-----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, CL8RC3XCm0A1U4ia8ERIv8kD9m/5LGxrP3eytJY1o6ZzIAKnC7tkcLBb5fagfWCU LLjib+vYzDTEABDssjQucQ== 0001012870-02-002877.txt : 20020628 0001012870-02-002877.hdr.sgml : 20020628 20020628163626 ACCESSION NUMBER: 0001012870-02-002877 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020628 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: 02691823 BUSINESS ADDRESS: STREET 1: 209 REDWOOD SHORES PARKWAY CITY: REDWOOD CITY STATE: CA ZIP: 94065 BUSINESS PHONE: 4155717171 MAIL ADDRESS: STREET 1: 209 REDWOOD SHORES PARKWAY CITY: REDWOOD CITY STATE: CA ZIP: 94065 FORMER COMPANY: FORMER CONFORMED NAME: ELECTRONIC ARTS DATE OF NAME CHANGE: 19911211 10-K 1 d10k.txt FORM 10-K UNITED STATES 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 For the fiscal year ended March 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___ to ___ Commission File No. 0-17948 ELECTRONIC ARTS INC. (Exact name of Registrant as specified in its charter) Delaware 94-2838567 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 209 Redwood Shores Parkway Redwood City, California 94065 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (650) 628-1500 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A 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 ___ -- Indicate 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 Class A common stock, $.01 par value, held by non-affiliates of the Registrant on June 4, 2002 was $5,685,093,156. As of June 4, 2002 there were 138,897,712 shares of Registrant's Class A common stock, $.01 par value, outstanding, and 6,233,463 shares of Registrant's Class B common stock, $.01 par value, outstanding. Documents Incorporated by Reference ----------------------------------- Portions of Registrant's definitive proxy statement (the "Proxy Statement") for its 2002 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. This report consists of 93 sequentially numbered pages. The Exhibit Index is located at sequentially numbered page 93. ELECTRONIC ARTS INC. 2002 FORM 10-K ANNUAL REPORT Table of Contents
PAGE ---- PART I Item 1. Business 3 Item 2. Properties 13 Item 3. Legal Proceedings 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 4A. Executive Officers of the Registrant 15 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 17 Item 6. Selected Financial Data 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 51 Item 8. Financial Statements and Supplementary Data 53 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 83 PART III Item 10. Directors and Executive Officers of the Registrant 84 Item 11. Executive Compensation 84 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 84 Item 13. Certain Relationships and Related Transactions 84 PART IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 85 Signatures 91 Exhibit Index 93
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 about circumstances that have not yet occurred. All statements, trend analysis and other information contained below relating to markets, our products and trends in revenue, as well as other statements including words such as "anticipate", "believe" or "expect" and statements in the future tense are forward-looking statements. These forward-looking statements are subject to business and economic risks, and actual events or our actual future results could differ materially from those set forth in the forward-looking statements due to such risks and uncertainties. We will not necessarily update this information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results and performance include, but are not limited to, those discussed under the heading "Risk Factors" on pages 45 to 50. Item 1: Business Overview Electronic Arts was initially incorporated in California in 1982. In September 1991, we were reincorporated under the laws of Delaware. Our principal executive offices are located at 209 Redwood Shores Parkway, Redwood City, California 94065 and our telephone number is (650) 628-1500. We operate in two principal business segments globally: . EA Core business segment: creation, marketing and distribution of entertainment software. . EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising. EA Core We create, market and distribute interactive entertainment software for a variety of hardware platforms. As of March 31, 2002, our business was comprised of the following: . Distribution of approximately 90 titles that we developed and/or published under one of our brand names in North America, including older titles marketed as "Classics". . Distribution of localized versions of our products in the rest of the world. . Distribution of additional titles that were either developed by other software publishers (that we refer to as Affiliated Labels) or titles we have assisted in the development of with other software publishers (referred to as Co-Published titles). In North America, we distributed approximately 30 Affiliated Label and Co-Published titles. . Of the titles shipped in fiscal 2002, there were 16 titles that sold over one million units. Since our inception, we have developed and are developing products for 42 different hardware platforms, including the following: . IBM(R) PC and compatibles . 32-bit Sony PlayStation(R) . 32-bit Nintendo Game Boy(R) Advance and Game Boy Color . 64-bit Nintendo(R) 64 . 128-bit Sony PlayStation 2 . 128-bit Microsoft Xbox(TM) . 128-bit Nintendo GameCube(TM) Our product development methods and organization are modeled on those used in the entertainment industry. We also market our products with techniques borrowed from other entertainment companies such as record producers, magazine publishers and video distributors. Employees whom we call "producers", who are responsible for the development of one or more products, oversee product development and direct teams comprised of both our employees and outside contractors. Our 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 we have contracts include: FIFA, NASCAR, John Madden, National Basketball Association, PGA TOUR, Tiger Woods, National Hockey League, Warner Bros. (Harry Potter), 3 MGM/Danjaq (James Bond) and National Football League. We maintain development studios in California, Canada, United Kingdom, Florida, Texas, Japan, Washington, Virginia and Nevada. We invest in the creation of state-of-the-art software tools and utilities that are then used in product development. These tools allow for more cost-effective product development and the ability to more efficiently convert products from one hardware platform to another. We have also made investments in facilities and equipment to facilitate the creation and editing of digital forms of video and audio recordings and product development efforts for new hardware platforms. We distribute our products and those of our Affiliated Labels primarily by direct sales to retail chains and outlets in the United States and Europe. In Japan and the Asia Pacific region, we distribute products both directly to retailers and through third party distributors. Our products are available in over 80,000 retail locations worldwide. In both fiscal 2002 and 2001, approximately 37% of our net revenues were generated by international operations, compared to 40% in fiscal 2000. EA.com On March 22, 2000, the stockholders of Electronic Arts authorized the issuance of a new series of common stock, designated as Class B common stock ("Tracking Stock"). The Tracking Stock is intended to reflect the performance of Electronic Arts' online and e-Commerce division ("EA.com"). As a result of the approval of the Tracking Stock Proposal, Electronic Arts' existing common stock has been re-classified as Class A common stock ("Class A Stock") and that stock reflects the performance of Electronic Arts' other businesses, EA Core. EA.com represents Electronic Arts' online and e-Commerce businesses. EA.com develops, publishes and distributes online interactive games. EA.com's business includes subscription revenues collected for Internet game play on our websites, website advertising, sales of packaged goods for Internet-only based games and sales of Electronic Arts games sold through the EA.com web store. Electronic Arts began development of its initial online product, Ultima Online(TM), during fiscal year 1996. We shipped Ultima Online during fiscal year 1998, and began development of our online business during the same year. EA.com's websites include EA.com, individual marketing sites for Electronic Arts' games or studios and the Games Channel on America Online, which launched in the second half of calendar 2000. We are the leading online games site in terms of unique monthly visitors according to March 2002 Media Metrix results. To date, the majority of our subscription revenues have been generated by Ultima Online, Ultima Online: The Second Age, Ultima Renaissance, Ultima Online Third Dawn and Ultima Online Lord Blackthorn's Revenge (collectively referred to as Ultima Online) and Motor City Online. In addition, our packaged goods revenues for online-only games have primarily been generated by these titles. The packaged good product is sold through our traditional distribution channel to various retailers. The end customer registers for EA.com's online service to enjoy online play on a month-to-month subscription basis. In addition, EA.com generates advertising revenues on the world wide web and the AOL Games Channel. Investments and Joint Ventures Acquisitions Pogo Corporation On February 28, 2001, EA.com acquired Pogo Corporation (now referred to as "Pogo") for $43,333,000, including an initial investment of $42,000,000 and the redemption of Pogo preferred stock of $1,333,000. The acquisition has been accounted for under the purchase method. Pogo operates an ad-supported games service that reaches a broad consumer market. Pogo's internet-based family games focus on easy-to-play card, board and puzzle games. See Note 13 of the Notes to Consolidated Financial Statements, included in item 8 hereof. Kesmai Corporation On February 7, 2000, we acquired Kesmai Corporation (now referred to as "Kesmai") from News America Corporation ("News Corp") in exchange for $22,500,000 in cash and approximately 206,000 shares of Electronic Arts' existing Class A common stock valued at $8,650,000. The transaction was accounted for under the purchase method. The Company granted 5 percent of the initial equity (Class B Stock) attributable to EA.com to News Corp in exchange for the 206,000 shares noted above, adjusting the total common stock consideration relating to the acquisition by $703,000 to $9,353,000. The Company has contributed Kesmai to EA.com. See Note 13 of the Notes to Consolidated Financial Statements, included in item 8 hereof. Other Business Combinations Additionally, during fiscal 2000, we acquired two software development companies. See Note 13 of the Notes to Consolidated Financial Statements, included in item 8 hereof. 4 Joint Ventures In May 1998, Electronic Arts and Square Co., Ltd. ("Square"), a leading developer and publisher of entertainment software in Japan, completed the formation of two new joint ventures in North America and Japan. In North America, the companies formed Square Electronic Arts, LLC ("Square EA"), which has exclusive publishing rights in North America for future interactive entertainment titles created by Square. We have the exclusive right to distribute in North America products published by this joint venture. Either party may terminate the existence of Square EA and the distribution agreement effective March 31, 2003. We own a 30% minority interest in this joint venture while Square owns 70%. In Japan, the companies established Electronic Arts Square KK ("EA Square KK"), which localizes and publishes in Japan our properties originally created in North America and Europe, as well as develops and publishes original video games in Japan. We own a 70% majority interest, while Square owns 30%. See Note 13 of the Notes to Consolidated Financial Statements, included in item 8 hereof. Investments We have made investments as part of our overall strategy and currently hold minority equity interests in several companies. As of March 31, 2002, our minority equity investments include investments in NovaLogic, Inc. and Firaxis Software, Inc. Market Historically, no hardware platform or video game system has achieved long-term dominance in the interactive entertainment market. In addition, the installed base of multimedia-enabled home computers, including those with Internet accessibility, has continued to grow as personal computer, or PC, prices have declined and the quality and choices of software have increased dramatically. We develop and publish products for multiple platforms, and this diversification continues to be a cornerstone of our strategy. The following table details select information on a sample of the hardware platforms for which we have published titles:
- ------------------------------------------------------------------------------------------------------------------ Video Game Console / Date Introduced Medium/ Manufacturer Platform Name in North America Product Base Technology - ------------------------------------------------------------------------------------------------------------------ Sega Genesis 1989 Cartridge 16-bit Nintendo Super NES(TM) 1991 Cartridge 16-bit Matsushita 3DO(TM) Interactive Multiplayer(TM) 1993 Compact Disk 32-bit Sega Saturn 1995 Compact Disk 32-bit Sony PlayStation 1995 Compact Disk 32-bit Nintendo Nintendo 64 1996 Cartridge 64-bit Sony PlayStation 2 2000 Digital Versatile Disk 128-bit Proprietary Optical Nintendo Nintendo GameCube 2001 Format 128-bit Microsoft Xbox 2001 Digital Versatile Disk 128-bit - ------------------------------------------------------------------------------------------------------------------
Sony Sony released the PlayStation 2 console in Japan in March 2000, in North America in October 2000 and in Europe in November 2000. The PlayStation 2 console is a 128-bit, Digital Versatile Disk ("DVD") based system that is Internet and cable ready, as well as backward compatible with the current PlayStation console software. We currently have various products under development for the Sony PlayStation 2 console. See Risk Factors - "New video game platforms create additional technical and business model uncertainties". Nintendo Nintendo launched the Nintendo GameCube console in Japan in September 2001, North America in November 2001 and in Europe in May 2002. Nintendo GameCube provides for games which are delivered and played using a proprietary optical format. We currently have various products under development for the Nintendo GameCube. 5 Microsoft Microsoft launched the Xbox console in North America in November 2001, in Japan in February 2002 and in Europe in March 2002. The Microsoft Xbox is a 128-bit DVD based system. We currently have various products under development for the Microsoft Xbox. New Entrants New entrants into the interactive entertainment and multimedia industries, such as cable television, telephone, and diversified media and entertainment companies, in addition to a proliferation of new technologies, such as online networks and the Internet, have increased the competition in our markets. Our new product releases in fiscal 2003 will be primarily for the PlayStation 2, PC, Nintendo GameCube and Xbox. We are also scheduled to release two online network gaming products during fiscal 2003. See Risk Factors - "New video game platforms create additional technical and business model uncertainties" and "The impact of e-Commerce and online games on our business is not known". The early investment in products for the 32-bit market, including both Compact Disk personal computer (or PC) and dedicated entertainment systems (that we call video game systems or consoles), has been strategically important in positioning us for the current generation of 128-bit machines. We believe that such investment continues to be important. During the fiscal years 2002 and 2001, the video and computer games industry has experienced a platform transition from 32-bit CD-based and 64-bit cartridge-based consoles to the current generation 128-bit DVD-based game consoles and related software. The transition to the current generation systems was initiated by the launch of Sony's PlayStation 2 in fiscal 2001, and continued with the launches of the Nintendo GameCube and Microsoft's Xbox in calendar year 2001. As the market continues to shift to the current generation systems, sales of 32-bit and 64-bit products have been declining and we expect a continued significant decline in fiscal 2003. In addition, our revenues and earnings are dependent on our ability to meet our product release schedule and our failure to meet those schedules could result in revenues and earnings which fall short of analysts' expectations in any individual quarter. See Risk Factors - "Product development schedules are frequently unreliable and make predicting quarterly results difficult". Online Games According to March 2002 Media Metrix results, EA.com continues to retain its position as the #1 gamesite in terms of unique monthly visitors with over 13.3 million unique visitors for the month of March across all public and AOL properties. In addition, EA.com comprised approximately 42% of all time spent on Internet gamesites in March, totaling 4.6 billion minutes. We believe the online gaming market will continue to grow due to the following factors: . Increasing popularity of PC gaming; . Growing interest in multiplayer games; . Growth in the number of households with PCs and Internet connections; . General growth in internet usage, including the number of users, communities and increased frequency of use by consumers; . Rapid innovation of new online entertainment experiences; . Mass market adoption of broadband technologies; and . Future introduction of online gaming capabilities for next-generation consoles. Competition EA Core See Risk Factors - "Our platform licensors are our chief competitors and frequently control the manufacturing of our video game products". EA.com We believe EA.com faces substantial competition from a number of existing and potential competitors including: . Console & PC Game Publishers. Other game publishers including Sony Computer Entertainment of America ("Sony"), Nintendo, Sega, Activision, THQ, Acclaim, Vivendi Universal, Microsoft, LucasArts, Interplay, Infogrames and Eidos, are each developing individual online games and games with online components. Currently, Flipside Inc., a subsidiary of Vivendi Universal, operates Flipside Network, an online game network that consists of Flipside.com, an online site that targets unique users and advertisers with specific channel offerings, including iWin.com, Uproar.com and Virtualvegas.com. Sony will launch its online service later this year. PlayStation 2 owners will be required to purchase a network adapter that will enable the console to connect to the network. Microsoft's Xbox has built-in broadband connectivity. Microsoft has announced its intentions to launch a service called Xbox Live in the fall of 2002, an online gaming service that will allow consumers for a monthly fee to play multi-player Xbox games with each other. In 2002, Sega announced its intentions to 6 develop games with online capabilities for the Nintendo GameCube, PlayStation 2 and Xbox consoles. Each of these companies may compete with EA.com for advertising, subscription and e-Commerce sales. . Portals. With respect to advertising and e-Commerce sales, EA.com will also compete with general purpose consumer web sites such as Yahoo, Lycos, and Microsoft Network. In addition, many of these Internet portals offer gaming sites such as Yahoo Games Channel, Lycos' Gamesville, and Microsoft Gaming Zone. Although most of the game areas of these portals have attained modest reach, their key placement on powerful portals makes them potentially significant competitors for gaming subscriptions as well. . Family Oriented Game Sites. A number of sites such as Station.com, Uproar.com and iWin.com, have driven significant amounts of traffic to their sites by offering unique games and entertainment content. In addition, several of the sites offer frequent prizes with easy to play "gamettes". These sites are typically monetizing their traffic by selling advertising. . Aggregators. Aggregators, such as Microsoft Gaming Zone, provide an aggregation of various types of online games, including aggregation of games developed by independent third parties. While these sites have been primarily focused on serving the gaming community, they have since adjusted their strategy to include games, such as parlor games, that reach a broader audience. . Sports Sites. Sports content sites such as ESPN.com, Sportsline.com and Foxsports.com typically feature fantasy league games and easy to play sports "gamettes" in addition to their editorial content. Such fantasy league games and sports "gamettes" typically appeal to the overall sports fan, rather than the sports gamer. However, these sites have significant financial and content resources at their disposal and will provide competition for advertising and e-Commerce sales. . Microsoft Gaming Zone ("MGZ"). Microsoft falls into a number of the foregoing categories, as it is a portal, an aggregator, and a publisher of PC Software Products, including game products. As such, Microsoft's offerings are the closest parallel to the proposed offerings of EA.com. MGZ currently offers both family games and games directed towards the more serious gamer and, at the same time, has the opportunity to leverage these experiences with games sold at retail. At present, MGZ offers matchmaking for about 80 games and offers approximately 40 playable online games, which consist primarily of card and parlor games. Relationships with Significant Hardware Platform Companies Sony In fiscal 2002, approximately 28% of our net revenues were derived from sales of software for the PlayStation 2 compared to 20% in fiscal 2001. We released 18 titles worldwide in fiscal 2002 for the PlayStation 2 compared to 15 titles in fiscal 2001. Key releases for the year included Madden NFL(TM) 2002, James Bond 007 in...Agent Under Fire(TM), FIFA 2002, NBA Street, NBA Live 2002, NCAA Football 2002, SSX Tricky, NHL 2002 and NASCAR Thunder 2002. Revenues increased for fiscal 2002 due to the higher installed base of PlayStation 2 hardware and more titles, including catalogue, available on the platform compared to the prior year. We expect revenues from PlayStation 2 products to continue to grow in fiscal 2003, but as revenues for these products increase, we do not expect to maintain these growth rates. In fiscal 2002, approximately 11% of our net revenues were derived from sales of software for the PlayStation compared to 23% in fiscal 2001. During fiscal 2002, we released five PlayStation games compared to 17 in fiscal 2001. As expected, PlayStation sales decreased for fiscal 2002 compared to the prior year primarily attributable to releasing fewer games and to the PlayStation 2 platform transition. Most of our franchises experienced significant decreases from prior year releases. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline significantly in fiscal 2003. See Risk Factors - "Product development schedules are frequently unreliable and make predicting quarterly results difficult". Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are authorized to develop and distribute CD-based software products compatible with the PlayStation. Furthermore, under the terms of an additional licensing agreement entered into with Sony Computer Entertainment of America as of April 2000 (the "PlayStation 2 Agreement"), as amended, we are authorized to develop and distribute DVD-based software products compatible with the PlayStation 2. Pursuant to these agreements, we engage Sony to manufacture its PlayStation and PlayStation 2 CDs and DVDs for us. Accordingly, we have limited ability to control our supply of PlayStation and PlayStation 2 CD and DVD products or the timing of their delivery. See Risk Factors - "Our platform licensors are our chief competitors and frequently control the manufacturing of our video game products". 7 Nintendo In fiscal 2002, we released our first five Nintendo GameCube titles, Madden NFL 2002, James Bond 007 in...Agent Under Fire, SSX Tricky, NBA Street and FIFA Soccer 2002, following the platform's launch in Japan in September 2001 and in North America in November 2001. During fiscal 2002, we released one title for the Nintendo 64 ("N64(R)") compared to three titles in fiscal 2001. In fiscal 2002, approximately 1% of our net revenues were derived from the sale of N64 products compared to 5% in 2001. The expected decrease in N64 revenues for the fiscal year, compared to the prior fiscal year, was primarily due to fewer releases. The decrease was also due to the weaker market for N64 products in the current year. We do not intend to release any new N64 products in fiscal 2003. Microsoft During fiscal 2002, following the launch of the Xbox platform in North America in November 2001, in Japan in February 2002 and in Europe in March 2002, we released our first ten Xbox titles. Titles released included Madden NFL 2002, NBA Live 2002, James Bond 007 in...Agent Under Fire, NASCAR Thunder 2002, NHL 2002, Triple Play(TM) 2002, SSX Tricky, Knockout Kings 2002 and F1 2001. Relationships with Internet Service Providers America Online, Inc. ("AOL") Our agreement with AOL establishes the basis for EA.com's creation of game sites on the world wide web that are available to AOL subscribers via the Games Channel on the AOL's flagship ISP service and to other consumers who use other AOL portals (AOL.com, CompuServe, Netscape/Netcenter and ICQ). Users can also access the EA.com website directly from the world wide web. EA.com is AOL's exclusive provider of a broad aggregation of online games and programs and manages all of the Games Channel content within AOL's flagship ISP service in the United States and other AOL portals. Within any of the AOL properties, users will be able to find a games channel or area which will provide the user access to EA.com games. Through this agreement, EA.com has significantly expanded its EA brand as a provider of online games. According to the March 2002 Media Metrix Top 50 Web and Digital Media Properties report which combines unduplicated home/work usage in the U.S., the total number of unique monthly visitors to the AOL branded properties that will have access to the EA.com games site was 92 million. For the terms of the AOL agreement, see Note 5 of the Notes to Consolidated Financial Statements, included in item 8 hereof. Products and Product Development In fiscal 2002, we generated approximately 61% of our revenues from EA Studio products released during the year. See Risk Factors - "Product development schedules are frequently unreliable and make predicting quarterly results difficult". As of March 31, 2002, we were actively marketing approximately 90 titles, comprising over 120 stock keeping units, or sku's, that were published by our development divisions and subsidiaries, EA Studios. During fiscal 2002, we introduced 32 EA Studios titles, representing 64 sku's, compared to 35 EA Studios titles, comprising 55 sku's, in fiscal 2001. In fiscal 2002, we had 16 titles that sold over one million units. In both fiscal 2001 and 2000, we had 14 titles that sold over one million units. The products published by EA Studios are designed and created by our in-house designers and artists and by independent software developers ("independent artists"). We typically pay the independent artists royalties based on the sales of the specific products, as defined in the related independent artist agreements. For fiscal 2002, we had one title, Harry Potter and the Sorcerer's Stone(TM), published on four different platforms, which represented approximately 12% of our total fiscal 2002 net revenues. For fiscal 2001 and 2000, no title represented revenues greater than 10% of our total fiscal 2001 and 2000 net revenues. We publish products in a number of categories such as sports, action, strategy, simulations, role playing and adventure, each of which is becoming increasingly competitive. Our sports-related products, marketed under the EA SPORTS(TM) brand name, accounted for a significant percentage of net revenues in fiscal years 2002, 2001 and 2000. There can be no assurance that we will be able to maintain our market share in the sports category. The front line retail selling prices in North America of our products, excluding older titles (marketed as "Classics"), typically range from $30.00 to $55.00. "Classics" titles have retail selling prices that range from $10.00 to $30.00. The retail selling prices of EA titles outside of North America vary based on local market conditions. 