesis Cartridge products which remain in its inventory or in the process of manufacture for a period of one hundred and eighty (180) days; provided, however, that EA shall continue to account for and pay Sega the royalties and manufacturing premiums owed with respect to such sales in accordance with the provisions of this Agreement." 56 2. NO OTHER CHANGES. Except as expressly amended by the terms of this Amendment, the Agreement will continue unchanged in full force and effect. IN WITNESS WHEREOF, the parties below have executed this Amendment as of the date first set forth above. For and on behalf of SEGA ENTERPRISES LTD. ELECTRONIC ARTS INC. By: /s/ Shinobu Toyoda By: /s/ John W. Heistand ------------------------------ ------------------------------ Name: Shinobu Toyoda Name: John W. Heistand ----------------------------- ----------------------------- Title: Chief Operating Officer, Title: Senior VP, Business ------------------------- ------------------------- Sega of America, Inc. Development ------------------------- ------------------------- 57 EX-11.1 4 EXH 11.01 EXHIBIT 11.01 ELECTRONIC ARTS INC. AND SUBSIDIARIES COMPUTATION OF PER SHARE EARNINGS Years Ended March 31, ----------------------------------------- 1996 1995 1994 ----------------------------------------- Net Income $40,489,000 $55,718,000 $44,737,000 Weighted average number of outstanding shares used in computation: Preferred Stock - - - Common Stock 51,992,165 50,329,131 49,195,735 Number of common stock equivalents as a result of stock options outstanding using the treasury stock method 2,170,355 1,967,643 3,089,977 ---------- ---------- ---------- Total common stock and 54,162,520 52,296,774 52,285,712 equivalents ---------- ---------- ---------- ---------- ---------- ---------- Primary and fully diluted net income per share $ 0.75 $ 1.07 $ 0.86 ---------- ---------- ---------- ---------- ---------- ---------- 58 EX-21.1 5 EXH 21.01 EXHIBIT 21.01 SUBSIDIARIES OF THE REGISTRANT Name in Jurisdiction Corporate Articles Doing Business As of Incorporation ------------------ ----------------- ---------------- ORIGIN Systems, Inc. ORIGIN Systems, Inc. Texas Electronic Arts, Electronic Arts, Pty. Commonwealth Proprietary Limited Ltd. (formerly of Australia (formerly Entertainment Entertainment and and Computer Computer Proprietary, Proprietary, Limited) Limited) Electronic Arts (Canada) Electronic Arts (Canada) British Columbia, Inc. (formerly Distinctive Inc. (formerly Distinctive Canada Software, Inc.) Software, Inc.) Electronic Arts, Limited Electronic Arts, Limited United Kingdom Electronic Arts S.A. Electronic Arts S.A. France Electronic Arts GmbH Electronic Arts GmbH Germany Electronic Arts Victor Inc. Electronic Arts Victor, Inc. Japan Electronic Arts Productions, Crocodile Productions Delaware Inc. Electronic Arts Puerto Rico Electronic Arts Puerto Rico Delaware Inc. Inc. Electronic Arts Electronic Arts California International Corporation International Corporation Electronic Arts Software Electronic Arts Software Spain S.A. (formerly DROSoft) S.A. (formerly DROSoft) Bullfrog Productions Ltd. Bullfrog Productions Ltd. United Kingdom Kingsoft GmbH Kingsoft GmbH Germany Electronic Arts Productions Electronic Arts Productions United Kingdom Ltd Ltd Electronic Arts Nordic Electronic Arts Nordic AB Sweden Aktienbolag Electronic Arts Asia Pacific Electronic Arts Asia Pacific Singapore PTE., LTD PTE., LTD Electronic Arts Seattle Electronic Arts Seattle Washington Vision Software (Pty) Vision Software (Pty) South Africa Limited Limited Electronic Arts V.I., Inc. Electronic Arts V.I., Inc. Virgin Islands (U.S.) Linear Arts, Inc. Linear Arts, Inc. Delaware 59 EX-23.1 6 EXH 23.01 EXHIBIT 23.01 Report on Financial Statement Schedule and Consent of Independent Auditors The Board of Directors Electronic Arts, Inc.: The audits referred to in our report dated May 2, 1996, include the related financial statement schedule for each of the years in the three-year period ended March 31, 1996, included in the Company's Annual Report on Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We consent to the incorporation by reference in the Registration Statements (Nos. 33-66836, 33-55212, 33-53302, 33-41955, 33-82166, 33-61781, 33-61783 and 333-01397) on Form S-8 of our reports included herein. KPMG Peat Marwick LLP Palo Alto, California June 27, 1996 60 EX-27 7 FDS EXH.27
5 1,000 12-MOS MAR-31-1996 APR-01-1995 MAR-31-1996 147,983 37,869 100,644 27,569 14,704 300,338 108,812 38,750 424,219 100,625 0 0 0 527 321,790 424,219 531,887 531,887 273,594 273,594 204,762 3,010 141 59,552 18,759 40,793 0 0 0 40,489 0.75 0.75 Includes minority interest in consolidated joint venture of (304)
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