8 We currently develop or publish products for eight different hardware platforms. In fiscal 2002, our product releases were for PlayStation 2, PC, Xbox, PlayStation, Nintendo GameCube, Game Boy Advance, Game Boy Color, online Internet play and N64. Our planned product introductions for fiscal 2003 are for the PlayStation 2, PC, Nintendo GameCube, Xbox, PlayStation, Game Boy Advance, online Internet play and Game Boy Color. See Risk Factors - "Product development schedules are frequently unreliable and make predicting quarterly results difficult" and "New video game platforms create additional technical and business model uncertainties". Our goal is to be the market leader on the next generation of video game consoles. We are investing in the development of tools and technologies associated with the introduction of the next generation video game console platforms. Our goal is to be the leading provider of interactive entertainment on the Internet. We will invest in the development of tools and technologies associated with the introduction of key online offerings in fiscal 2003. PlayStation has achieved significant market acceptance in all geographic territories. However, as the PlayStation console market has reached maturity, we expect sales of PlayStation products to continue to decline significantly in fiscal 2003. Most of the console video game products are convertible for use on multiple advanced hardware systems. We had research and development expenditures of $387.7 million in fiscal 2002, $388.9 million in fiscal 2001 and $262.0 million in fiscal 2000. See Risk Factors - "Product development schedules are frequently unreliable and make predicting quarterly results difficult". EA.com Web Site Free Content. In fiscal 2002, EA.com eliminated its free games offering under various "channels" on the site and redesigned the site to reflect this change in strategy. As part of this redesign, EA.com eliminated the majority of its games on the EA Games Channel and integrated its remaining browser-based games with Pogo free games subsequent to the Pogo acquisition. EA.com now offers free games on its site under the following three brands: Pogo brand, EA Games brand, and EA Sports brand. The majority of the free games are original games designed solely for online play while some of the product offerings capitalize on existing Electronic Arts franchises adapted for game play on the Internet. The product offerings within each brand incorporate some or all of the following: . Pogo. EA.com currently offers approximately 35 free games under this brand. The games offering, geared towards family entertainment, consists of card games, board games, casino games, word games, trivia games, puzzles, Bingo, and other products with appeal. This category leverages prizes, tournaments, community and Pogo's strength and popularity in free, familiar games to significantly increase EA.com's appeal to the broad consumer market. . EA Games. EA.com currently offers 15 free games under this brand. The EA Games offering consists of original arcade style games and other original EA games designed solely for online play, such as Tank Hunter, Bunny Luv and Meteor Madness. . EA Sports. EA.com currently offers 10 free games under this brand. Some of the games in this category leverage existing Electronic Arts' franchises, such as Knockout Kings and Nascar Web Racing, to develop a community of sports gamers. In addition, there are original games designed solely for online play such as Pebble Beach Golf, Pro 3-Point and It's Outta Here! Paid Content. In addition to the free games, EA.com offers premium pay-to-play persistent state world games on its website. In order to access these premium games, the player must purchase a CD-ROM through retail stores or through our online store which will entitle the consumer to one free month of game play. Thereafter, the player must pay a monthly subscription fee in order to continue playing. These persistent state world games are designed to target the avid gamers: teens and adults looking to participate in multi-player hard core games made up of fantastic worlds, characters, adventures or activities - big or small, real or imagined. This offering features immersive experiences and sophisticated game play appealing to dedicated gamers, as well as new forms of cutting-edge Internet entertainment targeted to mass market gamers. Currently, this offering capitalizes on the success of our existing Ultima Online product as well as Motor City Online. EA.com expects to release Earth & Beyond and The Sims Online(TM) in the future. Each of the categories above focuses on targeting and serving its specific consumer group by: . Offering engaging and accessible online games; . Building a community in which consumers can interact with one another via chat, bulletin boards, events and match-making services for multi-player games and other contests; . Delivering innovative content that continually entertains; and . Establishing a direct relationship with each audience member through personalization and customization of user experiences. 9 Marketing and Distribution Electronic Arts Distribution We distribute EA Studio, Affiliated Label and Co-Published products. We market our EA Studio products using the EA GAMES(TM), EA SPORTS(TM) and EA SPORTS BIG(TM) brands. EA GAMES consists of our separate brands, including Electronic Arts and Maxis. EA SPORTS brand simulates professional and collegiate sports and includes titles such as Madden NFL, FIFA and NBA Live. EA SPORTS BIG brand simulates extreme sports such as the SSX and NBA Street games. Affiliated Label products are delivered to us as completed products. Co-Published products are titles we have assisted in developing with other software publishers. As of March 31, 2002, we distributed approximately 30 Affiliated Label and Co-Published titles in North America. No single Affiliated Label Publisher has accounted for more than 10% of our net revenues in any of the last three fiscal years. In May 1998, Electronic Arts and Square Co., Ltd. formed a new joint venture in North America, creating Square Electronic Arts, LLC ("Square EA") as discussed in Note 13 of the Notes to Consolidated Financial Statements, included in item 8 hereof. In conjunction with the formation of this joint venture, we have the exclusive right in North America to distribute products published by this joint venture. Either party may terminate the existence of Square EA and the distribution agreement effective March 31, 2003. In fiscal 2002, Square EA published Final Fantasy(R) X for the PlayStation 2, which was a top ten selling title for Electronic Arts. We generated approximately 95% of our North American net revenues from direct sales to retailers through a field sales organization of professionals and a group of telephone sales representatives. The remaining 5% of our North American sales were made through a limited number of specialized and regional distributors and rack jobbers in markets where we believe direct sales would not be economical. We had sales to one customer, Wal-Mart Stores, Inc., which represented 14% of total net revenues in fiscal 2002 and 12% in both fiscal 2001 and 2000. The video game and PC businesses have become increasingly "hits" driven, requiring significantly greater expenditures for marketing and advertising, particularly for television advertising. There can be no assurance that we will continue to produce "hit" titles, or that advertising for any product will increase sales sufficiently to recoup those advertising expenses. We have stock-balancing programs for our personal computer products that, under certain circumstances and up to a specified amount, allow for the exchange of personal computer products by resellers. We may decide to provide price protection under certain circumstances for our personal computer and video game system products after we analyze: inventory remaining in the channel, the rate of inventory sell through in the channel, and our remaining inventory on hand. We maintain a policy of exchanging products or giving credits, but do not give cash refunds. Moreover, the risk of product returns for our products on mature platforms may increase as new hardware platforms, such as Xbox, Nintendo GameCube and PlayStation 2, become more popular. We monitor and manage the volume of our sales to retailers and distributors and their inventories as substantial overstocking in the distribution channel can result in high returns or the requirement for substantial price protection in subsequent periods. We believe that we provide adequate reserves for returns and price protection which are based on estimated future returns of products, taking into account historical returns, current sell through of distributor and retailer inventory of our products, current trends in the video game market and the overall economy, changes in customer demand and acceptance of our products and other related factors. We believe our current reserves will be sufficient to meet return and price protection requirements for current in-channel inventory. However, there can be no assurance that actual returns or price protection will not exceed our reserves. Within the EA.com site, we offer visitors the opportunity to purchase Electronic Arts software products directly from us. We utilize EA Core's distribution network to fulfill consumers' online orders. We also have a fulfillment group that sells product directly to consumers through a toll-free number and through our websites listed in advertising by us and our Affiliated Labels. This group is also responsible for targeted direct mail marketing and sells product backups and accessories to registered customers. The distribution channels through which consumer software products are sold have been characterized by change, including consolidations and financial difficulties of certain distributors. The bankruptcy or other business difficulties of a distributor or retailer could render our accounts receivable from such entity uncollectible, which could have an adverse effect on our operating results and financial condition. In January 2002, one of our retail customers, Kmart, declared bankruptcy. We have adequately reserved for our exposure to Kmart. In addition, an increasing number of companies are competing for access to these channels. Our arrangements with our distributors and retailers may be terminated by either party at any time without cause. Distributors and retailers often carry products that compete with ours. Retailers of our products typically have a limited amount of shelf space and promotional resources 10 for which there is intense competition. There can be no assurance that distributors and retailers will continue to purchase our products or provide our products with adequate levels of shelf space and promotional support. Segment Reporting We operate in two principal business segments globally: . EA Core business segment: creation, marketing and distribution of entertainment software. . EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising. Please see the discussion regarding segment reporting in the MD&A and Note 18 of the Notes to Consolidated Financial Statements, included in items 7 and 8 hereof. International Operations We have wholly owned subsidiaries throughout the world, including offices in the United Kingdom, France, Spain, Germany, Australia, Canada, South Africa, Singapore, Sweden, Japan, Malaysia, Brazil and Holland. The amounts of net revenues, operating profit and identifiable assets attributable to each of our geographic regions for each of the last three fiscal years are set forth in Note 18 of the Notes to Consolidated Financial Statements, included in item 8 hereof. International net revenues increased by 29% to $631,431,000, or 37% of consolidated fiscal 2002 net revenues, compared to $490,349,000 or 37% of consolidated fiscal 2001 net revenues due to the following: . Europe's net revenues increased 34% primarily due to higher PlayStation 2, AL and PC sales, partially offset by the expected decrease of revenues from Sony PlayStation. PlayStation 2 launched in November 2000. Consequently, fiscal 2001 includes five months of revenues as compared to twelve months of revenues from the PlayStation 2 in fiscal 2002, resulting in an 80% increase in PlayStation 2 revenues in fiscal 2002 as compared to fiscal 2001. . Asia Pacific's net revenues increased by 5% compared to the prior year primarily due to higher PlayStation 2, Game Boy Color(R) and PC revenue, partially offset by the expected decrease in PlayStation and Nintendo 64 sales, and an unfavorable exchange rate comparison of approximately 10%. PlayStation 2 revenues increased by 46%, partially offset by a 34% decrease in PlayStation revenues in fiscal 2002 as compared to fiscal 2001. . Japan's net revenues increased by 11% compared to the prior year primarily due to higher AL revenue and revenue generated from sales of PlayStation, Nintendo GameCube and Xbox products, offset by the strong sales of our first PlayStation 2 title, FIFA Soccer World Championship, in the prior year and weakness in the Yen currency during fiscal 2002 resulting in a rate decrease of approximately 14% from fiscal 2001. Also, Japan did not benefit from our primary PlayStation 2 releases during the current fiscal year, which have more appeal to the North American market. PlayStation 2 revenues decreased by 50% in fiscal 2002 as compared to fiscal 2001. Though international revenues are expected to grow in fiscal 2003, international revenues may not grow at as high a rate as in prior years. See Risk Factors - "Our business, our products, and our distribution are subject to increasing regulation of content, consumer privacy and online delivery in key territories" and "Foreign Sales and Currency Fluctuations". Manufacturing and Suppliers Materials In many instances, we are able to acquire materials on a volume-discount basis. We have multiple potential sources of supply for most materials, except with respect to our PlayStation, PlayStation 2, Xbox and Nintendo GameCube products, as previously mentioned. We also have alternate sources for the manufacture and assembly of most of our products. To date, we have not experienced any material difficulties or delays in production of our software and related documentation and packaging. However, a shortage of components or other factors beyond our control could impair our ability to manufacture, or have manufactured, our products. See Risk Factors - "Our platform licensors are our chief competitors and frequently control the manufacturing of our video game products". 11 Backlog We normally ship products within a few days after receipt of an order. However, a backlog may occur for EA Studio and Affiliated Label products that have been announced for release but not yet shipped. We do not consider backlog to be an indicator of future performance. Seasonality Our business is highly seasonal. We typically experience our 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. See Risk Factors - "Our business is both seasonal and cyclical". Employees As of March 31, 2002, we employed approximately 3,500 people, of whom over 1,400 were outside the United States. Of this amount, there were over 400 EA.com full-time employees. We believe that our ability to attract and retain qualified employees is an important factor in our growth and development and that our future success will depend, in large measure, on our ability to continue to attract and retain qualified employees. To date, we have been successful in recruiting and retaining sufficient numbers of qualified personnel to conduct our business successfully. See Risk Factors - "Because of the competition for qualified technical, creative, marketing and other personnel, we may not be able to attract and retain the personnel necessary for our businesses". 12 Item 2: Properties Our principal administrative, sales and marketing, research and development, and support facility is located in Redwood City, California, 20 miles south of San Francisco. In February of 1995, we entered into a build-to-suit lease with a financial institution on our headquarter's facility in Redwood City, California, which was extended in July of 2001 and runs through July of 2006. We accounted for this arrangement as an operating lease in accordance with Statement of Financial Accounting Standards No. 13 ("SFAS 13"), "Accounting for Leases", as amended. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. We have an option to purchase the property (land and facilities) for $145,000,000 or, at the end of the lease, to arrange for (1) an additional extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000 if the sales price is less than this amount, subject to certain provisions of the lease. In December 2000, we entered into a second build-to-suit lease with a financial institution for a five year term from December 2000 to expand our headquarter's facilities and develop adjacent property adding approximately 310,000 square feet to our campus. We expect to complete construction in June of 2002. We accounted for this arrangement as an operating lease in accordance with SFAS 13, as amended. The facilities will provide space for marketing, sales and research and development. We have an option to purchase the property for $127,000,000 or, at the end of the lease, to arrange for (1) an extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118,800,000 if the sales price is less than this amount, subject to certain provisions of the lease. Lease rates are based upon the Commercial Paper Rate. The two lease agreements described above require us to maintain certain financial covenants, all of which we were in compliance with as of March 31, 2002. Our North American distribution is supported by a newly centralized and expanded warehouse facility in Louisville, Kentucky occupying 250,000 sq. ft. The Hayward distribution center was closed in fiscal 2001 in conjunction with the expansion of our Louisville, Kentucky facility. We also occupy sales offices in the metropolitan areas of Toronto, Chicago, Dallas and New York. In addition to our Redwood City development studio, we own a 206,000 sq. ft. development facility in Burnaby, British Columbia, Canada and rent a 33,000 sq. ft. facility in Seattle, Washington. We also own a 173,500 sq. ft. development facility in Austin, Texas, and lease development facilities in Walnut Creek, San Francisco and Carlsbad, California, New York, New York and Charlottesville, Virginia. We own a 127,000 sq. ft. administrative, sales and development facility in Chertsey, England, which our United Kingdom subsidiaries moved into in March 2000, and a 5,000 sq. ft. development facility in Warrington, England. In Europe, we also lease a distribution hub in Heerlen, Holland, as well as sales and distribution facilities in Madrid, Spain and Sennwald, Switzerland. Additionally, we have sales and administrative offices throughout Europe. In Asia and the South Pacific, we maintain a 15,678 sq. ft. sales and distribution facility in Gold Coast, Australia. We also have sales and distribution facilities in New Zealand, Singapore, Thailand, Korea, South Africa and Taiwan, and representative offices in Hong Kong and Beijing, China. We also maintain a 27,000 sq. ft. sales and development office in Tokyo, Japan. See Notes 4 and 11 of the Notes to Consolidated Financial Statements, included in Item 8 hereof. We believe that these facilities are adequate for our current needs. We believe that suitable additional or substitute space will be available as needed to accommodate our future needs. 13 Item 3: Legal Proceedings We are 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 on our consolidated financial condition or results of operations. 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, 2002. 14 Item 4A: Executive Officers of the Registrant The following table sets forth information regarding the executive officers of Electronic Arts, who are chosen by and serve at the discretion of the Board of Directors: Name Age Position ---- --- -------- Lawrence F. Probst III 52 Chairman and Chief Executive Officer Don A. Mattrick 38 President, Worldwide Studios John S. Riccitiello 42 President and Chief Operating Officer William B. Gordon 52 Executive Vice President and Chief Creative Officer E. Stanton McKee, Jr. 57 Executive Vice President and Chief Financial and Administrative Officer Nancy L. Smith 49 Executive Vice President and General Manager, North American Publishing David L. Carbone 51 Senior Vice President, Finance David Gardner 37 Senior Vice President, European Publishing Ruth A. Kennedy 47 Senior Vice President, General Counsel and Secretary V. Paul Lee 37 Senior Vice President and Chief Operating Officer, Worldwide Studios J. Russell Rueff, Jr. 40 Senior Vice President, Human Resources Mr. Probst has been a director of Electronic Arts since January 1991 and currently serves as Chairman and Chief Executive Officer. He was elected as Chairman in July 1994. Mr. Probst has previously served as President of Electronic Arts; as Senior Vice President of EA Distribution, Electronic Arts' distribution division, from January 1987 to January 1991; and from September 1984, when he joined Electronic Arts, until December 1986, served as Vice President of Sales. Mr. Probst holds a B.S. degree from the University of Delaware. Mr. Mattrick has served as President of Worldwide Studios since September 1997. Prior to this, he served as Executive Vice President, North American Studios, since October 1996. From July 1991 to October 1996, he served as Senior Vice President, North American Studios, Vice President of Electronic Arts and Executive Vice President/General Manager for EA Canada. Mr. Mattrick was founder and former chairman of Distinctive Software Inc. from 1982 until it was acquired by us in 1991. Mr. Riccitiello has served as President and Chief Operating Officer since October 1997. Prior to joining Electronic Arts, Mr. Riccitiello served as President and Chief Executive Officer of the worldwide bakery division at Sara Lee Corporation. Before joining Sara Lee, he served as President and CEO of Wilson Sporting Goods Co. and has also held executive management positions at Haagen-Dazs, PepsiCo, Inc. and The Clorox Company. Mr. Riccitiello holds a degree in Economics and Marketing from the University of California, Berkeley. Mr. Gordon has served as Executive Vice President and Chief Creative Officer since March 1998. Prior to this, he served as Executive Vice President, Marketing since October 1995. From August 1993 to October 1995, he served as Executive Vice President of EA Studios and as Senior Vice President of Entertainment Production since February 1992. He also served as Senior Vice President of Marketing, as General Manager of EA Studios, as Vice President of Marketing, as Director of Advertising and as Vice President of our former entertainment division while employed by us. Mr. Gordon holds a B.A. degree from Yale University and an M.B.A. degree from Stanford University. 15 Mr. McKee joined Electronic Arts in March 1989 and is currently Executive Vice President and Chief Financial and Administrative Officer. Prior to October 1996, he served as Senior Vice President and Chief Financial and Administrative Officer. Mr. McKee holds B.A. and M.B.A. degrees from Stanford University and is also a Certified Public Accountant. Ms. Smith has served as Executive Vice President and General Manager, North American Publishing since March 1998. Prior to this, she served as Executive Vice President, North American Sales since October 1996. She previously held the position of Senior Vice President of North American Sales and Distribution from July 1993 to October 1996 and as Vice President of Sales from 1988 to 1993. Ms. Smith has also served as Western Regional Sales Manager and National Sales Manager since she joined Electronic Arts in 1984. Ms. Smith holds a B.S. degree in management and organizational behavior from the University of San Francisco. Mr. Carbone has served as Senior Vice President, Finance since December 2000. Prior to this, he served as Vice President, Finance since February 1991. He was elected Assistant Secretary of the Company in March 1991. Mr. Carbone holds a B.S. degree in accounting from King's College and is a Certified Public Accountant. Mr. Gardner has served as Senior Vice President and Managing Director, European Publishing since May 1999. Prior to this, he held several positions in EA Europe, which he helped establish in 1987, including Director of European Sales and Marketing and Managing Director of EA Europe. Mr. Gardner has also held various positions at Electronic Arts in the sales, marketing and customer support departments since joining the company in 1983. Ms. Kennedy has been employed by Electronic Arts since February 1990. She served as Corporate Counsel until March 1991 and is currently Senior Vice President, General Counsel and Secretary. Prior to October 1996, she served as Vice President, General Counsel and Secretary. Ms. Kennedy was elected Secretary in September 1994. Ms. Kennedy is a member of the State Bars of California and New York and received her B.A. degree from William Smith College and her Juris Doctor from the State University of New York. Mr. Lee has served as Senior Vice President and Chief Operating Officer, Worldwide Studios since 1998. Prior to this, he served as General Manager of EA Canada, Chief Operating Officer of EA Canada, Chief Financial Officer of EA Sports and Vice President, Finance and Administration of EA Canada. Mr. Lee was a principle of Distinctive Software Inc. until it was acquired by EA in 1991. Mr. Lee holds a Bachelor of Commerce degree from the University of British Columbia and is a Chartered Financial Analyst. Mr. Rueff has served as Senior Vice President of Human Resources since October 1998. Prior to joining Electronic Arts, Mr. Rueff held various positions with the PepsiCo companies for over 10 years, including: Vice President, International Human Resources; Vice President, Staffing and Resourcing at Pepsi-Cola International; Vice President, Restaurant Human Resources for Pizza Hut; and also various other management positions within the Frito-Lay Company. Mr. Rueff holds a M.S. degree in Counseling and a B.A. degree in Radio and Television from Purdue University in Indiana. 16 PART II Item 5: Market for Registrant's Common Equity and Related Stockholder Matters Our Class A Common Stock is traded on the Nasdaq National Market under the symbol "ERTS". The following table sets forth the quarterly high and low closing sales price per share of our Common Stock from April 1, 2000 through March 31, 2002. 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, 2001: (for Class A common stock, see note 2) First Quarter $39.06 $26.59 Second Quarter 54.47 37.06 Third Quarter 55.38 35.19 Fourth Quarter 56.13 29.84 Fiscal Year Ended March 31, 2002: (for Class A common stock) First Quarter $63.04 $48.31 Second Quarter 60.60 44.50 Third Quarter 66.01 42.40 Fourth Quarter 62.95 51.16 There were approximately 1,800 holders of record of our Common Stock as of June 1, 2002. In addition, we believe that a significant number of beneficial owners of our Common Stock hold their shares in street names. Dividend Policy We have not paid any cash dividends and do not anticipate paying cash dividends in the foreseeable future. 17 Item 6: Selected Financial Data ELECTRONIC ARTS AND SUBSIDIARIES SELECTED FIVE-YEAR FINANCIAL DATA Years Ended March 31, (In thousands, except per share data)
INCOME STATEMENT DATA 2002 2001 2000 1999 1998 - -------------------------------------------------------------------------------------------------------------------------------- Net revenues $ 1,724,675 $1,322,273 $ 1,420,011 $ 1,221,863 $908,852 Cost of goods sold 807,611 652,242 704,702 627,589 481,233 ------------------------------------------------------------------------------- Gross profit 917,064 670,031 715,309 594,274 427,619 Operating expenses: Marketing and sales 241,109 185,336 188,611 163,407 128,308 General and administrative 107,059 104,041 92,418 76,219 57,838 Research and development 387,736 388,928 261,966 199,375 145,732 Amortization of intangibles 25,418 19,323 11,989 5,880 -- Charge for acquired in-process technology -- 2,719 6,539 44,115 1,500 Merger costs -- -- -- -- 10,792 Restructuring and asset impairment charges 20,303 -- -- -- -- ------------------------------------------------------------------------------- Total operating expenses 781,625 700,347 561,523 488,996 344,170 ------------------------------------------------------------------------------- Operating income (loss) 135,439 (30,316) 153,786 105,278 83,449 Interest and other income, net 12,848 16,886 16,028 13,180 24,811 ------------------------------------------------------------------------------- Income (loss) before provision for (benefit from) income taxes and minority interest 148,287 (13,430) 169,814 118,458 108,260 Provision for (benefit from) income taxes 45,969 (4,163) 52,642 45,414 35,726 ------------------------------------------------------------------------------- Income (loss) before minority interest 102,318 (9,267) 117,172 73,044 72,534 Minority interest in consolidated joint venture (809) (1,815) (421) (172) 28 ------------------------------------------------------------------------------- Net income (loss) $ 101,509/(a)/ $ (11,082)/(b)/ $ 116,751/(c)/ $ 72,872/(d)/ $ 72,562/(e)/ ------------------------------------------------------------------------------- Net income per share: Basic N/A N/A $ 0.93 $ 0.60 $ 0.62 Diluted N/A N/A $ 0.88 $ 0.58 $ 0.60 Number of shares used in computation: Basic N/A N/A 125,660 121,495 117,734 Diluted N/A N/A 132,742 126,545 121,917 Class A common stock: Net income (loss): Basic $ 124,256 $ 11,944 N/A N/A N/A Diluted $ 101,509 $ (11,082) N/A N/A N/A Net income (loss) per share: Basic $ 0.91 $ 0.09 N/A N/A N/A Diluted $ 0.71 $ (0.08) N/A N/A N/A Number of shares used in computation: Basic 136,832 131,404 N/A N/A N/A Diluted 143,142 132,056 N/A N/A N/A Class B common stock: Net loss, net of retained interest in EA.com $ (22,747) $ (23,026) N/A N/A N/A Net loss per share: Basic $ (3.77) $ (3.83) N/A N/A N/A Diluted $ (3.77) $ (3.83) N/A N/A N/A Number of shares used in computation: Basic 6,026 6,015 N/A N/A N/A Diluted 6,026 6,015 N/A N/A N/A - --------------------------------------------------------------------------------------------------------------------------------
18 ELECTRONIC ARTS AND SUBSIDIARIES SELECTED FIVE-YEAR FINANCIAL DATA (Continued) Years Ended March 31, (In thousands, except per share data)
- ------------------------------------------------------------------------------------------------------------------------------------ BALANCE SHEET DATA AT FISCAL YEAR END 2002 2001 2000 1999 1998 - ------------------------------------------------------------------------------------------------------------------------------------ Cash, cash equivalents and short-term investments $ 796,936 $ 466,492 $ 339,804 $ 312,822 $ 374,560 Marketable securities 6,869 10,022 236 4,884 3,721 Working capital 699,561 478,701 440,021 333,256 408,098 Long-term investments - 8,400 8,400 18,400 24,200 Total assets 1,699,374 1,378,918 1,192,312 901,873 745,681 Total liabilities 452,982 340,026 265,302 236,209 181,713 Minority interest 3,098 4,545 3,617 2,733 - Total stockholders' equity 1,243,294 1,034,347 923,393 662,931 563,968
Note: (a) Net income includes restructuring and asset impairment charges of $14.0 million, net of taxes and goodwill amortization of $17.5 million, net of taxes. (b) Net loss includes one-time acquisition related charges of $1.9 million, net of taxes, incurred in connection with the acquisition of Pogo Corporation made during the year as well as goodwill amortization of $13.3 million, net of taxes. (c) Net income includes one-time acquisition related charges of $4.5 million, net of taxes, incurred in connection with the acquisition of Kesmai and other business combinations made during the year as well as goodwill amortization of $8.3 million, net of taxes. (d) Net income includes one-time acquisition related charges of $37.5 million, net of taxes, incurred in connection with the acquisition of Westwood Studios and other business combinations made during the year as well as goodwill amortization of $4.0 million, net of taxes. (e) Net income includes one-time acquisition related charges of $1.0 million, net of taxes, incurred in connection with the acquisition of the remaining minority ownership interest in Electronic Arts Victor, Inc. as well as merger costs of $7.2 million, net of taxes, associated with the merger with Maxis, offset by a one-time gain on sale of Creative Wonders, LLC in the amount of $8.5 million, net of taxes. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for discussions of EA Core and EA.com pro forma financial statements. 19 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations The following "Management's Discussion and Analysis of Financial Condition and Results of Operations", contains forward-looking statements about circumstances that have not yet occurred. All statements, trend analysis and other information contained below relating to markets, our products and trends in revenue, as well as other statements including words such as "anticipate", "believe" or "expect" and statements in the future tense are forward-looking statements. These forward-looking statements are subject to business and economic risks and actual events or our actual future results could differ materially from those set forth in the forward-looking statements due to such risks and uncertainties. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results and performance include, but are not limited to, those discussed under the heading "Risk Factors" at pages 45 to 50 of this Annual Report on Form 10-K. CRITICAL ACCOUNTING POLICIES Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The policies discussed below are considered by management to be critical because they are both important to the portrayal of our financial condition and results of operations and their application places the most significant demands on management's judgment, with financial reporting results relying on estimates about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions. Sales allowances and bad debt reserves We derive revenues from sales of our packaged goods product, subscriptions of online service, sales of packaged goods through our online store and website advertising. Product revenue is recognized net of an allowance for returns. We also have stock-balancing programs for our personal computer products that, under certain circumstances and up to a specified amount, allow for the exchange of personal computer products by resellers. We may decide to provide price protection under certain circumstances for our personal computer and video game system products after we analyze: inventory remaining in the channel, the rate of inventory sell through in the channel, and our remaining inventory on hand. We maintain a policy of exchanging products or giving credits, but do not give cash refunds. We estimate potential future product returns, price protection and stock-balancing programs related to current period product revenue. We analyze historical returns, current sell through of distributor and retailer inventory of our products, current trends in the video game market and the overall economy, changes in customer demand and acceptance of our products and other related factors when evaluating the adequacy of the sales returns and price protection allowances. In addition, management monitors and manages the volume of our sales to retailers and distributors and their inventories as substantial overstocking in the distribution channel can result in high returns or the requirement for substantial price protection in subsequent periods. In the past, actual returns have not generally exceeded our reserves. However, actual returns in any future period are inherently uncertain as unsold products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing products. For example, the risk of product returns for our products on mature platforms may increase as new hardware platforms, such as Xbox, Nintendo GameCube and PlayStation 2, become more popular. While management believes it can make reliable estimates for these matters, if we changed our assumptions and estimates, our returns reserves would change, which would impact the net revenue we report. In addition, if actual returns were significantly greater than the reserves we have established, the actual results would decrease our reported revenue. Conversely, if actual returns were significantly less than our reserves, this would increase our reported revenue. Similarly, management must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts in any accounting period. Management analyzes customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Material differences may result in the amount and timing of our bad debt expense for any period if management made different judgments or utilized different estimates. If our customers experience financial difficulties and are not able to meet their ongoing financial obligations to us, our results of operations may be adversely impacted. For example, in January 2002, one of our retail customers, Kmart, declared bankruptcy. We have adequately reserved for our exposure to Kmart. Our distribution channels have been characterized by change, including consolidations and financial difficulties of certain distributors and retailers. 20 Our gross accounts receivable balance was $306,365,000 and our allowance for product returns, pricing allowances and doubtful accounts was $115,870,000 as of March 31, 2002. As of March 31, 2001, our gross accounts receivable balance was $264,282,000 and our allowance for product returns, pricing allowances and doubtful accounts was $89,833,000. Prepaid royalties Prepaid royalties consist primarily of prepayments for manufacturing royalties, co-publishing and/or distribution affiliates and license fees paid to celebrities, professional sports organizations and other organizations for use of their trade name and content. Also included in prepaid royalties are prepayments made to independent software developers under development arrangements that have alternative future uses. Prepaid royalties are expensed at the contractual or effective royalty rate as cost of goods sold based on actual net product sales. We evaluate the future realization of prepaid royalties quarterly and charge to research and development expense any amounts that we deem unlikely to be realized through product sales. We rely on forecasted revenue to evaluate the future realization of prepaid royalties. If actual revenues, or revised forecasted sales, fall below the initial forecasted sales, the charge to research and development expense may be larger than anticipated in any given quarter. Once the charge has been taken to research and development expense, that amount will not be expensed in future quarters when the product has shipped. The current portion of prepaid royalties, included in other current assets, was $65,484,000 at March 31, 2002 and $46,264,000 at March 31, 2001. The long-term portion of prepaid royalties, included in other assets, was $1,164,000 at March 31, 2002 and $9,664,000 at March 31, 2001. Valuation of long-lived assets, including goodwill and other intangible assets Under current accounting standards, we make judgments about the remaining useful lives of goodwill, purchased intangible assets and other long-lived assets whenever events or changes in circumstances indicate an other than temporary impairment in the remaining value of the assets recorded on our balance sheet. In order to judge the remaining useful life of an asset, management makes various assumptions about the value of the asset in the future. This may include assumptions about future prospects for the business that the asset relates to and typically involves computations of the estimated future cash flows to be generated by these businesses. Please refer to the Operations by Segment discussion of the Management's Discussion and Analysis of Financial Condition and Results of Operations for discussions of EA Core and EA.com. For our EA Core division, our future net cash flows are primarily dependent on the sale of products for play on proprietary video game platforms. The success of our products is affected by the ability to accurately predict which platforms and which products we develop will be successful. Also, our revenues and earnings are dependent on our ability to meet our product release schedules. For our EA.com division, the future net cash flows are dependent on the success of online games. Offering games solely for online play is a substantial departure from our traditional business of selling packaged software games. Because of our inexperience in predicting usage patterns for our games, we may not be effective in achieving success that may otherwise be attainable from offering our games online. Due to these and other factors described in our Risk Factors, we may not realize the future net cash flows necessary to recover our long-lived assets. For example, our product Majestic(TM) and our Platinum offering, which contained certain browser-based entertainment games, were launched with a monthly subscription pricing model and obtained only limited commercial success. Accordingly, we did not realize our projected cash flows and discontinued these offerings as part of EA.com's restructuring plan. Based on these judgments and assumptions, management determines whether we need to take an impairment charge to reduce the value of the asset stated on our balance sheet to reflect its estimated fair value. Judgments and assumptions about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including but not limited to, significant negative industry or economic trends, significant changes in the manner or use of the acquired assets or the strategy of our overall business and significant underperformance relative to expected historical or projected future operating results. Although we believe the judgments and assumptions management has made in the past have been reasonable and appropriate, there is nonetheless a high degree of uncertainty and judgment involved. For example, as part of a restructuring plan to reduce EA.com's workforce and consolidate facilities in the fiscal year ended March 31, 2002, we recorded impairment charges to write down certain of EA.com's depreciable assets and certain intangibles to their estimated fair value and to write off certain assets which were abandoned. The impairment charges were based on management's projections regarding the assets' remaining useful lives and future values. The EA.com business is still in the growing stages, therefore evaluating its business and prospects is more difficult than would be the case for a more mature business. We continue to encounter the risks and difficulties faced with launching a new business. We continue to look for ways to streamline the business by consolidating systems and reducing infrastructure costs. Different judgments and assumptions could materially impact our reported financial results. More conservative assumptions of the anticipated future benefits from these businesses would result in greater impairment charges, which would decrease net income and result in lower asset values on our balance sheet. Conversely, less conservative assumptions would result in smaller impairment charges, higher net income and higher asset values. Impairment charges on long-lived assets amounted to $12,818,000 for the fiscal year ended March 31, 2002. There were no impairment charges on long-lived assets for the years ended March 31, 2001 and 2000. On April 1, 2002, we adopted Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which supersedes Accounting Principles Board Opinion No. 17 "Intangible Assets". As a result of adopting this standard, we will continue to amortize finite-lived intangibles, but will no longer amortize certain other intangible assets, most notably goodwill 21 and acquired workforce, which had a net book value at March 31, 2002 of $69,050,000. Amortization of goodwill and acquired workforce totaled approximately $13,125,000 for fiscal 2002, approximately $9,182,000 for fiscal 2001 and approximately $6,411,000 for fiscal 2000. Based on intangible assets as of March 31, 2002, we estimate that amortization of finite-lived intangibles will total approximately $8,700,000 for fiscal 2003. Following adoption of SFAS 142, we will continue to evaluate whether any event has occurred which might indicate that the carrying value of an intangible asset is not recoverable. In addition, SFAS 142 requires that goodwill be subject to at least an annual assessment for impairment by applying a fair value-based test. Income taxes As part of the process of preparing our consolidated financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our current tax exposures in each jurisdiction including the impact, if any, of additional taxes resulting from tax examinations as well as making judgments regarding the recoverability of deferred tax assets. To the extent recovery of deferred tax assets is not likely based on our estimation of future taxable income in each jurisdiction, a valuation allowance is established. Tax exposures can involve complex issues and may require an extended period to resolve. To determine the quarterly tax rate, we are required to estimate full-year income and the related income tax expense in each jurisdiction. The estimated effective tax rate is adjusted for the tax related to significant unusual items. Changes in the geographic mix or estimated level of annual pre-tax income can effect the overall effective tax rate. RESULTS OF OPERATIONS Comparison of Fiscal 2002 to 2001: Revenues We derive revenues primarily from shipments of entertainment software, which includes EA Studio products for dedicated entertainment systems (that we call video game systems or consoles such as PlayStation, PlayStation 2, Xbox and Nintendo GameCube, and handheld systems such as Game Boy Advance), EA Studio personal computer products (or PC), Co-Publishing products that are co-published and distributed by us, and Affiliated Label (or AL) products that are published by third parties and distributed by us. We also derive revenues from licensing of EA Studio products and AL products through hardware companies (or OEM), selling subscriptions on our online gaming service, selling advertisements on our online web pages and selling our packaged goods through our online store. Information about our net revenues for North America and foreign areas for fiscal 2002 and 2001 is summarized below (in thousands):
2002 2001 Increase % change ------------------------------------------------------------------------------- North America $ 1,093,244 $ 831,924 $ 261,320 31.4 % ------------------------------------------------------------------------------ Europe 519,458 386,728 132,730 34.3 % Asia Pacific 53,376 51,039 2,337 4.6 % Japan 58,597 52,582 6,015 11.4 % ------------------------------------------------------------------------------ International 631,431 490,349 141,082 28.8 % ------------------------------------------------------------------------------ Consolidated Net Revenues $ 1,724,675 $1,322,273 $ 402,402 30.4 % ==============================================================================
North America Net Revenues The increase in North America net revenues for fiscal 2002 compared to fiscal 2001 was primarily attributable to: ... A 111% increase in PlayStation 2 revenues for the year due to the shipment of key titles such as Madden NFL 2002, James Bond 007 in ...Agent Under Fire, NBA Street, NBA Live 2002 and SSX Tricky, a higher installed base of hardware and a strong catalogue business. PlayStation 2 launched in October 2000. Consequently, fiscal 2001 includes six months of revenues as compared to twelve months of revenues for the PlayStation 2 in fiscal 2002. ... The launch of the Xbox platform in North America in November 2001, which generated $73,609,000 in revenues from titles such as Madden NFL 2002, NBA Live 2002, James Bond 007 in...Agent Under Fire, NASCAR Thunder 2002, NHL 2002 and SSX Tricky. ... The launch of Nintendo GameCube in North America in November 2001, which generated $48,744,000 for the year from key titles such as Madden NFL 2002, James Bond 007 in...Agent Under Fire, SSX Tricky, NBA Street and FIFA Soccer 2002. 22 ... New revenues were generated by Game Boy Advance of $25,989,000 for the year from key titles including Harry Potter and the Sorcerer's Stone, Madden NFL and NHL 2002. Also, Game Boy Color generated new revenues of $16,870,000 for the year from titles such as Harry Potter and the Sorcerer's Stone, Madden NFL 2002 and The World Is Not Enough. ... Advertising revenues increased by $31,849,000 for the twelve months ended March 31, 2002 as we commenced generating advertising revenues immediately following the launch of our gamesite on the world wide web in October 2000. In addition, advertising revenues were generated from Pogo Corporation's ("Pogo") websites subsequent to the February 2001 acquisition. ... These increases were partially offset by the continued expected decreases in Sony PlayStation and Nintendo 64 ("N64") revenues due to those declining markets and fewer titles shipping compared to the same period in the prior year. International Net Revenues The increase in international net revenues for fiscal 2002 compared to fiscal 2001 was attributable to the following: ... Europe's net revenues increased by 34% compared to the prior year primarily due to higher PlayStation 2, AL and PC sales, partially offset by the expected decrease of revenues from Sony PlayStation. PlayStation 2 launched in November 2000. Consequently, fiscal 2001 includes five months of revenues as compared to twelve months of revenues from the PlayStation 2 in fiscal 2002, resulting in an 80% increase in PlayStation 2 revenues. ... Asia Pacific's net revenues increased by 5% compared to the prior year primarily due to higher PlayStation 2, Game Boy Color and PC revenue, partially offset by the expected decrease in PlayStation and Nintendo 64 sales, and an unfavorable exchange rate comparison of approximately 10%. PlayStation 2 revenues increased by 46%, partially offset by a 34% decrease in PlayStation revenues in fiscal 2002 as compared to fiscal 2001. ... Japan's net revenues increased by 11% compared to the prior year primarily due to higher AL revenue and revenue generated from sales of PlayStation, Nintendo GameCube and Xbox products, offset by the strong sales of our first PlayStation 2 title, FIFA Soccer World Championship, in the prior year and weakness in the Yen currency during fiscal 2002 resulting in a rate decrease of approximately 14% from fiscal 2001. Also, Japan did not benefit from our primary PlayStation 2 releases during the current fiscal year, which have more appeal to the North American market. PlayStation 2 revenues decreased by 50% in fiscal 2002 as compared to fiscal 2001. Information about our worldwide net revenues by product line for fiscal 2002 and 2001 is presented below (in thousands):
Increase/ 2002 2001 (Decrease) % change ------------------------------------------------------------------------ EA Studio: - ---------- PlayStation 2 $ 482,882 $ 258,988 $ 223,894 86.4 % PC 456,292 405,256 51,036 12.6 % PlayStation 189,535 309,988 (120,453) (38.9 %) Xbox 78,363 - 78,363 N/A Nintendo GameCube 51,740 - 51,740 N/A Game Boy Advance 43,653 - 43,653 N/A Game Boy Color 38,026 - 38,026 N/A Advertising 38,024 6,175 31,849 515.8 % Online Subscriptions 30,940 28,878 2,062 7.1 % License, OEM and Other 24,762 20,468 4,294 21.0 % N64 18,152 67,044 (48,892) (72.9 %) Online Packaged Goods 3,296 3,198 98 3.1 % ----------------------------------------------------------------------- 1,455,665 1,099,995 355,670 32.3 % Affiliated Label: 269,010 222,278 46,732 21.0 % - ----------------- ----------------------------------------------------------------------- Consolidated Net Revenues $ 1,724,675 $ 1,322,273 $ 402,402 30.4 % =======================================================================
PlayStation 2 Product Net Revenues Revenues increased for the twelve months ended March 31, 2002 due to the higher installed base of PlayStation 2 hardware and more titles, including catalogue, available on the platform compared to the same period last year. Major releases for the fiscal year include titles such as Madden NFL 2002, James Bond 007 in .....Agent Under Fire, FIFA 2002, NBA Street, NBA Live 2002, NCAA Football 2002, SSX Tricky, NHL 2002 and NASCAR Thunder 2002. We released 18 PlayStation 2 titles in the current fiscal year compared to 15 in the same period last year. We expect revenues from PlayStation 2 products to continue to grow in fiscal 2003, but as revenues for these products increase, we do not expect to maintain these growth rates. 23 Personal Computer Product Net Revenues The increase in sales of PC products for the twelve months ended March 31, 2002 compared to the same period last year was primarily due to the continued strong sales of The Sims, which shipped over two years ago. Key current year releases were Harry Potter and the Sorcerer's Stone, The Sims Hot Date Expansion Pack, Medal of Honor: Allied Assault(TM), Command & Conquer Renegade(TM) and Madden NFL 2002. We released 16 PC titles in the twelve months ended March 31, 2002 compared to 18 in the same period last year. The Sims continues to be the number one PC title and has now sold over six million copies. Due to the sales of The Sims in fiscal 2002, we expect revenues from PC products to be flat or lower in fiscal 2003. PlayStation Product Net Revenues We released five PlayStation titles in the twelve months ended March 31, 2002 compared to 17 titles in the same period last year. As expected, PlayStation sales decreased for the twelve months ended March 31, 2002 compared to the prior year primarily attributable to the transition to next generation console systems and fewer titles released for the product during the current year. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline significantly in fiscal 2003. Under the terms of a licensing agreement entered into with Sony Computer Entertainment of America in July 1994 (the "Sony Agreement"), as amended, we are authorized to develop and distribute CD-based software products compatible with the PlayStation. Furthermore, under the terms of an additional licensing agreement entered into with Sony Computer Entertainment of America as of April 2000 (the "PlayStation 2 Agreement"), as amended, we are authorized to develop and distribute DVD-based software products compatible with the PlayStation 2. Pursuant to these agreements, we engage Sony to manufacture its PlayStation and PlayStation 2 CDs and DVDs for us. Accordingly, we have limited ability to control our supply of PlayStation and PlayStation 2 CD and DVD products or the timing of their delivery. Xbox Net Revenues Following the launch of the Xbox platform in North America in November 2001, we released our first ten Xbox titles during fiscal 2002. Titles released included Madden NFL 2002, NBA Live 2002, James Bond 007 in ... Agent Under Fire, NASCAR Thunder 2002, NHL 2002, Triple Play(TM) 2002, SSX Tricky, Knockout Kings 2002 and F1 2001. Nintendo GameCube Net Revenues We released our first five Nintendo GameCube titles, Madden NFL 2002, James Bond 007 in ...Agent Under Fire, SSX Tricky, NBA Street and FIFA Soccer 2002, during fiscal 2002 following the platform's launch in Japan in September 2001 and in North America in November 2001. Game Boy Advance Net Revenues We released our first three Game Boy Advance titles, Harry Potter and the Sorcerer's Stone, Madden NFL 2002 and NHL 2002 during fiscal 2002. Game Boy Color Net Revenues We released three Game Boy Color titles, Harry Potter and the Sorcerer's Stone, Madden NFL 2002 and The World is Not Enough during fiscal 2002. Advertising Revenues We commenced generating advertising revenues in the third quarter of fiscal year 2001 following the launch of our gamesite on the world wide web and the AOL Games Channel in October 2000. In addition, we generated advertising revenue from Pogo's websites subsequent to the purchase of Pogo in February 2001. As a result of establishing our ad business in late fiscal 2001, we experienced significant revenue growth in fiscal 2002. Due to this and continuing uncertainties in the ad market, we will not be able to sustain the same annual growth rate as experienced in fiscal 2002. Online Subscription Net Revenues The increase in online revenues for fiscal 2002 as compared to fiscal 2001 was primarily attributable to the following: ... An increase in the number of paying customers for Ultima Online to 207,000 as of March 31, 2002 as compared to 203,000 as of March 31, 2001. This increase was primarily due to the continued strong sales of Ultima Online Third Dawn and the release of Ultima Online Lord Blackthorn's Revenge in February 2002. In addition, the launch of Motor City Online in October 2001, which contributed $1,500,000 in subscription revenues for fiscal 2002. 24 ... Offset by a decrease in subscription revenues of $5,000,000 for Gamestorm, Kesmai Corporation ("Kesmai") and Worldplay online games (most of which were transferred to our free service when the EA/AOL site went live in October 2000) in fiscal 2002 as compared to fiscal 2001. License, OEM and Other Revenues The increase in license, OEM and other revenues for the twelve months ended March 31, 2002 was primarily due to a new OEM agreement with a customer in Europe and higher revenues in North America. Nintendo 64 Product Net Revenues We released one N64 title in fiscal 2002 compared to three titles during fiscal 2001. The expected decrease in N64 revenues for the fiscal year, compared to the prior fiscal year, was primarily due to the declining market for N64 products and fewer titles released on this platform in the current fiscal year. We do not intend to release any new N64 products in fiscal 2003. Online Packaged Goods Net Revenues Online Packaged Goods revenues for fiscal 2002 were slightly higher than fiscal 2001 primarily due to the release of Motor City Online in October 2001. Affiliated Label Product Net Revenues AL product sales increased for fiscal 2002 compared to the prior fiscal year primarily due to strong sales of hit titles including Devil May Cry and Resident Evil: Code Veronica resulting from new distribution deals with Capcom as well as The Simpsons(TM) Road Rage in the current year. This was partially offset by lower revenues from shipment of Square EA products due to fewer titles released in fiscal 2002 compared to fiscal 2001. Operations by Segment Management considers EA.com to be a separate reportable segment. We operate in two principal business segments globally (see Note 2 of the Notes to Consolidated Financial Statements): . EA Core business segment: creation, marketing and distribution of entertainment software. . EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising. EA.com represents Electronic Arts' online and e-Commerce businesses. EA.com's business includes subscription revenues collected for Internet game play on our websites, website advertising, sales of packaged goods for Internet-only based games and sales of Electronic Arts games sold through the EA.com web store. The Consolidated Statements of Operations includes all revenues and costs directly attributable to EA.com, including charges for shared facilities, functions and services used by EA.com and provided by EA Core. Certain costs and expenses have been allocated based on management's estimates of the cost of services provided to EA.com by EA Core. 25 Information about our operations by segment for fiscal 2002 and 2001 is presented below (in thousands):
- ---------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2002 ------------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,647,502 $ 77,173 $ - $ 1,724,675 Group sales 4,016 - (4,016) /(a)/ - ------------------------------------------------------------------------- Total net revenues 1,651,518 77,173 (4,016) 1,724,675 ------------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 794,738 12,873 - 807,611 Group cost of goods sold - 4,016 (4,016) /(a)/ - ------------------------------------------------------------------------- Total cost of goods sold 794,738 16,889 (4,016) 807,611 ------------------------------------------------------------------------- Gross profit 856,780 60,284 - 917,064 Operating expenses: Marketing and sales 202,749 20,496 17,864 /(c)/ 241,109 General and administrative 96,919 10,140 - 107,059 Research and development 257,762 59,892 70,082 /(b)/ 387,736 Network development and support - 59,483 (59,483) /(b)/ - Customer relationship management - 10,599 (10,599) /(b)/ - Carriage fee - 17,864 (17,864) /(c)/ - Amortization of intangibles 12,888 12,530 - 25,418 Restructuring and asset impairment charges - 20,303 - 20,303 ------------------------------------------------------------------------- Total operating expenses 570,318 211,307 - 781,625 ------------------------------------------------------------------------- Operating income (loss) 286,462 (151,023) - 135,439 Interest and other income (expense), net 13,472 (624) - 12,848 ------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 299,934 (151,647) - 148,287 Provision for income taxes 45,969 - - 45,969 ------------------------------------------------------------------------- Income (loss) before minority interest 253,965 (151,647) - 102,318 Minority interest in consolidated joint venture (809) - - (809) ------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 253,156 $ (151,647) $ - $ 101,509 ------------------------------------------------------------------------- Allocation of retained interest (in thousands):
- ---------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2002 ------------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 253,156 $ (151,647) $ - $ 101,509 Net loss related to retained interest in EA.com (128,900) 128,900 - - - ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 124,256 $ (22,747) $ - $ 101,509 ============================================================================================================================
26
- ------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2001 ---------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ------------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,280,172 $ 42,101 $ - $ 1,322,273 Group sales 2,658 - (2,658) (a) - ---------------------------------------------------------------------- Total net revenues 1,282,830 42,101 (2,658) 1,322,273 ---------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 640,239 12,003 - 652,242 Group cost of goods sold - 2,658 (2,658) (a) - ---------------------------------------------------------------------- Total cost of goods sold 640,239 14,661 (2,658) 652,242 ---------------------------------------------------------------------- Gross profit 642,591 27,440 - 670,031 Operating expenses: Marketing and sales 163,928 12,475 8,933 (c) 185,336 General and administrative 93,885 10,156 - 104,041 Research and development 248,534 77,243 63,151 (b) 388,928 Network development and support - 51,794 (51,794) (b) - Customer relationship management - 11,357 (11,357) (b) - Carriage fee - 8,933 (8,933) (c) - Amortization of intangibles 12,829 6,494 - 19,323 Charge for acquired in-process technology - 2,719 - 2,719 ---------------------------------------------------------------------- Total operating expenses 519,176 181,171 - 700,347 ---------------------------------------------------------------------- Operating income (loss) 123,415 (153,731) - (30,316) Interest and other income, net 16,659 227 - 16,886 ---------------------------------------------------------------------- Income (loss) before benefit from income taxes and minority interest 140,074 (153,504) - (13,430) Benefit from income taxes (4,163) - - (4,163) ---------------------------------------------------------------------- Income (loss) before minority interest 144,237 (153,504) - (9,267) Minority interest in consolidated joint venture (1,815) - - (1,815) ---------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 142,422 $ (153,504) $ - $ (11,082) ---------------------------------------------------------------------- Allocation of retained interest (in thousands): - ------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2001 ---------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ------------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in $ 142,422 $ (153,504) $ - $ (11,082) EA.com Net loss related to retained interest in EA.com (130,478) 130,478 - - - ------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 11,944 $ (23,026) $ - $ (11,082) =========================================================================================================================
(a) Represents elimination of intercompany sales of EA Core packaged goods products to EA.com, and represents elimination of royalties paid to EA Core by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. (c) Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. 27 The following table shows our pro forma results reconciled to the Generally Accepted Accounting Principles ("GAAP") Consolidated Statements of Operations. Our pro forma results do not include unusual events or transactions, such as restructuring and asset impairment costs and charge for acquired in-process technology, and also excludes amortization of intangibles and non-cash stock compensation charges. In addition, income taxes are allocated to EA Core and EA.com at the consolidated effective tax rate (31%) on a pro rata basis. We believe the disclosure of the pro forma net income (loss) and operating profit (loss), which excludes the items noted in the table below, helps investors more meaningfully evaluate the results of our ongoing operations. However, we urge investors to carefully review the GAAP financial information included as part of this Annual Report on Form 10-K and compare GAAP financial information with the pro forma financial results disclosed in this Annual Report on Form 10-K. (in thousands): - -------------------------------------------------------------------------------- Reconciliation of GAAP to Pro Forma net income (loss)
Fiscal Year Ended ------------------------------------------------------------------------------------------ March 31, 2002 March 31, 2001 -------------------------------------------- ------------------------------------------ EA Core Electronic EA Core Electronic (excl. EA.com) EA.com Arts (excl. EA.com) EA.com Arts ------------------------------------------------------------------------------------------ Net income (loss) - GAAP $ 124,256 $ (22,747) $ 101,509 $ 11,944 $ (23,026) $ (11,082) Net loss related to retained interest in EA.com (note 1) 128,900 (128,900) - 130,478 (130,478) - Pro forma allocation of income taxes (note 2) (47,011) 47,011 - (47,586) 47,586 - -------------------------------------------- ------------------------------------------ Pro forma net income (loss) 206,145 (104,636) 101,509 94,836 (105,918) (11,082) Amortization of intangibles 12,888 12,530 25,418 12,829 6,494 19,323 Restructuring and asset impairment charges - 20,303 20,303 - - - Charge for acquired in-process technology - - - - 2,719 2,719 Non-cash stock compensation for non-employees (note 3) 2,677 422 3,099 2,479 228 2,707 Income tax effect on the above items (4,825) (10,309) (15,134) (4,745) (2,927) (7,672) -------------------------------------------- ------------------------------------------ Pro forma net income (loss) excluding the items above $ 216,885 $ (81,690) $ 135,195 $ 105,399 $ (99,404) $ 5,995 ============================================ ==========================================
- -------------------------------------------------------------------------------- 1) EA Core maintains approximately 85% retained interest in EA.com and is reflected in the Net income - GAAP for EA Core. The pro forma statements exclude the retained interest allocation. 2) The provision for income taxes was allocated between EA Core and EA.com at the worldwide effective tax rate (31%) based on each segment's pro rata share of income or loss. The sum of tax provision for EA Core and EA.com is the same as consolidated tax provision. 3) Total non-cash stock compensation charges are included in Research and Development in GAAP financials, and excluded in the pro forma. 28 Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income (Loss) for both EA Core and EA.com Segments Cost of Goods Sold. Cost of goods sold for our packaged goods business consists of actual product costs, royalties expense for celebrities, professional sports and other organizations and independent software developers, manufacturing royalties, expense for defective products and operations expense. Cost of goods sold for our subscription business consists primarily of data center and bandwidth costs associated with hosting our websites, credit card fees and royalties for use of EA and third party properties. Cost of goods sold for our advertising business consists primarily of ad serving costs. Marketing and Sales. Marketing and sales expenses consist of personnel-related costs, advertising and marketing and promotional expenses. In addition, marketing and sales includes the amortization of the AOL carriage fee ("Carriage Fee"), which began with the launch of EA.com in October 2000. The Carriage Fee is being amortized straight-line over the term of the AOL agreement. General and Administrative. General and administrative expenses consist of personnel and related expenses of executive and administrative staff, fees for professional services such as legal and accounting and allowances for bad debts. Research and Development. Research and development expenses consist of personnel-related costs, consulting and equipment depreciation, customer relationship management expenses associated with Electronic Arts' product and online games and write-offs of prepaid royalties. EA.com has research and development expenses incurred by Electronic Arts' studios consisting of direct development costs and related overhead costs (facilities, network and development management and supervision) in connection with the development and production of EA.com online games. Research and development expenses also include product development expenses incurred directly by EA.com. Network Development and Support. Network development and support costs consist of expenses associated with development of web content, depreciation on server equipment to support online games, network infrastructure direct expenses, software licenses and maintenance, and network and management overhead. Cost of Goods Sold - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $807,611,000 46.8% $652,242,000 49.3% 23.8% - -------------------------------------------------------------------------------- Cost of goods sold as a percentage of revenues decreased in fiscal 2002 compared to fiscal 2001 due to: ... Revenues from the Xbox and Nintendo GameCube with lower cost of goods sold as a percentage of revenue. ... Higher mix of PlayStation 2 revenues in the current fiscal year. ... Higher advertising revenues with low cost of goods sold as a percentage of revenue. ... Lower revenue on N64 products with high cost of goods sold as a percentage of revenue. ... Higher AL margins due to a higher number of co-publishing titles with lower cost of goods sold as a percentage of revenue. ... Higher average margins on PC products. These items were partially offset by: ... Higher cost of goods sold as a percentage of revenues on the PlayStation and PlayStation 2 products as compared to the prior year. ... Revenues from Nintendo Game Boy Advance and Game Boy Color with higher cost of goods sold as a percentage of revenue. ... Lower mix of high margin PC revenues in the current fiscal year. Marketing and Sales - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $241,109,000 14.0% $185,336,000 14.0% 30.1% - -------------------------------------------------------------------------------- As a percent of revenue, marketing and sales expense in fiscal 2002 was comparable to fiscal 2001 at 14%. Marketing and sales expenses for fiscal 2002 increased 30.1%, primarily attributed to: 29 ... Higher marketing and advertising in North America and Europe for programs to support Madden NFL 2002, James Bond 007 in...Agent Under Fire, SSX Tricky, Harry Potter and the Sorcerer's Stone, FIFA Soccer 2002 and NBA Live 2002. ... Higher EA.com marketing and sales expenses due to increased consumer promotions and advertising media placement costs to promote new game offerings, particularly Majestic and Motor City Online, and higher expenditures associated with selling advertising on both EA.com and Pogo's gamesites. ... The amortization of the AOL Carriage Fee, which began with the launch of EA.com in October 2000. General and Administrative - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $107,059,000 6.2% $104,041,000 7.9% 2.9% - -------------------------------------------------------------------------------- General and administrative expenses increased 2.9% for fiscal 2002, primarily attributed to: ... $1,000,000 contribution to charity organizations providing support for the September 11th tragedy. ... Increase in payroll and occupancy costs to support the increased growth in North America. ... Increase in bad debt expense of $1,820,000 due to higher product sales. Research and Development
- ----------------------------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - ----------------------------------------------------------------------------------------------------- Research and development $317,654,000 18.4% $325,777,000 24.6% (2.5%) Network development and support 59,483,000 3.5% 51,794,000 3.9% 14.8% Customer relationship management 10,599,000 0.6% 11,357,000 0.9% (6.7%) - ----------------------------------------------------------------------------------------------------- Total research and development $387,736,000 22.5% $388,928,000 29.4% (0.3%) - -----------------------------------------------------------------------------------------------------
Research and development expenses (excluding Network Development and Support and Customer Relationship Management). Research and development expenses (excluding Network Development and Support and Customer Relationship Management) decreased in absolute dollars by 2.5% for fiscal 2002, primarily attributed to: ... Headcount reductions in EA.com in October 2001 (see Charge for Restructuring and Impairment discussion below). ... Replacement of EA.com's free games channel with Pogo free games. ... Offset by increased payroll costs due to higher headcount in EA studios, net of co-development arrangements. ... Offset by increased spending on EA.com online projects in development, primarily The Sims Online and Earth & Beyond(TM). We expect research and development spending to increase in fiscal 2003 due to an increase in development spending for next generation console products including the PlayStation 2, Xbox and Nintendo GameCube, as well as extending our investment in the PC platform. Network Development and Support. Network development and support expenses increased in absolute dollars by 14.8% for fiscal 2002 primarily due to: ... Increased depreciation related to both hardware and internally developed software that began when the site went live in October 2000. ... Increased headcount and network-related costs associated with Pogo. ... Partially offset by reduced consultant costs related to project and site enhancements. The expense run rate has been reduced as a result of the restructuring. We do not expect expenses to increase in fiscal 2003. Customer Relationship Management. Customer relationship management expenses decreased in absolute dollars by 6.7% for fiscal 2002 primarily due to headcount reductions in EA.com that occurred in October 2001 as part of the restructuring plan (see Charge for Restructuring and Impairment discussion below). 30 Amortization of Intangibles - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $25,418,000 1.5% $19,323,000 1.5% 31.5% - -------------------------------------------------------------------------------- The amortization of intangibles results primarily from the acquisitions of Westwood, Kesmai, DreamWorks Interactive, ABC Software, Pogo and other acquisitions. Amortization of intangibles was $12,888,000 for EA Core and $12,530,000 for EA.com for fiscal 2002. Amortization of intangibles was $12,829,000 for EA Core and $6,494,000 for EA.com for fiscal 2001. The increase in fiscal year 2002 for EA.com, compared to the prior year, was due to the acquisition of Pogo in February 2001. With the implementation of new accounting pronouncements (see Impact of Recently Issued Accounting Standards on page 43) as of April 2002, we will continue to amortize finite-lived intangibles, but will no longer amortize goodwill and acquired workforce. Amortization of goodwill and acquired workforce totaled approximately $13,125,000 for fiscal 2002 and approximately $9,182,000 for fiscal 2001. Based on intangible assets as of March 31, 2002, we estimate that amortization of finite-lived intangibles will total approximately $8,700,000 for fiscal 2003. Following adoption of SFAS 142, we will continue to evaluate whether any event has occurred which might indicate that the carrying value of an intangible asset is not recoverable. In addition, SFAS 142 requires that goodwill be subject to at least an annual assessment for impairment by applying a fair value-based test. We are in the process of completing an evaluation for impairment of goodwill in accordance with SFAS 142. We believe the implementation of SFAS 142 will not have a material impact on our consolidated financial statements. Charge for Acquired In-Process Technology - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $ - N/A $2,719,000 0.2% (100.0%) - -------------------------------------------------------------------------------- In connection with the acquisition of Pogo in the fourth fiscal quarter of fiscal 2001, we allocated and expensed $2,719,000 of the $43,333,000 purchase price to acquired in-process technology. At the date of acquisition, this amount was expensed as a non-recurring charge as the in-process technology had not yet reached technological feasibility and had no alternative future uses. Pogo had various projects in progress at the time of the acquisition. As of the acquisition date, costs to complete Pogo projects acquired were expected to be approximately $1,200,000 in future periods. During fiscal 2002, all of these development projects were completed and launched on Pogo gamesites. In conjunction with the acquisition of Pogo, we accrued approximately $100,000 related to direct transaction and other related costs. This charge was made after we concluded that the in-process technology had not reached technological feasibility and had no alternative future use after taking into consideration the potential for usage of the software in different products and resale of the software. Charge for Restructuring and Impairment - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $20,303,000 1.2% $ - N/A N/M - -------------------------------------------------------------------------------- During fiscal 2002, we announced a restructuring plan for EA.com to reduce its workforce and consolidate facilities. These restructuring and resulting asset impairment charges were necessary in order to focus on key online priorities and reduce EA.com's operating cost structure. A pre-tax charge of $20,303,000 was recorded in fiscal 2002, consisting of $4,173,000 for workforce reductions, $3,312,000 for consolidation of facilities and other administrative charges and $12,818,000 for the write-off of non-current assets as a direct result of the restructuring. The pre-tax charge of $20,303,000 consisted of $6,836,000 in cash outlays and $13,467,000 in non-cash charges related to the write-offs of non-current assets and facilities. As of March 31, 2002, an aggregate of $4,016,000 in cash had been paid out under the restructuring plan. Of the remaining cash outlay of $2,820,000, $1,590,000 is expected to occur in fiscal 2003 while the remaining $1,230,000 related to future lease payments will occur is fiscal years 2004 and beyond. Adjustments to the restructuring reserves will be made in future periods, if necessary, based upon current events and circumstances. The restructuring plan resulted in the termination of approximately 270 personnel, or one third of EA.com's workforce, which affected all departments across the organization. The estimated costs for consolidation of facilities are comprised of contractual rental commitments under real estate leases for unutilized office space offset by estimated future sub-lease income. Included in these costs 31 are estimated costs to close offices or consolidate facilities in various locations and costs to write off a portion of the assets from these facilities. In addition, the restructuring efforts required an evaluation of asset impairment in accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", to adjust these depreciable assets and certain intangibles to their estimated fair value. Management evaluated the impact of consolidating or abandoning certain EA.com technologies and processes and reviewed the effect of changes to EA.com's subscription product offerings in relation to EA.com's asset base. Impairment charges on long-lived assets amounted to $12,818,000 and included $11,177,000 relating to consolidated or abandoned technologies for the EA.com infrastructure and $1,641,000 of goodwill and intangibles impairment charges relating to the EA.com's San Diego and Kesmai studios. There are no assurances that the impairment factors evaluated by management will not change in subsequent periods and accordingly, this could result in additional impairment charges in future periods. We will continue to evaluate the effectiveness of products, departments, technology and processes and look for ways to consolidate and streamline EA.com operations in an effort to further reduce operating expenses. Interest and Other Income, Net - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $12,848,000 0.7% $16,886,000 1.3% (23.9%) - -------------------------------------------------------------------------------- Interest and other income, net, decreased in absolute dollars by 23.9% primarily due to lower interest income as a result of lower interest rates in the current year and an increase in the cost of utilizing foreign exchange hedge contracts. Income Taxes - -------------------------------------------------------------------------------- Effective Effective 2002 tax rate 2001 tax rate % change - -------------------------------------------------------------------------------- $45,969,000 31.0% $(4,163,000) 31.0% N/M - -------------------------------------------------------------------------------- Our effective tax rate was 31.0% for fiscal 2002 and fiscal 2001. At March 31, 2002, we generated a federal income tax net operating loss. This loss will be carried forward to future tax years. At March 31, 2001, we also generated a federal income tax net operating loss. A substantial portion of this loss was utilized in a carryback claim with the remainder being carried forward. The net operating losses for both fiscal 2002 and fiscal 2001 resulted from losses from EA.com's operations as well as stock option deductions. A valuation allowance has not been established on these loss carryforwards or other net deferred tax assets as we believe it is more likely than not that the results of future operations will generate sufficient taxable income to realize them. Net Income (loss) - -------------------------------------------------------------------------------- % of net % of net 2002 revenues 2001 revenues % change - -------------------------------------------------------------------------------- $101,509,000 5.9% $(11,082,000) (0.8%) N/M - -------------------------------------------------------------------------------- In absolute dollars, reported net income (loss) increased in fiscal 2002 primarily related to higher net revenues, partially offset by higher expenses compared to the same period last year. The increase in expenses was primarily due to increases in marketing and advertising costs to support a higher number of franchise titles. In addition, higher expenses were due to the charge for restructuring and impairment in fiscal 2002. We believe the disclosure of pro forma net income (loss) and operating profit (loss), which does not include unusual events or transactions, such as restructuring and asset impairment costs and charge for acquired in-process technology, and also excludes amortization of intangibles and non-cash stock compensation charges, helps investors more meaningfully evaluate the results of our ongoing operations. However, we urge investors to carefully review the GAAP financial information included as part of this Annual Report on Form 10-K and compare GAAP financial information with the pro forma financial results disclosed in this Annual Report on Form 10-K. Pro forma net income, excluding the items noted above, was $135,195,000 for the fiscal year ended March 31, 2002 and $5,995,000 for the fiscal year ended March 31, 2001. The increase in pro forma net income for the fiscal year ended March 31, 2002 was due to higher revenues and gross profits as compared to the same periods last year. This was partially offset by an increase in marketing and sales expenses to support programs for key titles shipped in the current year. 32 With the implementation of new accounting pronouncements relating to goodwill and intangible assets (see Impact of Recently Issued Accounting Standards on page 43) as of April 2002, we will continue to amortize finite-lived intangibles, but will no longer amortize goodwill and acquired workforce. Amortization of goodwill and acquired workforce totaled approximately $13,125,000 for fiscal 2002 and approximately $9,182,000 for fiscal 2001. Based on intangible assets as of March 31, 2002, we estimate that amortization of finite-lived intangibles will total approximately $8,700,000 for fiscal 2003. Following adoption of SFAS 142, we will continue to evaluate whether any event has occurred which might indicate that the carrying value of an intangible asset is not recoverable. In addition, SFAS 142 requires that goodwill be subject to at least an annual assessment for impairment by applying a fair value-based test. We are in the process of completing an evaluation for impairment of goodwill in accordance with SFAS 142. We believe the implementation of SFAS 142 will not have a material impact on our consolidated financial statements. Comparison of Fiscal 2001 to 2000: Revenues Information about our net revenues for North America and foreign areas for fiscal 2001 and 2000 is summarized below (in thousands): Increase/ 2001 2000 (Decrease) % change ----------------------------------------------------- North America $ 831,924 $ 846,637 $ (14,713) (1.7 %) ----------------------------------------------------- Europe 386,728 486,816 (100,088) (20.6 %) Asia Pacific 51,039 53,187 (2,148) (4.0 %) Japan 52,582 33,371 19,211 57.6 % ----------------------------------------------------- International 490,349 573,374 (83,025) (14.5 %) ----------------------------------------------------- Consolidated Net Revenues $1,322,273 $1,420,011 $ (97,738) (6.9 %) ===================================================== North America Net Revenues The decrease in North America net revenues for fiscal 2001 compared to fiscal 2000 was primarily attributable to: ... Expected declines in sales of PlayStation and N64 titles due to the beginning of the transition to next generation consoles. PlayStation net revenues decreased 49% and N64 net revenues decreased 46% also due to fewer titles shipping in fiscal 2001 for both platforms. ... A 6% decrease in AL revenues primarily due to the acquisition of an affiliate, DreamWorks Interactive, by us in the fourth quarter of fiscal 2000. ... Offset partially by the launch of PlayStation 2 platform in North America which generated $171,034,000 in revenue for fiscal 2001 from titles such as Madden NFL 2001, SSX, NBA Live 2001 and NHL 2001. PlayStation 2 revenues in fiscal 2001 did not offset the decrease in PlayStation revenues due to a reduced number of hardware units reaching the market due to hardware component shortages, according to Sony. ... Offset by a 21% increase in PC revenues due to the shipment of key releases including Command & Conquer Red Alert(TM) 2 and The Sims: Livin' Large and continued strong catalog sales of The Sims in fiscal 2001. International Net Revenues The decrease in international net revenues for fiscal 2001 compared to fiscal 2000 was attributable to the following: ... Europe's net revenues decreased 21% primarily due to the console transition, lower AL sales due to product release slips and fewer hit titles released in fiscal 2001, lower PC sales with fewer titles shipping in fiscal 2001, the strong sales of Command & Conquer: Tiberian Sun(TM) for the PC in fiscal 2000, and weakness in the Euro currency. In addition, PlayStation revenues decreased 43% due to fewer titles shipping during the console transition period in fiscal 2001 with most franchise titles showing significant decreases from fiscal 2000 releases. PlayStation 2 revenues did not offset the decrease in PlayStation revenues due to fewer hardware units reaching the market and the weighting of titles specifically appropriate for the North American market rather than the European market. ... Asia Pacific's net revenues decreased 4%, mainly due to the decrease in PlayStation revenues as there were no significant new titles released in fiscal 2001. This was offset by sales of PlayStation 2 titles such as SSX and FIFA 2001. ... Offset by Japan's net revenues which increased 58% compared to fiscal 2000 primarily due to the shipment of PlayStation 2 titles such as FIFA Soccer World Championship, FIFA 2001 and SSX in fiscal 2001. 33 Information about our net revenues by product line for fiscal 2001 and 2000 is presented below (in thousands):
Increase/ 2001 2000 (Decrease) % change ------------------------------------------------------------------------ EA Studio: - ---------- PC $ 405,256 $ 395,522 $ 9,734 2.5 % PlayStation 309,988 586,821 (276,833) (47.2 %) PlayStation 2 258,988 - 258,988 N/A N64 67,044 120,415 (53,371) (44.3 %) Online Subscriptions 28,878 16,771 12,107 72.2 % Online Packaged Goods 3,198 2,255 943 41.8 % License, OEM and Other 20,468 22,894 (2,426) (10.6 %) Advertising 6,175 - 6,175 N/A ----------------------------------------------------------------------- 1,099,995 1,144,678 (44,683) (3.9 %) Affiliated Label: 222,278 275,333 (53,055) (19.3 %) - ----------------- ----------------------------------------------------------------------- Consolidated Net Revenues $ 1,322,273 $ 1,420,011 $ (97,738) (6.9 %) =======================================================================
Personal Computer Product Net Revenues The increase in sales of PC products for fiscal 2001 was primarily attributable to the continued strong sales of The Sims, which shipped in fiscal 2000. Key fiscal 2001 releases were Command & Conquer Red Alert 2 and The Sims: Livin' Large. We released 20 PC titles in fiscal 2001 compared to 31 titles in fiscal 2000. The Sims continued to be the number one PC title. PlayStation Product Net Revenues We released 17 PlayStation titles in fiscal 2001 compared to 30 in fiscal 2000. As expected, PlayStation sales decreased for fiscal 2001 compared to fiscal 2000 primarily attributable to the PlayStation 2 platform transition. With the exception of Madden NFL, all of our franchises experienced significant decreases from fiscal 2000 releases. PlayStation 2 Product Net Revenues We released 15 titles worldwide in fiscal 2001 for the PlayStation 2. Key releases for fiscal 2001 included Madden NFL 2001, SSX, FIFA 2001, NBA Live 2001 and NHL 2001. Revenue was lower than expected due to the shortage of PlayStation 2 hardware in fiscal 2001 resulting from component shortages which limited the number of units that could be manufactured, according to Sony. Affiliated Label Product Net Revenues The decrease in Affiliated Label net revenues for fiscal 2001 compared to fiscal 2000 was primarily due to the strong sales of Final Fantasy(R) VIII in fiscal 2000, our acquisition of DreamWorks Interactive, formerly an AL, in the fourth quarter of fiscal 2000, fewer hit AL product releases and product release slips in Europe. N64 Product Net Revenues We released three N64 titles in fiscal 2001 compared to eight titles during fiscal 2000. The expected decrease in N64 revenues for fiscal 2001, compared to fiscal 2000, was primarily due to fewer releases. The decrease was also due to the weaker market for N64 products in fiscal 2001. The key release for fiscal 2001 was The World Is Not Enough. Online Net Revenues The increase in online revenues for fiscal 2001 as compared to fiscal 2000 was attributable to the following: . The average number of paying customers for Ultima Online increased to approximately 200,000 for fiscal 2001 as compared to over 140,000 for fiscal 2000. This increase was due to continued strong sales of Ultima Online, the addition of new events and parties within the Ultima worlds and the release of Ultima Online Renaissance in April 2000. . We generated over $5,100,000 in subscription revenues for Kesmai and Worldplay online games for fiscal 2001. These products were not part of EA.com in fiscal 2000 due to the Kesmai acquisition in the fourth quarter of fiscal 2000. License, OEM and Other Revenues The decrease in license, OEM and other revenues for fiscal 2001 as compared to fiscal 2000 was primarily a result of lower license revenue of certain titles on the Game Boy platform. 34 Advertising Following the launch of EA.com on the worldwide web and the AOL Games Channel in October 2000, we began selling advertising on EA.com and AOL properties, including the Slingo game. In addition, we generated advertising revenue from Pogo's websites as a result of the purchase of Pogo in February 2001. Operations by Segment Information about our operations by segment for fiscal 2001 and 2000 is presented below (in thousands):
- ---------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2001 ------------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,280,172 $ 42,101 $ - $ 1,322,273 Group sales 2,658 - (2,658) /(a)/ - ------------------------------------------------------------------------- Total net revenues 1,282,830 42,101 (2,658) 1,322,273 ------------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 640,239 12,003 - 652,242 Group cost of goods sold - 2,658 (2,658) /(a)/ - ------------------------------------------------------------------------- Total cost of goods sold 640,239 14,661 (2,658) 652,242 ------------------------------------------------------------------------- Gross profit 642,591 27,440 - 670,031 Operating expenses: Marketing and sales 163,928 12,475 8,933 /(c)/ 185,336 General and administrative 93,885 10,156 - 104,041 Research and development 248,534 77,243 63,151 /(b)/ 388,928 Network development and support - 51,794 (51,794) /(b)/ - Customer relationship management - 11,357 (11,357) /(b)/ - Carriage fee - 8,933 (8,933) /(c)/ - Amortization of intangibles 12,829 6,494 - 19,323 Charge for acquired in-process technology - 2,719 - 2,719 ------------------------------------------------------------------------- Total operating expenses 519,176 181,171 - 700,347 ------------------------------------------------------------------------- Operating income (loss) 123,415 (153,731) - (30,316) Interest and other income, net 16,659 227 - 16,886 ------------------------------------------------------------------------- Income (loss) before benefit from income taxes and minority interest 140,074 (153,504) - (13,430) Benefit from income taxes (4,163) - - (4,163) ------------------------------------------------------------------------- Income (loss) before minority interest 144,237 (153,504) - (9,267) Minority interest in consolidated joint venture (1,815) - - (1,815) ------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 142,422 $ (153,504) $ - $ (11,082) -------------------------------------------------------------------------
Allocation of retained interest (in thousands):
- ---------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2001 ------------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in $ 142,422 $ (153,504) $ - $ (11,082) EA.com Net loss related to retained interest in EA.com (130,478) 130,478 - - - ---------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 11,944 $ (23,026) $ - $ (11,082) ============================================================================================================================
35
- ---------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2000 ------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ---------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,399,093 $ 20,918 $ - $ 1,420,011 Group sales 2,014 - (2,014)/(a)/ ------------------------------------------------------------------- Total net revenues 1,401,107 20,918 (2,014) 1,420,011 ------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 700,024 4,678 - 704,702 Group cost of goods sold - 2,014 (2,014)/(a)/ - ------------------------------------------------------------------- Total cost of goods sold 700,024 6,692 (2,014) 704,702 ------------------------------------------------------------------- Gross profit 701,083 14,226 - 715,309 Operating expenses: Marketing and sales 185,714 2,897 - 188,611 General and administrative 87,513 4,905 - 92,418 Research and development 205,933 34,716 21,317 /(b)/ 261,966 Network development and support - 17,993 (17,993)/(b)/ - Customer relationship management - 3,324 (3,324)/(b)/ - Amortization of intangibles 10,866 1,123 - 11,989 Charge for acquired in-process technology 2,670 3,869 - 6,539 ------------------------------------------------------------------- Total operating expenses 492,696 68,827 - 561,523 ------------------------------------------------------------------- Operating income (loss) 208,387 (54,601) - 153,786 Interest and other income, net 16,017 11 - 16,028 ------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 224,404 (54,590) - 169,814 Provision for income taxes 52,642 - - 52,642 ------------------------------------------------------------------- Income (loss) before minority interest 171,762 (54,590) - 117,172 Minority interest in consolidated joint venture (421) - - (421) - ---------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 171,341 $ (54,590) $ - $ 116,751 ======================================================================================================================
(a) Represents elimination of intercompany sales of EA Core packaged goods products to EA.com, and represents elimination of royalties paid to EA Core by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. (c) Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. 36 The following table shows our pro forma results reconciled to the GAAP Consolidated Statements of Operations. Our pro forma results do not include unusual events or transactions, such as restructuring and asset impairment costs and charge for acquired in-process technology, and also excludes amortization of intangibles and non-cash stock compensation charges. In addition, income taxes are allocated to EA Core and EA.com at the consolidated effective tax rate (31%) on a pro rata basis. We believe the disclosure of the pro forma net income (loss) and operating profit (loss), which excludes the items noted in the table below, helps investors more meaningfully evaluate the results of our ongoing operations. However, we urge investors to carefully review the GAAP financial information included as part of this Annual Report on Form 10-K and compare GAAP financial information with the pro forma financial results disclosed in this Annual Report on Form 10-K. (in thousands):
- ------------------------------------------------------------------------------------------------------------------------- Reconciliation of GAAP to Pro Forma net income (loss) Fiscal Year Ended ---------------------------------------------------------------------------------------- March 31, 2001 March 31, 2000 ------------------------------------------- ------------------------------------------ EA Core Electronic EA Core Electronic (excl. EA.com) EA.com Arts (excl. EA.com) EA.com Arts ---------------------------------------------------------------------------------------- Net income (loss) - GAAP $ 11,944 $ (23,026) $ (11,082) $ 116,751 $ - $ 116,751 Net loss related to retained interest in EA.com (note 1) 130,478 (130,478) - 54,590 (54,590) - Pro forma allocation of income taxes (note 2) (47,586) 47,586 - (16,923) 16,923 - ------------------------------------------- ------------------------------------------ Pro forma net income (loss) 94,836 (105,918) (11,082) 154,418 (37,667) 116,751 Amortization of intangibles 12,829 6,494 19,323 10,866 1,123 11,989 Charge for acquired in-process technology - 2,719 2,719 2,670 3,869 6,539 Non-cash stock compensation for non-employees (note 3) 2,479 228 2,707 736 - 736 Income tax effect on the above items (4,745) (2,927) (7,672) (4,424) (1,548) (5,972) ------------------------------------------- ------------------------------------------ Pro forma net income (loss) excluding the items above $ 105,399 $ (99,404) $ 5,995 $ 164,266 $ (34,223) $ 130,043 =========================================== ==========================================
1) EA Core maintains approximately 85% retained interest in EA.com and is reflected in the Net income - GAAP for EA Core. The pro forma statements exclude the retained interest allocation. 2) The provision for income taxes was allocated between EA Core and EA.com at the worldwide effective tax rate (31%) based on each segment's pro rata share of income or loss. The sum of tax provision for EA Core and EA.com is the same as consolidated tax provision. 3) Total non-cash stock compensation charges are included in Research and Development in GAAP financials, and excluded in the pro forma. 37 Costs and Expenses, Interest and Other Income, Net, Income Taxes and Net Income (Loss) for both EA Core and EA.com Segments Cost of Goods Sold - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $652,242,000 49.3% $704,702,000 49.6% (7.4%) - -------------------------------------------------------------------------------- Cost of goods sold as a percentage of revenues decreased in fiscal 2001 due to: ... An increase in sales of higher margin PC titles as a percentage of revenues. Fiscal 2001 included sales on titles such as The Sims, Command & Conquer Red Alert 2 and The Sims: Livin' Large. ... The introduction of higher margin PlayStation 2 products in fiscal 2001. ... A decrease in sales of lower margin AL and N64 titles. ... An increase in higher margin Online and Advertising revenue. ... Offset by a decrease in sales of PlayStation titles combined with the decrease in average margins on PlayStation products due to a decrease in the average sales price on front line and catalog products. Marketing and Sales - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $185,336,000 14.0% $188,611,000 13.3% (1.7%) - -------------------------------------------------------------------------------- Marketing and sales expenses for fiscal 2001 increased as a percentage of revenue, primarily attributed to: ... Higher EA.com marketing and sales expenses due to increased staff required to support the live game site and advertising campaigns run on the AOL service promoting the Games Channel. ... The amortization of the AOL Carriage Fee, which began with the launch of EA.com in October 2000. ... Offset by lower television and print advertising in North America and Europe due to fewer number of releases compared to fiscal 2000. General and Administrative - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $104,041,000 7.9% $92,418,000 6.5% 12.6% - -------------------------------------------------------------------------------- General and administrative expenses increased 12.6% for fiscal 2001, primarily attributed to: ... The expansion of the EA.com staff and additional administrative-related costs required to support the growth of the EA.com business. ... Increase in bad debts due to a write off of a receivable as a result of the default of payment from a customer in Europe for approximately $1,000,000. ... Increase in depreciation expense for Europe due to the implementation of a new transaction processing system. Research and Development
- -------------------------------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------------------------------- Research and development $325,777,000 24.6% $240,649,000 16.9% 35.4% Network development and support 51,794,000 3.9% 17,993,000 1.3% 187.9% Customer relationship management 11,357,000 0.9% 3,324,000 0.2% 241.7% - -------------------------------------------------------------------------------------------------------- Total research and development $388,928,000 29.4% $261,966,000 18.4% 48.5% - --------------------------------------------------------------------------------------------------------
38 Research and Development (excluding Network Development and Support and Customer Relationship Management). Research and development expenses (excluding Network Development and Support and Customer Relationship Management) increased in absolute dollars by 35.4% for fiscal 2001, primarily attributed to: ... Increase in research and development expenses by EA.com (including expenses incurred by EA Core on behalf of EA.com) due to an increase in the number of online projects in development and increased development staff to support these products. ... An increase in development spending for next generation console products including development for the PlayStation 2 console, Xbox and Nintendo GameCube. ... The increase is also due to research and development expenses related to the acquisition of DreamWorks Interactive, a software development company, in the fourth quarter of fiscal 2000. We released a total of 55 new packaged goods products in fiscal 2001 compared to 69 new products in fiscal 2000. In addition, the EA.com website launched in October 2000, and had over 80 live games. Network Development and Support. The increase in network development and support expenses was primarily due to increased spending for the network infrastructure, and the Games Channel on the AOL service and the amortization of capitalized costs as required under Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", associated with the pre-launch network infrastructure build. Customer Relationship Management. Customer relationship management increased due to increased headcount-related costs associated with the formation of our customer relationship management organization for the live game site. Amortization of Intangibles - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $19,323,000 1.5% $11,989,000 0.8% 61.2% - -------------------------------------------------------------------------------- The amortization of intangibles resulted primarily from the acquisitions of Westwood, Kesmai, DreamWorks Interactive, ABC Software, Pogo and other acquisitions. Amortization of intangibles was $12,829,000 for EA Core and $6,494,000 for EA.com for fiscal 2001. Amortization of intangibles was $10,866,000 for EA Core and $1,123,000 for EA.com for fiscal 2000. Charge for Acquired In-Process Technology - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $2,719,000 0.2% $6,539,000 0.5% (58.4%) - -------------------------------------------------------------------------------- Fiscal 2001: In connection with the acquisition of Pogo in the fourth quarter of fiscal 2001, we allocated and expensed $2,719,000 of the $43,333,000 purchase price to acquired in-process technology. At the date of acquisition, this amount was expensed as a non-recurring charge as the in-process technology had not yet reached technological feasibility and had no alternative future uses. Pogo had various projects in progress at the time of the acquisition. As of the acquisition date, costs to complete Pogo projects acquired were expected to be approximately $1,200,000 in future periods. During fiscal 2002, all of these development projects were completed and launched on Pogo gamesites. In conjunction with the acquisition of Pogo, we accrued approximately $100,000 related to direct transaction and other related costs. Fiscal 2000: ... In connection with the acquisition of Kesmai by EA.com in the fourth quarter of fiscal 2000, we allocated and expensed $3,869,000 of the purchase price to acquired in-process technology. ... In connection with the acquisitions of two development companies by EA Core, made in the second and fourth quarters of fiscal 2000, we allocated and expensed $2,670,000 of the purchase price to acquired in-process technology. These charges were made after we concluded that the in-process technology had not reached technological feasibility and had no alternative future use after taking into consideration the potential for usage of the software in different products and resale of the software. 39 Interest and Other Income, Net - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $16,886,000 1.3% $16,028,000 1.1% 5.4% - -------------------------------------------------------------------------------- Interest and other income, net, increased in absolute dollars primarily due to higher interest income as a result of higher average cash balances and investing in higher yielding taxable securities in fiscal 2001. Those gains were partially offset by realized gains on sales of marketable securities in fiscal 2000. Income Taxes - -------------------------------------------------------------------------------- Effective Effective 2001 tax rate 2000 tax rate % change - -------------------------------------------------------------------------------- $(4,163,000) 31.0% $52,642,000 31.0% (107.9%) - -------------------------------------------------------------------------------- Our effective tax rate was 31.0% for fiscal 2001 and fiscal 2000. At March 31, 2001, we generated a federal income tax net operating loss. A substantial portion of this loss was utilized in a carryback claim with the remainder being carried forward. A valuation allowance was not established on this loss carryforward or other net deferred tax assets as we believed it was more likely than not that the results of future operations would generate sufficient taxable income to realize them. Net Income (loss) - -------------------------------------------------------------------------------- % of net % of net 2001 revenues 2000 revenues % change - -------------------------------------------------------------------------------- $(11,082,000) (0.8%) $116,751,000 8.2% (109.5%) - -------------------------------------------------------------------------------- In absolute dollars, reported net income (loss) decreased in fiscal 2001 primarily related to lower revenues as well as higher costs and expenses compared to fiscal 2000. The decrease in revenues was primarily due to the beginning of the transition period to next generation console systems. The increase in expenses was primarily due to increases in development of next generation console products in the Core business and the investment in EA.com, including expenses to build network and online game products and to launch our game sites in October 2000. Excluding goodwill, non-cash compensation and one-time charges in the amount of $17,077,000, net of taxes, for fiscal 2001, net income would have been $5,995,000. Excluding goodwill, non-cash compensation and one-time charges in the amount of $13,292,000, net of taxes, for fiscal 2000, net income would have been $130,043,000. 40 LIQUIDITY AND CAPITAL RESOURCES - -------------------------------------------------------------------------------- EA Core and EA.com As of March 31, 2002, our working capital was $699,561,000 compared to $478,701,000 at March 31, 2001. Cash, cash equivalents and short-term investments increased by $330,444,000 in fiscal 2002. We generated $284,971,000 of cash from operations, $98,840,000 of cash through the sale of equity securities under our stock plans, offset by $51,518,000 of cash used in capital expenditures during fiscal 2002. Reserves for bad debts and sales returns increased from $89,833,000 at March 31, 2001 to $115,870,000 at March 31, 2002. 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. Our principal source of liquidity is $796,936,000 in cash, cash equivalents and short-term investments and $6,869,000 in marketable securities. We expect that for the foreseeable future, our operating expenses will constitute a significant use of our cash balances. 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 on both a short-term and long-term basis. However, our ability to maintain sufficient liquidity could be affected by various risks and uncertainties, including but not limited to, those related to customer demand and acceptance of titles on new platforms and new title versions on existing platforms, our ability to collect our accounts receivable as they become due, successfully achieving our product release schedules and attaining our forecasted sales objectives, the impact of competition, the economic conditions in the domestic and international markets, seasonality in operating results, risks of product returns and the other risks listed in the "Risk Factors" section. EA.com Included in the amounts above is the following for the EA.com business: . With the exception of the proceeds from the sale of stock and warrant to AOL in fiscal 2000 in the amount of $20,000,000, to date, EA.com has been funded solely by Electronic Arts. This funding has been accounted for as capital contributions from Electronic Arts. Excess cash generated from operations is transferred to Electronic Arts, and has been accounted for as a return of capital. We anticipate these funding procedures will continue in the near-term. However, Electronic Arts may, at its discretion, provide funds to EA.com under a debt arrangement, instead of treating such funding as a capital contribution. . During fiscal 2002, EA.com used $99,696,000 of cash in operations (including payments to AOL of approximately $11,250,000), $13,112,000 in capital expenditures for computer equipment, network infrastructure, internal use software and related third party software, offset by $114,837,000 provided through the capital contributions from Electronic Arts. As a result of the net operating loss generated, we realized a tax benefit of approximately $47,011,000. . During fiscal 2001, EA.com used $132,210,000 of cash in operations (including payments to AOL of approximately $11,250,000), $68,887,000 in capital expenditures for computer equipment, network infrastructure, internal use software and related third party software, $43,333,000 for the acquisition of Pogo, excluding cash received of $762,000, offset by $245,141,000 provided through the capital contributions from Electronic Arts. As a result of the net operating loss generated, we realized a tax benefit of approximately $47,586,000. Under the AOL agreement entered into in November 1999, EA.com is required to pay $81,000,000 to AOL over the life of the five-year agreement. Of this amount, $36,000,000 was paid upon signing the agreement with the remainder due in four equal annual installments beginning with the first anniversary of the initial payments. EA.com paid AOL $11,250,000 in both fiscal 2001 and 2002. Future liquidity needs of EA.com will be met by Electronic Arts as Electronic Arts intends to continue to fund the cash requirements of EA.com for the foreseeable future. 41 Other Commitments Advertising Commitments We made a commitment to spend $15,000,000 in offline media advertisements promoting our online games, including those on the AOL service, prior to March 31, 2005. As of March 31, 2002, we have spent approximately $3,500,000 against this commitment. On February 7, 2000, we acquired Kesmai from News America Corporation ("News Corp") in exchange for $22,500,000 in cash and approximately 206,000 shares of our existing common stock valued at $8,650,000. We agreed to spend $12,500,000 through the period ended June 1, 2002 in advertising with News Corp or any of its affiliates. In addition, if certain conditions are met, including that a qualified public offering of Class B common stock does not occur within twenty-four months of News Corp's purchase of such shares and all of the Class B outstanding shares have been converted to Class A common stock, then (1) News Corp has the right to (i) exchange Class B common stock for approximately 206,000 shares of Class A common stock, and (ii) receive cash from Electronic Arts in the amount of $9,650,000, and (2) we will agree to spend an additional $11,675,000 in advertising with News Corp and its affiliates. Lease Commitments We lease certain of our current facilities and certain equipment under non-cancelable capital and operating lease agreements. We are required to pay property taxes, insurance and normal maintenance costs for certain of our facilities and will be required to pay any increases over the base year of these expenses on the remainder of our facilities. In February of 1995, we entered into a build-to-suit lease with a financial institution on our headquarter's facility in Redwood City, California, which was extended in July of 2001 and runs through July of 2006. We accounted for this arrangement as an operating lease in accordance with Statement of Financial Accounting Standards No. 13 ("SFAS 13"), "Accounting for Leases", as amended. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. We have an option to purchase the property (land and facilities) for $145,000,000 or, at the end of the lease, to arrange for (1) an additional extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000 if the sales price is less than this amount, subject to certain provisions of the lease. In December 2000, we entered into a second build-to-suit lease with a financial institution for a five year term from December 2000 to expand our headquarter's facilities and develop adjacent property adding approximately 310,000 square feet to our campus. We expect to complete construction in June of 2002. We accounted for this arrangement as an operating lease in accordance with SFAS 13, as amended. The facilities will provide space for marketing, sales and research and development. We have an option to purchase the property for $127,000,000 or, at the end of the lease, to arrange for (1) an extension of the lease or (2) sale of the property to a third party with us retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118,800,000 if the sales price is less than this amount, subject to certain provisions of the lease. Lease rates are based upon the Commercial Paper Rate. The two lease agreements described above require us to maintain certain financial covenants, all of which we were in compliance with as of March 31, 2002. Letters of Credit In connection with our purchases of N64 cartridges and Nintendo GameCube optical disks for distribution in North America, Nintendo requires us to provide irrevocable letters of credit prior to Nintendo's acceptance of purchase orders from us for purchases of these cartridges and optical disks. For purchases of N64 cartridges and Nintendo GameCube optical disks for distribution in Japan and Europe, Nintendo requires us to make cash deposits. Development, Celebrity, League and Content Licenses: Payments and Commitments The products published by EA Studios are designed and created by our in-house designers and artists and by independent software developers ("independent artists"). We typically pay the independent artists royalties based on the sales of the specific products, as defined in the related independent artist agreements. Advance payments on these royalties are paid to independent artists upon meeting deliverables as detailed in the contractual agreement. In addition, certain celebrity, league and content license contracts contain minimum guarantee payments and marketing commitments that are not dependent on any deliverables. Celebrities and organizations with whom we have contracts include: FIFA, NASCAR, John Madden, National Basketball Association, PGA TOUR, Tiger Woods, National Hockey League, Formula One, Warner Bros. (Harry Potter), MGM/Danjaq (James Bond) and National Football League. These minimum guarantee payments and marketing commitments are included in the table below. 42 Summary of minimum contractual obligations and commercial commitments as of March 31, 2002 (in thousands):
- --------------------------------------------------------------------------------------------------------------------------------- Commercial Contractual Obligations Commitments --------------------------------------------------------------- -------------------------- Bank and Fiscal Year Ended Minimum Other Letters of Ended March 31, Leases Advertising Guarantees AOL Marketing Guarantees Credit Total ------------------------------------------------------------------------------------------------------------ 2003 $18,288 $14,000 $35,663 $11,250 $19,541 $1,050 $1,122 $100,914 2004 15,011 3,500 22,812 11,250 16,554 171 - 69,298 2005 11,354 4,500 15,137 - 11,159 171 - 42,321 2006 10,810 - 16,483 - 4,572 171 - 32,036 2007 9,122 - 3,145 - 3,571 170 - 16,008 Thereafter 11,609 - 2,260 - 3,571 170 - 17,610 - --------------------------------------------------------------------------------------------------------------------------------- $76,194 $22,000 $95,500 $22,500 $58,968 $1,903 $1,122 $278,187 - ---------------------------------------------------------------------------------------------------------------------------------
Transactions with Related Parties Square EA In May 1998, we completed the formation of a new joint venture with Square Co., Ltd. ("Square"), a leading developer and publisher of entertainment software in Japan. In North America, the companies formed Square Electronic Arts, LLC ("Square EA"), which has exclusive publishing rights in North America for future interactive entertainment titles created by Square. Additionally, we have the exclusive right to distribute in North America products published by this joint venture. Either party may terminate the existence of Square EA and the distribution agreement effective March 31, 2003. We own a 30% minority interest in this joint venture while Square owns 70%. This joint venture is accounted for under the equity method. In March 2002, we announced a publishing and distribution partnership with Square for Final Fantasy(R) X in Asia Pacific. The deal grants us the rights to distribute Final Fantasy X International for the PlayStation 2 computer entertainment system in Taiwan, Hong Kong, Singapore, Thailand, Malaysia and Korea. We generated $80,847,000 in net revenues from sales of Square EA products in fiscal 2002, $106,586,000 in net revenues from sales of Square EA products in fiscal 2001 and $83,657,000 in net revenues from sales of Square EA products in fiscal 2000. Impact of Recently Issued Accounting Standards In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142, "Goodwill and Other Intangible Assets", which supersedes Accounting Principles Board Opinion No. 17 ("APB 17"), "Intangible Assets". SFAS 142 addresses the accounting treatment for goodwill and other intangible assets acquired individually or with a group of other assets upon their acquisition, but not acquired in a business combination. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. With the adoption of SFAS 142, goodwill is no longer subject to amortization over its estimated useful life; rather, goodwill will be subject to at least an annual assessment for impairment by applying a fair-value-based test. Also, if the benefit of an intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented or exchanged, an acquired intangible asset should be separately recognized. The terms of SFAS 142 are effective as of the beginning of the first quarter of the fiscal year beginning after December 15, 2001. Certain provisions of SFAS 142 shall be applied to goodwill and other acquired intangible assets for which the acquisition date is after June 30, 2001. On April 1, 2002, we adopted SFAS 142. As a result of adopting this standard, we will continue to amortize finite-lived intangibles, but will no longer amortize certain other intangible assets, most notably goodwill and acquired workforce, which had a net book value at March 31, 2002 of $69,050,000. Amortization of goodwill and acquired workforce totaled approximately $13,125,000 for fiscal 2002, approximately $9,182,000 for fiscal 2001 and approximately $6,411,000 for fiscal 2000. Based on intangible assets as of March 31, 2002, we estimate that amortization of finite-lived intangibles will total approximately $8,700,000 for fiscal 2003. Following adoption of SFAS 142, we will continue to evaluate whether any event has occurred which might indicate that the carrying value of an intangible asset is not recoverable. In addition, SFAS 142 requires that goodwill be subject to at least an annual assessment for impairment by applying a fair value-based test. We are in the process of completing an evaluation for impairment of goodwill in accordance with SFAS 142. We believe the implementation of SFAS 142 will not have a material impact on our consolidated financial statements. 43 In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for Asset Retirement Obligations". SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. SFAS 143 is effective for fiscal years beginning after June 15, 2002. We do not expect the adoption of SFAS 143 to have a material impact on our consolidated financial position or results of operations. In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. SFAS 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. We are in the process of determining the impact of this new accounting standard. We believe the implementation of SFAS 144 will not have a material impact to our consolidated financial statements. 44 RISK FACTORS Electronic Arts' business is subject to many risks and uncertainties which may affect our future financial performance. Some of those important risks and uncertainties which may cause our operating results to vary or which may materially and adversely affect our operating results are as follows: Risk Factors Relating to Our Core Business New Video Game Platforms Create Additional Technical and Business Model Uncertainties Large portions of our revenues are derived from the sale of products for play on proprietary video game platforms such as the Sony PlayStation. The success of our products is significantly affected by acceptance of the new video game hardware systems and the life span of older hardware platforms and our ability to accurately predict which platforms will be most successful. Sometimes we will spend development and marketing resources on products designed for new video game systems that have not yet achieved large installed bases or will continue product development for older hardware platforms that may have shorter life cycles than we expected. Conversely, if we do not develop for a platform that achieves significant market acceptance, or discontinue development for a platform that has a longer life cycle than expected, our revenue growth may be adversely affected. For example, the Sega Dreamcast console launched in Japan in early 1999 and in the United States in September of 1999. We have developed no products for this platform. Had this platform achieved wide market acceptance, our revenue growth would have been adversely affected. Similarly, we are developing products for the Xbox and Nintendo GameCube. If these platforms do not achieve wide commercial acceptance, our revenue growth will be adversely impacted. Product Development Schedules Are Frequently Unreliable and Make Predicting Quarterly Results Difficult Product development schedules, particularly for new hardware platforms and high-end multimedia personal computers, or PCs, are difficult to predict because they involve creative processes, use of new development tools for new platforms and the learning process, research and experimentation associated with development for new technologies. For example, EMPEROR: Battle for Dune for the PC, which was expected to ship in fiscal 2001 was not released until the first quarter of fiscal 2002 due to development delays. Also, James Bond 007 in...Agent Under Fire for the PS2, which was expected to ship in fiscal 2001, released in October of fiscal 2002 due to development delays. Additionally, development risks for CD-ROM and DVD 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. Our revenues and earnings are dependent on our ability to meet our product release schedules, and our failure to meet those schedules could result in revenues and earnings which fall short of analysts' expectations for any individual quarter and the fiscal year. Our Business Is Both Seasonal and Cyclical Our business is highly seasonal with a significant percentage of our revenues occurring in the December quarter. In fiscal 2002, these seasonal trends were magnified by general industry factors, including the platform transition, the fall 2001 launches of the Xbox and Nintendo GameCube in North America and the economic slowdown in the United States and other territories. Our business is also cyclical; video game platforms have historically had a life cycle of four to six years, and decline as more advanced platforms are being introduced. As one group of platforms is reaching the end of its cycle and new platforms are emerging, buying patterns may change. Purchases of products for older platforms may slow at a faster rate than sales of new platforms. We have been going through a platform transition during the last 18 months and are now well into a new platform cycle. Sony shipped its PlayStation 2 console in Japan in March 2000, in North America in October 2000 and in Europe in November 2000. Nintendo launched the Nintendo GameCube console in Japan in September 2001, North America in November 2001 and in Europe in May 2002. Microsoft launched the Xbox console in North America in November 2001, in Japan in February 2002 and in Europe in March 2002. Sales of our products for the N64 and Sony PlayStation platforms have already been adversely affected, and we expect this trend to continue. The Impact of e-Commerce and Online Games on Our Business Is Not Known While we do not currently derive significant revenues from online sales of our packaged products, we believe that such form of distribution will become a more significant factor in our business in the future. E-Commerce is becoming an increasingly popular method for conducting business with consumers. How that form of distribution will affect the more traditional retail distribution, at 45 which we have historically had success, and over what time period, is uncertain. In addition, we expect the number and popularity of online games to increase and become a significant factor in the interactive games business generally. We do not know how that increase generally, or the emerging business of EA.com specifically, will affect the sales of packaged goods. Our Business, Our Products, and Our Distribution Are Subject to Increasing Regulation of Content, Consumer Privacy and Online Delivery in Key Territories Legislation is increasingly introduced which may affect the content of our products and their distribution. For example, privacy rules in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory while of course the Internet recognizes no geographical boundaries. Other countries such as Germany have adopted laws regulating content transmitted over the Internet that are stricter than current United States laws. In the United States, in response to recent events, the federal and several state governments are considering content restrictions on products such as those made by us as well as restrictions on distribution of such products. Any one or more of these factors could harm our business. Our Platform Licensors Are Our Chief Competitors and Frequently Control the Manufacturing of Our Video Game Products Our agreements with hardware licensors, which are also our chief competitors, typically give significant control to the licensor over the approval and manufacturing of our products. This fact could, in certain circumstances, leave us unable to get our products approved, manufactured and shipped to customers. In most events, control of the approval and manufacturing process by the platform licensors increases both our manufacturing lead times and costs as compared to those we can achieve independently. For example, in prior years, we experienced delays in obtaining approvals for and manufacturing of PlayStation products which caused delays in shipping those products. The potential for additional delay or refusal to approve or manufacture our products continues with our platform licensors. Such occurrences would harm our business and adversely affect our financial performance. Additionally, we have not negotiated a final publishing agreement with Nintendo for the Nintendo GameCube platform and although we are currently operating under an understanding with Nintendo, we cannot be assured that the final terms of the formal agreement will be favorable. Proliferation and Assertion of Patents Poses Serious Risks to our Business Many patents have been issued that may apply to widely used game technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of existing games. Several such patents have been asserted against us. Such claims can harm our business. We will incur substantial expenses in evaluating and defending against such claims, regardless of the merits of the claims. In the event that there is a determination that we have infringed a third party patent, we could incur significant monetary liability and be prevented from using the rights in the future. Risk Factors Relating to Our Online Business Because of EA.com's Limited Operating History, It Will Be Difficult To Evaluate its Business and Prospects EA.com's business is still in the developing stages, so evaluating its business and prospects will be more difficult than would be the case for a more mature business. We will continue to encounter the risks and difficulties faced in launching a new business, and we may not achieve our goals or may be compelled to change the manner in which we seek to develop the business. These uncertainties as to the future operations of EA.com will increase the difficulty we face in completing and pursuing the essential plans for the development of the business and will also make it more difficult for our stockholders and securities analysts to predict the operating results of this business. EA.com Has a History of Losses and Expects To Continue To Incur Losses and May Never Achieve Profitability EA.com has incurred substantial losses to date, including the current fiscal year. We expect EA.com to continue to incur losses as it builds its business. EA.com will be required to maintain the significant support, service and product enhancement demands of online users, and we cannot be certain that EA.com will produce sufficient revenues from its operations to support these costs. Even if profitability is achieved, EA.com may not be able to sustain it over a period of time. Our Agreements with America Online May Not Prove Successful to the Development of EA.com's Business We have a series of agreements with America Online ("AOL") for the offering of our games for online play. These agreements require that we make substantial guaranteed payments to AOL and that we commit our resources to the pursuit of the online game opportunity. We cannot be assured that the substantial costs associated with the AOL agreements will be justified by the revenues 46 generated from that relationship. In addition, restrictions included in the AOL agreements limiting other channels we may develop for offering online games may limit our ability to diversify our online distribution strategies. The success for us of the AOL agreements will also be a result of AOL's performance under the agreements, a factor over which we will have very little control. We Have Limited Experience with Online Games and May Not Be Able To Operate This Business Effectively Offering games solely for online play is a substantial departure from our traditional business of selling packaged software games. We have employed various revenue models, including subscription fees, "pay to play fees" and advertising. We have limited experience with developing optimal pricing strategies for online games. For example, our product Majestic and our Platinum offering, which contained certain browser-based entertainment games, were launched with a monthly subscription pricing model and obtained only limited commercial success. Accordingly, we did not realize our projected cash flows and discontinued these offerings as part of EA.com's restructuring plan. Similarly, we have limited experience in predicting usage patterns for our games. Because of our inexperience in this area, we may not be effective in achieving success that may otherwise be attainable from offering our games online. Online Games Have Risks That Are Not Associated with Our Traditional Business Online games, particularly multiplayer games, pose risks to player enjoyment that do not generally apply to packaged goods games. Players frequently would not be acquainted with other players, which may adversely affect the playing experience. Social issues raised by a player's conduct may impact the experience for other players. It is difficult to monitor player behavior that impairs the game experience. In addition, there are substantial technical challenges to be met both in the introduction of our games online and in maintaining an effective game playing environment over time. Also, hacking and spamming has become a serious problem for online sites, and significant hacking and spamming could seriously interfere with online game play. If these risks are not successfully controlled and technical challenges resolved, potential customers for our games may be unwilling to play in sufficient volume to allow us to attain or sustain profitability. Proliferation and Assertion of Patents Poses Serious Risks to the Business of EA.com Many patents have been issued that may apply to widely used Internet technologies. Additionally, many recently issued patents are now being asserted against Internet implementations of older technologies. Several such patents have been asserted against us. Such claims can harm our business. We will incur substantial expenses in evaluating and defending against such claims, regardless of the merits of the claims. In the event that there is a determination that we have infringed a third party patent, we could incur significant monetary liability and be prevented from using the rights in the future. Development of EA.com's Business Will Require Significant Capital, and We Cannot Be Assured That It Will Be Available EA.com will not be successful if it does not continue to receive substantial financing that is required to continue to build its business. Electronic Arts has agreed to provide a limited amount of funding to EA.com, but this financing alone may not be sufficient for the development of EA.com's business. Any additional funding that is obtained from Electronic Arts may either be treated as a debt arrangement or would increase Electronic Arts' retained interest in EA.com and correspondingly decrease the interest of the holders of outstanding shares of Class B common stock. The attraction of additional equity or debt financing for EA.com from third parties may not be possible or may only be possible on terms that result in significant dilution to Class A and Class B common stockholders or incremental interest payments and debt-related restrictions on the operation of the business. To date, nearly all funding (except warrants and cash from revenues) has been provided by Electronic Arts. If Use of the Internet Does Not Continue To Develop and Reliably Support the Demands Placed on It by Electronic Commerce, EA.com's Business Will Be Harmed EA.com's success depends upon growth in the use of the Internet as a medium for playing games. The use of the Internet for sophisticated games like ours is relatively new. Our business would be seriously harmed if: . use of the Internet does not continue to increase or increases more slowly than expected, . the infrastructure for the Internet does not effectively support online game play, . concerns over the secure transmission of confidential information over public networks inhibit the growth of the Internet as a means of conducting commercial transactions, or 47 . government regulations regarding Internet content, privacy or other conditions impede the effectiveness of the Internet to users. Capacity Restraints May Restrict the Use of the Internet as a Forum for Game Play, Resulting in Decreased Demand for Our Products The Internet infrastructure may not be able to support the demands placed on it by increased usage or the limited capacity of networks to transmit large amounts of data. Other risks associated with commercial use of the Internet could slow its growth, including: . outages and other delays resulting from the inadequate reliability of the network infrastructure, . slow development of enabling technologies and complementary products, and . limited availability and adoption by consumers of cost-effective, high speed access. Delays in the development or adoption of new equipment standards or protocols required to handle increased levels of Internet activity, or increased governmental regulation, would cause the Internet to fail to gain, or lose, viability as a means of game playing. If these or any other factors cause use of the Internet for commerce to slow or decline, the Internet may not prove viable as a commercial marketplace. This, in turn, would result in decreased demand for EA.com's products and services. To Become and Remain Competitive, EA.com Must Continually Develop New Content. This Is Inherently Risky and Expensive. EA.com's success depends on our ability to develop new products and services for the EA.com site. Our agreement with AOL requires us to develop new games for the EA.com site. We cannot assure you that products will be developed on time, in a cost effective manner, or that they will be commercially successful. Currently, the release of several products such as The Sims Online and Earth & Beyond for which we expect to generate subscription revenue, have been delayed due to longer than anticipated development schedules. Similarly, the online product Majestic achieved only limited commercial success due in part to the length of time it took to download the online software component. Accordingly, we discontinued Majestic on May 1, 2002. We May Not Be Able To Respond to Rapid Technological Change The market for Internet products and services is characterized by rapid technological change and evolving industry standards. We will be required to continually improve performance, features, reliability and capacity of our network infrastructure. We cannot assure you that we will be successful in responding rapidly or in a cost effective manner to such developments. Increasing Governmental Regulation of the Internet Could Limit the Market for Our Products As Internet commerce continues to evolve, we expect that federal, state and foreign governments will adopt laws and regulations covering issues such as user privacy, taxation of goods and services provided over the Internet, pricing, content and quality of products and services. It is possible that legislation could expose companies involved in electronic commerce to liability, taxation or other increased costs, any of which could limit the growth of electronic commerce generally. Legislation could dampen the growth in Internet usage and decrease its acceptance as a communications and commercial medium. If enacted, these laws and regulations could limit the market for EA.com's products. Our Revenues Have Been Heavily Dependent on a Single Product and Would Be Adversely Affected if That Product's Popularity Were To Decline In the near term, EA.com's subscription revenues to date have consisted primarily of revenues from sales of our online product Ultima Online, and we would be adversely affected if revenues from that product were to decline for any reason and not be replaced. We expect the online game market to become increasingly competitive, and it is possible that competing products could cause revenues from Ultima Online to decline. In addition, popularity of Ultima Online could decline over time simply because of consumer preference for new game experiences. 48 We Continue to Invest in Research and Development and Network Technology and Operations for EA.com, and We Cannot Be Assured That We Will Achieve Revenues That Support This Level of Spending We have invested heavily, and expect to continue to invest, in research and development and network technology and operations for our website and online games. While we have reduced the overall level of spending for EA.com, we will continue to invest in the technologies, tools and network infrastructure that are necessary for us to launch and support our key products, Earth & Beyond and The Sims Online. Accordingly, there are no assurances that the revenues from these products will exceed the associated costs in order for EA.com to achieve profitability. If we cannot increase revenues to profitable levels, the value of EA.com will be impaired. In order to develop the broad game offerings that we envision for our online operations it will continue to be necessary to engage in significant developmental efforts both to adapt existing Electronic Arts games to the online format and to create new online games. Our agreements with AOL require us to maintain a substantial commitment to online game development and we cannot be assured that we will realize acceptable returns from this investment. Online Product Development Schedules Are Unreliable and Make Predicting Quarterly Results Difficult Online product development schedules, particularly for Internet based games are difficult to predict because they involve creative processes, use of new development tools, Internet latency issues, a learning process to better understand Internet based game mechanics, and research and experimentation associated with development for new online technologies. Additionally, development risks for Internet based products can cause particular difficulties in predicting quarterly results because of the challenges associated with game testing, live Beta testing, integration into network servers and integration on to the Games web site and may impact the release ("go live") dates of products during a particular quarter. Several online products currently under development such as The Sims Online and Earth & Beyond have experienced development delays and will be released later than planned. Our revenues and operating costs are dependent on our ability to meet our product "go live" schedules, and our failure to meet those schedules could result in revenues falling short of analysts' expectations, resulting in increased operating losses for EA.com. We Are Heavily Dependent on a Few Internet Infrastructure Service Providers to Host and Manage Our Servers at Co-Location Facilities and Our Operating Results May Be Adversely Affected if We Must Change Service Providers We are dependent on a few third party internet infrastructure service providers to host and manage the majority of our servers that support our online games. The performance of these service providers are outside of our control. Many of the service providers in the internet infrastructure space require substantial financial resources to build, maintain and manage co-location facilities. To the extent that industry, economic, financial or competitive factors influence the level of performance that we expect from service providers we currently use for co-location space (bandwidth and rack), we may need to re-locate our servers to another co-location facility which would increase our expenses and may result in delays or reduced shipments of our online products, thereby adversely impact our operating results. GENERAL RISK FACTORS Because of the Competition for Qualified Technical, Creative, Marketing and Other Personnel, We May Not Be Able To Attract and Retain the Personnel Necessary for our Businesses The market for technical, creative, marketing and other personnel essential to the development of online businesses and management of our online and core businesses continues to be competitive, although current market conditions have made it less difficult to attract and retain the employees we need. In the last fiscal year, notwithstanding the downturn of the economy generally, competitive recruiting efforts aimed at Electronic Arts' employees and executives continued. Electronic Arts' leading position within the interactive entertainment industry makes us a prime target for recruiting of executives and key creative talent to assist in the consolidation that the interactive entertainment industry is experiencing. In addition, the cost of real estate in the San Francisco Bay area - - the location of our headquarters and largest studio remains relatively high, and has made recruiting from other areas and relocating employees to our headquarters more difficult. If we cannot successfully recruit and retain the employees we need, our ability to develop and manage our businesses will be impaired. Foreign Sales and Currency Fluctuations For the fiscal years ended March 31, 2002 and 2001, international net revenues comprised 37% of total consolidated net revenues. We expect foreign sales to continue to account for a significant and growing portion of our revenues. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies which may fluctuate. While we hedge against foreign currency fluctuations, we cannot control translation issues. For example, our 49 Japan and Asia Pacific revenues in fiscal 2002 were adversely impacted by a devaluation of the Yen and Australian Dollar as compared to the prior year. The devaluation had an adverse effect for the year on our net revenues and net income. Any of these factors may significantly harm our business. Increased Difficulties in Forecasting Results During platform transition periods, where the success of our products is significantly impacted by the changing market for our products, forecasting our revenues and earnings is more difficult than in more stable or rising product markets. The demand for our products may decline during a transition faster than we anticipate, negatively impacting both revenues and earnings. At launch, Sony shipped only half of the number of PlayStation 2 units to retail in North America than it had originally planned, and it shipped significantly fewer units than planned at launch in Europe as well. Shortages were announced as being caused by shortages of components for manufacturing. Due to these shortages, our results of operations for fiscal 2001 were adversely affected. Consequently, if Microsoft or Nintendo do not ship the number of units planned for the Xbox and Nintendo GameCube, our sales of these products may be adversely affected in fiscal 2002. The Current Legislative and Regulatory Environment Affecting Generally Accepted Accounting Principles is Uncertain and Volatile, and Significant Changes in Current Principles Could Affect Our Financial Statements Going Forward. Recent actions and public comments from the SEC have focused on the integrity of financial reporting generally. Similarly, Congress has considered a variety of bills that could affect certain accounting principles. In addition, the FASB and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, some of which represent a significant change from current industry practices. While we do not anticipate that such proposals will affect the actual conduct of our business and we believe that our financial statements have been prepared in accordance with generally accepted accounting principles, we cannot predict the impact of the adoption of any such proposals on our financial statements going forward. 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 our common stock in any given period. As a result of the factors discussed in this report and other factors that may arise in the future, the market price of our common stock historically has been, and we expect will continue to be, subject to significant fluctuations over a short period of time. These fluctuations may be due to factors specific to us, to changes in analysts' earnings estimates, or to factors affecting the computer, software, Internet, entertainment, media or electronics businesses. In addition, fluctuations may be due to uncertainties in the securities markets in general. For example, during the fiscal year ended March 31, 2001, the price per share of our Class A common stock ranged from $26.59 to $56.13 and $42.40 to $66.01 during the fiscal year ended March 31, 2002. World Events The terrorist attacks of September 11, 2001 in the Unites States, the subsequent US military action, and the continuing concerns over potential additional terrorist attacks against US interests and citizens pose serious uncertainties in our business. Consumer spending, consumer preferences in entertainment, and the securities markets generally may be affected on an ongoing and unpredictable basis by these events, all of which may make prediction of our results more difficult. Because of these and other factors affecting our 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. 50 Item 7A: Quantitative and Qualitative Disclosures About Market Risk Market Risk We are exposed to various market risks, including the changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from changes in market rates and prices. Foreign exchange contracts used to hedge foreign currency exposures and short-term investments are subject to market risk. We do not consider our cash and cash equivalents to be subject to interest rate risk due to their short maturities. We do not enter into derivatives or other financial instruments for trading or speculative purposes. Foreign Currency Exchange Rate Risk We utilize foreign exchange contracts to hedge foreign currency exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies, thereby, limiting our risk. Gains and losses on foreign exchange contracts are reflected in the Consolidated Statement of Operations. At March 31, 2002, we had foreign exchange contracts, all with maturities of less than three months to purchase and sell approximately $226,330,000 in foreign currencies, primarily British Pounds, European Currency Units ("Euro"), Canadian Dollars and other currencies. Fair value represents the difference in value of the contracts at the spot rate and the forward rate. The counterparties to these contracts are substantial and creditworthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts are not considered to be material. Notwithstanding our efforts to manage foreign exchange risks, there can be no assurances that our hedging activities will adequately protect us against the risks associated with foreign currency fluctuations. The following table below provides information about our foreign currency forward exchange contracts at March 31, 2002. The information is provided in U.S. dollar equivalents and presents the notional amount (forward amount), the weighted average contractual foreign currency exchange rates and fair value. ===================================================================== Weighted- Average Contract Contract Amount Rate Fair Value - --------------------------------------------------------------------- (in thousands) (in thousands) Foreign currency to be sold under contract: British Pound $131,622 1.4229 $ (52) Euro 41,121 0.8749 179 Canadian Dollar 16,986 1.5895 67 Japanese Yen 6,431 132.64 (5) Swedish Krona 5,427 10.3189 43 Australian Dollar 4,206 0.5258 (58) South African Rand 3,125 12.4801 (281) Norwegian Krone 2,262 8.8409 13 Danish Krone 2,001 8.4965 10 Swiss Franc 1,199 1.6680 10 - --------------------------------------------------------------------- Total $214,380 $ (74) - --------------------------------------------------------------------- Foreign currency to be purchased under contract: British Pound $ 11,950 1.4253 $ (207) - --------------------------------------------------------------------- Total $ 11,950 $ (207) - --------------------------------------------------------------------- - --------------------------------------------------------------------- Grand total $226,330 $ (281) - --------------------------------------------------------------------- While the contract amounts provide one measurement of the volume of these transactions, they do not represent the amount of our exposure to credit risk. The amounts (arising from the possible inabilities of counterparties to meet the terms of their contracts) are generally limited to the amounts, if any, by which the counterparties' obligations exceed our obligations as these contracts can be settled on a net basis at our option. We control credit risk through credit approvals, limits and monitoring procedures. Interest Rate Risk Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We manage our interest rate risk by maintaining an investment portfolio primarily consisting of debt instruments of high credit quality and relatively short average maturities. We also manage our interest rate risk by maintaining sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity. At March 31, 2002, our cash 51 equivalents, short-term and long-term investments included debt securities of $662,359,000. Notwithstanding our efforts to manage interest rate risks, there can be no assurances that we will be adequately protected against the risks associated with interest rate fluctuations. The table below presents the amounts and related weighted average interest rates of our investment portfolio at March 31, 2002: ===================================================================== Average Interest Rate Cost Fair Value - --------------------------------------------------------------------- (Dollars in thousands) Cash equivalents/(1)/ Fixed rate 3.75% $ 10,141 $ 10,141 Variable rate 2.06% $408,108 $408,108 Short-term investments/(1)(2)/ Fixed rate 3.61% $235,769 $235,710 Variable rate 6.35% $ 8,400 $ 8,653 - --------------------------------------------------------------------- (1) See definition in Note 1 of the Notes to Consolidated Financial Statements. (2) Maturity dates for short-term investments range from 3 months to 31 months with call dates ranging from 3 months to 10 months. 52 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 53 through 82. INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Electronic Arts Inc. and Subsidiaries: We have audited the accompanying consolidated balance sheets of Electronic Arts Inc. and subsidiaries as of March 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended March 31, 2002. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits 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 Inc. and subsidiaries as of March 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Mountain View, California KPMG LLP May 3, 2002 53 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(In thousands, except share data) As of March 31, 2002 2001 - ------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash, cash equivalents and short-term investments $ 796,936 $ 466,492 Marketable securities 6,869 10,022 Receivables, less allowances of $115,870 and $89,833, respectively 190,495 174,449 Inventories, net 23,780 15,686 Other current assets 134,463 152,078 ----------------------------- Total current assets 1,152,543 818,727 Property and equipment, net 308,827 337,199 Long-term investments - 8,400 Investment in affiliates 19,077 19,052 Goodwill and other intangibles, net 110,512 136,764 Other assets 108,415 58,776 ----------------------------- $1,699,374 $1,378,918 ============================= LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 88,563 $ 73,061 Accrued and other liabilities 364,419 266,965 ----------------------------- Total current liabilities 452,982 340,026 Minority interest in consolidated joint venture 3,098 4,545 Stockholders' equity: Preferred stock, $0.01 par value. Authorized 10,000,000 shares - - Common stock Class A common stock, $0.01 par value. Authorized 400,000,000 shares; issued and outstanding 138,429,269 and 134,714,464 shares, respectively 1,384 1,347 Class B common stock, $0.01 par value. Authorized 100,000,000 shares; issued and outstanding 6,233,413 and 6,250,000 shares, respectively 62 63 Paid-in capital 649,777 540,354 Retained earnings 606,795 505,286 Accumulated other comprehensive loss (14,724) (12,703) ----------------------------- Total stockholders' equity 1,243,294 1,034,347 ----------------------------- $1,699,374 $1,378,918 =============================
See accompanying Notes to Consolidated Financial Statements. 54 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data) Years Ended March 31, 2002 2001 2000 ------------------------------------------------------------------------------------------------------------------ Net revenues $1,724,675 $1,322,273 $1,420,011 Cost of goods sold 807,611 652,242 704,702 ------------------------------------------------ Gross profit 917,064 670,031 715,309 Operating expenses: Marketing and sales 241,109 185,336 188,611 General and administrative 107,059 104,041 92,418 Research and development 387,736 388,928 261,966 Amortization of intangibles 25,418 19,323 11,989 Charge for acquired in-process technology - 2,719 6,539 Restructuring and asset impairment charges 20,303 - - ------------------------------------------------ Total operating expenses 781,625 700,347 561,523 ------------------------------------------------ Operating income (loss) 135,439 (30,316) 153,786 Interest and other income, net 12,848 16,886 16,028 ------------------------------------------------ Income (loss) before provision for (benefit from) income taxes and minority interest 148,287 (13,430) 169,814 Provision for (benefit from) income taxes 45,969 (4,163) 52,642 ------------------------------------------------ Income (loss) before minority interest 102,318 (9,267) 117,172 Minority interest in consolidated joint venture (809) (1,815) (421) ------------------------------------------------ Net income (loss) $ 101,509 $ (11,082) $ 116,751 ================================================ Net income per share: Basic N/A N/A $ 0.93 Diluted N/A N/A $ 0.88 Number of shares used in computation: Basic N/A N/A 125,660 Diluted N/A N/A 132,742 Class A common stock: Net income (loss): Basic $ 124,256 $ 11,944 N/A Diluted $ 101,509 $ (11,082) N/A Net income (loss) per share: Basic $ 0.91 $ 0.09 N/A Diluted $ 0.71 $ (0.08) N/A Number of shares used in computation: Basic 136,832 131,404 N/A Diluted 143,142 132,056 N/A Class B common stock: Net loss, net of retained interest in EA.com $ (22,747) $ (23,026) N/A Net loss per share: Basic $ (3.77) $ (3.83) N/A Diluted $ (3.77) $ (3.83) N/A Number of shares used in computation: Basic 6,026 6,015 N/A Diluted 6,026 6,015 N/A
See accompanying Notes to Consolidated Financial Statements, including segment information in Note 18. 55 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended March 31, 2002, 2001 and 2000 (In thousands) Class A Class B Accumulated Common Stock Common Stock Other Treasury Stock ---------------------------------------- Paid-In Retained Comprehensive -------------------- Shares Amount Shares Amount Capital Earnings Loss Shares Amount Total - ------------------------------------------------------------------------------------------------------------------------------------ Balances at March 31, 1999 122,584 $1,226 - $ - $267,086 $402,112 $ (2,567) (246) $(4,926) $ 662,931 Net income 116,751 116,751 Change in unrealized appreciation of investments, net 1,739 1,739 Reclassification adjustment for gains realized in net income, net (5,194) (5,194) Translation adjustment (339) (339) ---------- Comprehensive income 112,957 Proceeds from sales of shares through stock plans 6,285 62 83,096 (2,495) 246 4,926 85,589 Issuance of Class B common stock 6,000 60 27,993 28,053 Issuance of Class B stock warrant 1,300 1,300 Tax benefit related to stock options 32,563 32,563 ------------------------------------------------------------------------------------------------------------ Balances at March 31, 2000 128,869 1,288 6,000 60 412,038 516,368 (6,361) - - 923,393 Net loss (11,082) (11,082) Change in unrealized appreciation of investments, net 3,097 3,097 Translation adjustment (9,439) (9,439) ---------- Comprehensive loss (17,424) Proceeds from sales of shares through stock plans 5,845 59 101,937 101,996 Issuance of Class B common stock 250 3 2,247 2,250 Notes receivable in connection with issuance of Class B stock (1,618) (1,618) Tax benefit related to stock options 25,750 25,750 ------------------------------------------------------------------------------------------------------------ Balances at March 31, 2001 134,714 1,347 6,250 63 540,354 505,286 (12,703) - - 1,034,347 ------------------------------------------------------------------------------------------------------------
56 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (continued)
Years Ended March 31, 2002, 2001 and 2000 (In thousands) Class A Class B Accumulated Common Stock Common Stock Other Treasury Stock --------------------------------------- Paid-In Retained Comprehensive ------------------ Shares Amount Shares Amount Capital Earnings Loss Shares Amount Total - ------------------------------------------------------------------------------------------------------------------------------------ Balances at March 31, 2001 134,714 1,347 6,250 63 540,354 505,286 (12,703) - - 1,034,347 Net income 101,509 101,509 Change in unrealized depreciation of investments, net (3,540) (3,540) Reclassification adjustment for losses realized in net income, net 66 66 Translation adjustment 1,453 1,453 ---------- Comprehensive income 99,488 Proceeds from sales of shares through stock plans 3,995 40 - - 98,701 98,741 Sale of stock under stock purchase agreement 8 - 100 100 Purchase of treasury stock (280) (11,922) (11,922) Retirement of treasury stock (280) (3) (11,919) 280 11,922 - Other (25) (1) (1) Tax benefit related to stock options 22,541 22,541 --------------------------------------------------------------------------------------------------------- Balances at March 31, 2002 138,429 $1,384 6,233 $62 $649,777 $606,795 $(14,724) - $ - $1,243,294 =========================================================================================================
See accompanying Notes to Consolidated Financial Statements. 57 ELECTRONIC ARTS AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Years Ended March 31, 2002 2001 2000 ------------------------------------------------------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income (loss) $ 101,509 $ (11,082) $ 116,751 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Minority interest in consolidated joint venture 809 1,815 421 Equity in net income of affiliates (2,999) (820) (1,138) Gain on sale of affiliate (200) (214) (842) Depreciation and amortization 110,901 78,601 46,725 Non-cash restructuring and asset impairment charges 13,399 - - Loss on sale of fixed assets 331 1,992 31 (Gain) loss on marketable securities 96 - (7,528) Bad debt expense 9,361 7,541 6,714 Charge for acquired in-process technology - 2,719 6,539 Tax benefit from exercise of stock options 22,541 25,750 32,563 Change in assets and liabilities, net of acquisitions: Receivables (25,407) 53,775 (77,779) Inventories (8,094) 7,300 (579) Other assets (1,718) (4,238) (69,727) Accounts payable 15,502 (27,476) 29,673 Accrued and other liabilities 90,996 91,356 (6,919) Deferred income taxes (42,056) (33,080) 2,994 --------------------------------------------------- Net cash provided by operating activities 284,971 193,939 77,899 --------------------------------------------------- INVESTING ACTIVITIES Proceeds from sale of property and equipment 299 4,134 444 Proceeds from sales of marketable securities, net - - 8,598 Proceeds from sale of affiliate 570 - 8,842 Capital expenditures (51,518) (120,347) (134,884) Investment in affiliates, net 2,919 1,662 (4,099) Purchase of marketable securities - (2,479) - Dividend to joint venture (2,481) - - Change in short-term investments, net (190,342) 46,907 (13,860) Acquisition of Pogo Corporation, net of cash acquired - (42,571) - Acquisition of Kesmai - - (22,500) Acquisition of other subsidiaries, net of cash acquired - - (22,096) --------------------------------------------------- Net cash used in investing activities (240,553) (112,694) (179,555) --------------------------------------------------- FINANCING ACTIVITIES Proceeds from sales of Class A shares through employee stock plans and other plans 98,741 101,996 85,589 Proceeds from sales of Class B shares and stock warrants 99 632 20,000 Purchase of treasury shares (11,922) - - --------------------------------------------------- Net cash provided by financing activities 86,918 102,628 105,589 --------------------------------------------------- Translation adjustment 1,678 (10,326) 124 --------------------------------------------------- Increase in cash and cash equivalents 133,014 173,547 4,057 Beginning cash and cash equivalents 419,812 246,265 242,208 --------------------------------------------------- Ending cash and cash equivalents 552,826 419,812 246,265 Short-term investments 244,110 46,680 93,539 --------------------------------------------------- Ending cash, cash equivalents and short-term investments $ 796,936 $ 466,492 $ 339,804 =================================================== Supplemental cash flow information: Cash paid during the year for income taxes $ 9,955 $ 13,556 $ 15,525 =================================================== Non-cash investing activities: Class B common stock issued in connection with the Kesmai acquisition $ - $ - $ 9,353 Change in unrealized appreciation (depreciation) of investments and marketable securities $ (5,035) $ 4,488 $ (5,008) ===================================================
See accompanying Notes to Consolidated Financial Statements. 58 ELECTRONIC ARTS AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2002, 2001 and 2000 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements of Electronic Arts Inc. and its wholly-owned and majority-owned subsidiaries (the "Company") follows: (a) Consolidation The accompanying consolidated financial statements include the accounts of the Company. All significant intercompany balances and transactions have been eliminated in consolidation. (b) 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 2002 contain 52 weeks. The results of operations for fiscal 2001 and 2000 contain 53 and 52 weeks, respectively. For clarity of presentation herein, all fiscal periods are treated as ending on a calendar month end. (c) Revenue Recognition The Company's revenue recognition policies are in compliance with American Institute of Certified Public Accountants Statement of Position ("SOP") 97-2, "Software Revenue Recognition", as amended by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions", which provide guidance on generally accepted accounting principles for recognizing revenue on software transactions. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements", which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC. The adoption of SAB 101 did not have a material impact on the Company's consolidated financial position and results of operations. Product Sales: The Company recognizes revenue upon shipment of its packaged goods products based on "FOB Shipping" terms. Under FOB Shipping terms, title and risk of loss are transferred when the products are delivered to the customer. In order to recognize revenue, the Company must not have any continuing obligations and it must also be probable that the Company will collect the accounts receivable. Subject to certain limitations, the Company permits customers to obtain exchanges within certain specified periods and provides price protection on certain unsold merchandise. Revenue is recognized net of an allowance for returns and price protection. Online Subscription Revenues: Online subscription revenues are derived principally from subscription revenues collected from customers for online play, who are only contractually obligated to pay on a month-to-month basis. Prepaid monthly subscription revenues, including revenues collected from credit card sales as well as sales of Gametime subscription cards, are deferred and subsequently recognized ratably over the period for which the hosting services are provided. Advertising Revenues: Advertising revenues are derived principally from the sale of banner and in-game advertisements. Banner and in-game advertising is typically generated from contracts in which either the Company or AOL provides a minimum number of impressions over the term of the agreed upon commitment. Revenue is recognized as the impressions are delivered, provided that no significant obligations remain and collection of the related receivable is probable. Advertising revenue generated on the AOL Games Channel is recorded net of the applicable revenue share owed to AOL under the AOL agreement (see Note 5 of the Notes to Consolidated Financial Statements). Software Licenses: For those agreements which provide the customers the right to multiple copies in exchange for guaranteed minimum royalty amounts, revenue is recognized at delivery of the product master or the first copy. Per copy royalties on sales that exceed the guarantee are recognized as earned. Revenue from the licensing of software was $23,291,000, $18,944,000 and $21,704,000 for the fiscal years ended March 31, 2002, 2001 and 2000, respectively. (d) Sales Returns and Other Reserves The Company estimates potential future product returns and price protection related to current period product revenue. The Company analyzes historical returns, current sell through of distributor and retailer inventory of the Company's products, current trends in the video game market and the overall economy, changes in customer demand and acceptance of the Company's products and other related factors when evaluating the adequacy of the sales returns and price protection allowances. In addition, the Company monitors and manages the volume of sales to retailers and distributors and their inventories as substantial overstocking in the distribution channel can result in high 59 returns or the requirement for substantial price protection in subsequent periods. Similarly, the Company must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts in any accounting period. The Company analyzes customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. (e) Cash and Investments Cash equivalents consist of highly liquid investments with insignificant rate risk and with maturities of three months or less at the date of purchase. Short-term investments include securities with maturities greater than three months and less than one year, except for certain investments with stated maturities greater than one year. Long-term investments consist of securities with maturities greater than one year. The Company accounts for investments under Statement of Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities". The Company's policy is to protect the value of its investment portfolio and to minimize principal risk by earning returns based on current interest rates. Management determines the appropriate classification of its debt and equity securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Securities classified as held-to-maturity are carried at amortized cost, which is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Debt securities, not classified as held-to-maturity, are classified as available-for-sale and are stated at fair value. Securities sold are based on the specific identification method. (f) Prepaid Royalties Prepaid royalties consist primarily of prepayments for manufacturing royalties, co-publishing and/or distribution affiliates and license fees paid to celebrities, professional sports organizations and other organizations for use of their trade name and content. Also included in prepaid royalties are prepayments made to independent software developers under development arrangements that have alternative future uses. Prepaid royalties are expensed at the contractual or effective 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 realized through product sales. Royalty advances are classified as current and non-current assets based upon estimated net product sales for the following year. The current portion of prepaid royalties, included in other current assets, was $65,484,000 and $46,264,000 at March 31, 2002 and 2001, respectively. The long-term portion of prepaid royalties, included in other assets, was $1,164,000 and $9,664,000 at March 31, 2002 and 2001, respectively. (g) Software Development Costs Research and development costs, which consist primarily of software development costs, are expensed as incurred. Statement of Financial Accounting Standards No. 86 ("SFAS 86"), "Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed", provides for the capitalization of certain software development costs incurred after technological feasibility of the software is established or for development costs that have alternative future uses. Under the Company's current practice of developing new products, the technological feasibility of the underlying software is not established until substantially all product development is complete, which generally includes the development of a working model. The software development costs that have been capitalized to date have been insignificant. (h) Inventories Inventories are stated at the lower of cost or market. Inventories at March 31, 2002 and 2001 consisted of: - --------------------------------------------------------------- 2002 2001 - --------------------------------------------------------------- (in thousands) Raw materials and work in process $ 1,025 $ 976 Finished goods 22,755 14,710 - --------------------------------------------------------------- $23,780 $15,686 - --------------------------------------------------------------- (i) Advertising Costs The Company generally expenses advertising costs as incurred, except for production costs associated with media campaigns which are deferred and charged to expense at the first run of the ad. Cooperative advertising with distributors and retailers is accrued when revenue is recognized. Cooperative advertising credits are reimbursed when qualifying claims are submitted. The Company has adopted the provisions of Emerging Issues Task Force issue No. 01-09 ("EITF 01-09"), "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products". The adoption of EITF 01-09 did not have a material impact in the Company's consolidated financial position or results of operations. For the fiscal years ended March 31, 2002, 2001 and 2000, advertising expenses totaled approximately $105,712,000, $75,429,000 and $87,377,000, respectively. (j) Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the accelerated and straight-line methods over the following useful lives: 60 - ------------------------------------------------------------------ Buildings 20 to 25 years - ------------------------------------------------------------------ Computer equipment and software 3 to 7 years - ------------------------------------------------------------------ Furniture and equipment 3 to 7 years - ------------------------------------------------------------------ Leasehold improvements Lesser of the lease terms or the estimated useful lives of the improvements - ------------------------------------------------------------------ Under the provisions of SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", the Company capitalizes costs associated with customized internal-use software systems that have reached the application stage and meet recoverability tests. Such capitalized costs include external direct costs utilized in developing or obtaining the applications and payroll and payroll-related expenses for employees who are directly associated with the applications. Capitalization of such costs begins when the preliminary project stage is complete and ceases at the point in which the project is substantially complete and ready for its intended purpose. Capitalized costs associated with internal-use software amounted to $121,002,000 at March 31, 2002, and are being depreciated on a straight-line basis over each project's estimated useful life. (k) Intangible Assets Intangible assets net of accumulated amortization at March 31, 2002 and 2001, of $110,512,000 and $136,764,000, respectively, include goodwill, costs of obtaining product technology and noncompete covenants which are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from two to twelve years. Amortization expense for fiscal years ended March 31, 2002, 2001 and 2000 was $25,418,000, $19,323,000 and $11,989,000, respectively. The Company assesses the recoverability of goodwill by determining whether the carried value of the assets may be recovered through estimated future undiscounted net cash flows. On April 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which supersedes Accounting Principles Board Opinion No. 17 "Intangible Assets". As a result of adopting this standard, the Company will continue to amortize finite-lived intangibles, but will no longer amortize certain other intangible assets, most notably goodwill and acquired workforce, which had a net book value at March 31, 2002 of $69,050,000. Amortization of goodwill and acquired workforce totaled approximately $13,125,000 for fiscal 2002, approximately $9,182,000 for fiscal 2001 and approximately 6,411,000 for fiscal 2000. Based on intangible assets as of March 31, 2002, the Company estimates that amortization of finite-lived intangibles will total approximately $8,700,000 for fiscal 2003. Following adoption of SFAS 142, the Company will continue to evaluate whether any event has occurred which might indicate that the carrying value of an intangible asset is not recoverable. In addition, SFAS 142 requires that goodwill be subject to at least an annual assessment for impairment by applying a fair value-based test. The Company is in the process of completing an evaluation for impairment of goodwill in accordance with SFAS 142. The Company believes the implementation of SFAS 142 will not have a material impact on its consolidated financial statements. (l) Long-Lived Assets The Company evaluates long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. This may include assumptions about future prospects for the business that the asset relates to and typically involves computations of the estimated future cash flows to be generated by these businesses. Based on these judgments and assumptions, the Company determines whether it needs to take an impairment charge to reduce the value of the asset stated on the balance sheet to reflect its actual fair value. Judgments and assumptions about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including but not limited to, significant negative industry or economic trends, significant changes in the manner or the Company's use of the acquired assets or the strategy of the Company's overall business and significant underperformance relative to expected historical or projected future operating results. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. In April 2002, the Company adopted Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The Company is in the process of determining the impact of this new accounting standard. The Company believes the implementation of SFAS 144 will not have a material impact to its consolidated financial statements. (m) Income Taxes The Company uses the asset and liability method of accounting for income taxes. Under the asset and liability method, the Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Deferred tax assets and liabilities are based on temporary differences resulting from differing treatment of items for tax and accounting purposes. The Company records a valuation allowance to reduce tax assets to an amount whose realization is more likely than not. The valuation allowance is based on the Company's estimates of taxable income by 61 jurisdiction in which the Company operates and the period over which the Company's deferred tax assets will be recoverable. (n) 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 included as a component of accumulated other comprehensive income (loss) in 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 operations are foreign currency transaction losses of $412,000, $888,000 and $1,781,000, for the fiscal years ended March 31, 2002, 2001 and 2000, respectively. On April 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities and requires us to recognize these as either assets or liabilities on the balance sheet and measure them at fair value. As described in Note 3 of the Notes to Consolidated Financial Statements, gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting. The adoption of this accounting standard did not have a material impact on the Company's consolidated financial position or results of operations. (o) Net Income (Loss) Per Share The following summarizes the computations of Basic Earnings Per Share ("EPS") and Diluted EPS. Basic EPS is computed as net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock-based compensation plans including stock options, restricted stock awards, warrants and other convertible securities using the treasury stock method. Net income (loss) per share was calculated on a consolidated basis until Class A common stock and Class B common stock were created as a result of the approval of the Tracking Stock Proposal (see Note 2 of the Notes to Consolidated Financial Statements). Net income (loss) per share is computed individually for Class A common stock and Class B common stock. Please see the discussion regarding segment reporting in the Management's Discussion and Analysis of Financial Condition and Results of Operations. (In thousands, except for per share amounts): - ------------------------------------------------------------------ Year Ended March 31, 2002 Class A Class A common common stock- stock- Class B Basic Diluted common stock - ------------------------------------------------------------------ Net income (loss) before retained interest in EA.com $ 253,156 $ 101,509 $ (151,647) Net loss related to retained interest in EA.com (128,900) - 128,900 - ------------------------------------------------------------------ Net income (loss) $ 124,256 $ 101,509 $ (22,747) - ------------------------------------------------------------------ Shares used to compute net income (loss) per share: Weighted-average common shares 136,832 136,832 6,026 Dilutive stock equivalents - 6,310 - - ------------------------------------------------------------------ Dilutive potential common shares 136,832 143,142 6,026 - ------------------------------------------------------------------ Net income (loss) per share: Basic $ 0.91 N/A $ (3.77) Diluted N/A $ 0.71 $ (3.77) (In thousands, except for per share amounts): - ------------------------------------------------------------------ Year Ended March 31, 2001 Class A Class A common common stock- stock- Class B Basic Diluted common stock - ------------------------------------------------------------------ Net income (loss) before retained interest in EA.com $ 142,422 $(11,082) $ (153,504) Net loss related to retained interest in EA.com (130,478) - 130,478 - ------------------------------------------------------------------ Net income (loss) $ 11,944 $(11,082) $ (23,026) - ------------------------------------------------------------------ Shares used to compute net income (loss) per share: Weighted-average common shares 131,404 131,404 6,015 Dilutive stock equivalents - 652 - - ------------------------------------------------------------------ Dilutive potential common shares 131,404 132,056 6,015 - ------------------------------------------------------------------ Net income (loss) per share: Basic $ 0.09 N/A $ (3.83) Diluted N/A $ (0.08) $ (3.83) 62 (In thousands, except for per share amounts): - ----------------------------------------------------------------- Year Ended March 31, 2000 - ----------------------------------------------------------------- Net income $116,751 - ----------------------------------------------------------------- Shares used to compute net income per share: Weighted-average common shares 125,660 Dilutive stock equivalents 7,082 - ----------------------------------------------------------------- Dilutive potential common shares 132,742 - ----------------------------------------------------------------- Net income per share: Basic $ 0.93 Diluted $ 0.88 The Diluted EPS calculation for Class A common stock, presented above, includes the potential dilution from the conversion of Class B common stock to Class A common stock in the event that the initial public offering for Class B common stock does not occur. Net income used for the calculation of Diluted EPS for Class A common stock is $101,509,000 for the fiscal year ended March 31, 2002. This net income includes the remaining 15% interest in EA.com, which is directly attributable to outstanding Class B shares owned by third parties, which would be included in the Class A common stock EPS calculation in the event that the initial public offering for Class B common stock does not occur. Due to the net loss attributable for the twelve months ended March 31, 2001 on a diluted basis to Class A Stockholders, stock options have been excluded from the Diluted EPS calculation. Had net income been reported for this period, an additional 5,971,000 shares would have been added to diluted potential common shares for Class A common stock for the twelve months ended March 31, 2001. Due to the net loss attributable for the twelve months ended March 31, 2002 and 2001 on a diluted basis to Class B Stockholders, stock options have been excluded from the Diluted EPS calculation. Had net income been reported for these periods, an additional 842,000 and 472,000 shares, respectively, would have been added to diluted potential common shares for Class B common stock for the twelve months ended March 31, 2002 and 2001. Excluded from the above computation of weighted-average shares for Class A diluted EPS for the fiscal years ended March 31, 2002, 2001 and 2000 were options to purchase 1,515,000, 2,705,000 and 229,000 shares of common stock, respectively, as the options' exercise price was greater than the average market price of the common shares. Class B common stock, authorized on March 22, 2000, was excluded from the Company's calculations of basic and diluted EPS for the fiscal year ended March 31, 2000 because its impact on the calculations was immaterial. (p) Employee Benefits The Company has a 401(k) Plan covering substantially all of its U.S. employees. The 401(k) Plan permits the Company to make discretionary contributions to employees' accounts based on the Company's financial performance. The Company contributed $4,811,000, $1,127,000 and $1,799,000 to the Plan in fiscal 2002, fiscal 2001 and fiscal 2000, respectively. (q) Stock-based Compensation The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees" and Financial Accounting Standards Board issued Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving Stock Compensation (an interpretation of APB Opinion No. 25)". The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation". (r) Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure 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, long-lived assets, deferred income taxes, warranty provisions, and estimates regarding the recoverability of prepaid royalty advances and inventories. Actual results could differ from those estimates. (s) Reclassifications Certain amounts have been reclassified to conform to fiscal 2002 presentation. (2) TRACKING STOCK On March 22, 2000, the stockholders of Electronic Arts authorized the issuance of a new series of common stock, designated as Class B common stock ("Tracking Stock"). The Tracking Stock is intended to reflect the performance of Electronic Arts' online and e-Commerce division, EA.com. As a result of the approval of the Tracking Stock Proposal, Electronic Arts' existing common stock has been re-classified as Class A common stock ("Class A Stock") and that stock reflects the performance of Electronic Arts' other businesses, EA Core. 63 (3) FINANCIAL INSTRUMENTS (a) Cash and Investments - ---------------------------------------------------------------- As of March 31, 2002 2001 - ---------------------------------------------------------------- (in thousands) Cash and cash equivalents: Cash $134,577 $ 70,196 Money market funds 380,632 250,182 Municipal securities 27,189 91,879 Commercial paper 10,428 7,555 - ---------------------------------------------------------------- Cash and cash equivalents 552,826 419,812 - ---------------------------------------------------------------- Short-term investments: Available-for-sale U.S. Agency bonds 222,985 - Corporate bonds 8,236 4,076 Municipal securities 4,489 42,604 Held-to-maturity U.S. Treasury securities 8,400 - - ---------------------------------------------------------------- Short-term investments 244,110 46,680 - ---------------------------------------------------------------- Cash, cash equivalents and short- term investments $796,936 $466,492 - ---------------------------------------------------------------- - ---------------------------------------------------------------- Long-term investments: U.S. Treasury securities $ - $ 8,400 - ---------------------------------------------------------------- Long-term and short-term held-to-maturity investments include commercial notes with original maturities of five to eight years secured by U.S. Treasury Notes which enable the Company to take advantage of certain tax incentives from its Puerto Rico operation. These investments are treated as held-to-maturity for financial reporting purposes. The fair value of held-to-maturity securities at March 31, 2002 was $8,653,000 which included gross unrealized gains of $253,000. The fair value of held-to-maturity securities at March 31, 2001 was $8,601,000 which included gross unrealized gains of $201,000. (b) Marketable Securities Marketable securities are comprised of equity securities. The Company has accounted for investments in equity securities as "available-for-sale" and has stated applicable investments at fair value, with net unrealized appreciation (depreciation) reported as a separate component of accumulated other comprehensive loss in stockholders' equity. Marketable securities had an aggregate cost of $6,954,000 and $7,066,000 at March 31, 2002 and 2001, respectively. At March 31, 2002, marketable securities included gross unrealized losses of $85,000. At March 31, 2001, marketable securities included gross unrealized gains of $2,956,000. There were no sales of marketable securities in fiscal years 2002 and 2001. (c) Foreign Currency Forward Exchange Contracts The Company utilizes foreign exchange contracts to hedge foreign currency exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies, thereby limiting its risk. The Company does not use forward exchange contracts for speculative or trading purposes. The Company's accounting policies for these instruments are based on the Company's designation of such instruments as hedging transactions. The criteria the Company uses for designating an instrument as a hedge include the instrument's effectiveness in risk reduction and one-to-one matching of forward exchange contracts to underlying transactions. Gains and losses on currency forward contracts that are designated and effective as hedges of existing transactions are recognized in income in the same period as losses and gains on the underlying transactions are recognized and generally offset. Net Loss Recognized in Other Income Relating to Fair Value Hedging of the Balance Sheet: - --------------------------------------------------------------- Year Ended March 31, 2002 2001 - --------------------------------------------------------------- (in thousands) Gain (loss) on foreign currency assets and liabilities $ 991 $(26,104) Gain (loss) on hedges of foreign currency assets and liabilities (1,403) 25,216 - --------------------------------------------------------------- Net loss recognized in other income $ (412) $ (888) - --------------------------------------------------------------- The Company transacts business in various foreign currencies. At March 31, 2002, the Company had foreign exchange contracts, all with maturities of less than three months, to purchase and sell approximately $226,330,000 in foreign currencies, primarily in British Pounds, European Currency Units ("Euros"), Canadian Dollars, and other currencies. Fair value represents the difference in value of the contracts at the spot rate and the forward rate, plus the unamortized premium or discount. At March 31, 2002, fair value of these contracts is not significant. The counterparties to these contracts are substantial and creditworthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts are not considered to be material. Notwithstanding the Company's efforts to manage foreign exchange risk, there can be no assurances that it's hedging activities will adequately protect against the risks associated with foreign currency fluctuations. (4) LEASE COMMITMENTS The Company leases certain of its current facilities and certain equipment under non-cancelable capital and 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 64 increases over the base year of these expenses on the remainder of the Company's facilities. In February of 1995, the Company entered into a build-to-suit lease with a financial institution on its headquarter's facility in Redwood City, California, which was extended in July of 2001 and runs through July of 2006. The Company accounted for this arrangement as an operating lease in accordance with Statement of Financial Accounting Standards No. 13 ("SFAS 13"), "Accounting for Leases", as amended. Existing campus facilities developed in phase one comprise a total of 350,000 square feet and provide space for sales, marketing, administration and research and development functions. The Company has an option to purchase the property (land and facilities) for $145,000,000 or, at the end of the lease, to arrange for (1) an additional extension of the lease or (2) sale of the property to a third party with the Company retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128,900,000 if the sales price is less than this amount, subject to certain provisions of the lease. In December 2000, the Company entered into a second build-to-suit lease with a financial institution for a five year term from December 2000 to expand its headquarter's facilities and develop adjacent property adding approximately 310,000 square feet to its campus. The Company expects to complete construction in June of 2002. The Company accounted for this arrangement as an operating lease in accordance with SFAS 13, as amended. The facilities will provide space for marketing, sales and research and development. The Company has an option to purchase the property for $127,000,000 or, at the end of the lease, to arrange for (1) an extension of the lease or (2) sale of the property to a third party with the Company retaining an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118,800,000 if the sales price is less than this amount, subject to certain provisions of the lease. Lease rates are based upon the Commercial Paper Rate. The two lease agreements described above require the Company to maintain certain financial covenants, all of which the Company was in compliance with as of March 31, 2002. Total future minimum lease commitments as of March 31, 2002 are: - --------------------------------------------------------- Year Ended March 31, (in thousands) 2003 $18,288 2004 15,011 2005 11,354 2006 10,810 2007 9,122 Thereafter 11,609 - --------------------------------------------------------- $76,194 - --------------------------------------------------------- Total rent expense for all operating leases was $25,177,000, $27,526,000 and $23,591,000, for the fiscal years ended March 31, 2002, 2001 and 2000, respectively. (5) AMERICA ONLINE, INC. ("AOL") AGREEMENT In November 1999, Electronic Arts Inc., EA.com and AOL entered into a five-year agreement which establishes the basis for EA.com's production of a games site on the world wide web that will be available to AOL subscribers and to users of other branded AOL properties. The Company is required to pay to AOL $81,000,000 over the life of the five-year agreement. Of this amount, $36,000,000 was paid upon signing the agreement with the remainder due in four equal installments on the first four anniversaries of the initial payment. The Company paid AOL $11,250,000 in both fiscal 2002 and 2001. The fair value of the payments made under the AOL agreement was determined by an independent valuation and the resulting amounts are being amortized using the straight-line method (beginning with the site launch) over the remaining term of the five-year agreement. Advances of $38,597,000 and $41,462,000 are included in other long-term assets as of March 31, 2002 and 2001, respectively. The Company made a commitment to spend $15,000,000 in offline media advertisements promoting their online games, including those on the AOL service, prior to March 31, 2005. As of March 31, 2002, the Company has spent approximately $3,500,000 against this commitment. Sale of Class B Common Stock and Warrant to AOL In connection with the agreement with AOL, the Company sold shares of Class B common stock to AOL (the "AOL Shares") representing 10 percent of the initial equity value attributable to EA.com valued at $18,700,000. In addition to the AOL Shares, the Company sold AOL a warrant (the "AOL Warrant") to purchase shares of Class B common stock representing an additional 5 percent of the initial equity value attributable to EA.com for $1,300,000. The aggregate exercise price of the AOL Warrant will be $40,000,000. The AOL Warrant expires at the latest at the fifth anniversary of its date of issuance, and under certain conditions may expire at an earlier date. AOL Exchange Rights AOL may exchange their Class B common stock shares for a number of Class A common stock based on the ratio of per share price paid by AOL for the Class B stock relative to $41.89. As of March 31, 2002, none of the AOL shares have been exchanged for Class A common stock. 65 (6) CONCENTRATION OF CREDIT RISK The Company extends credit to various companies in the retail and mass merchandising industry. Collection of trade receivables may be affected by changes in economic or other industry conditions and may, accordingly, impact the Company's overall credit risk. Although the Company generally does not require collateral, the Company performs ongoing credit evaluations of its customers and reserves for potential credit losses are maintained. For the fiscal year ended March 31, 2002, the Company had receivable balances from one customer which represented 13% of total gross accounts receivables. For the fiscal years ended March 31, 2001 and 2000, there were no customers with receivable balances greater than 10% of total gross accounts receivables. Short-term investments are placed with high credit-quality financial institutions or in short-duration high quality securities. The Company limits the amount of credit exposure in any one institution or type of investment instrument. (7) 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 or results of operations of the Company. (8) PREFERRED STOCK At March 31, 2002 and 2001, the Company had 10,000,000 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. (9) TREASURY STOCK In September 2001, the Board of Directors approved a plan to purchase up to two million shares of the Company's Class A common stock. For the fiscal year ended March 31, 2002, the Company repurchased 280,000 shares for approximately $11,922,000 under the program. In February 2002, all of the 280,000 shares were retired. (10) STOCK PLANS (a) Employee Stock Purchase Plan The Company has an Employee Stock Purchase Plan program whereby eligible employees may authorize payroll deductions of up to 10% of their compensation to purchase shares at 85% of the lower of the fair market value of the Class A Common Stock on the date of commencement of the offering or on the last day of the six-month purchase period. The program commenced in September 1991. A new Employee Stock Purchase Plan program was approved by the Board of Directors in May 2000 and commenced in August 2000. In addition, the Company has a stock purchase plan which was adopted without stockholder approval, the International Employee Stock Purchase Plan. The International Employee Stock Purchase Plan was adopted by the Board of Directors in June 1996 and amended in October 1998, February 1999 and February 2002 and is in all material respects identical to the Employee Stock Purchase Plan approved by the stockholders for US employees. In fiscal 2002, 313,240 shares were purchased by the Company and distributed to employees at prices ranging from $42.45 to $45.05. In fiscal 2001, 350,164 shares were purchased by the Company and distributed to employees at prices ranging from $29.14 to $42.50. In fiscal 2000, 491,046 shares were purchased by the Company and distributed to employees at prices ranging from $16.21 to $29.14. The weighted average fair value of the fiscal 2002, fiscal 2001 and fiscal 2000 awards was $18.88, $18.31 and $10.00, respectively. At March 31, 2002, the Company had 1,009,673 shares of Class A Common Stock reserved for future issuance under the Plans. (b) Stock Option Plans The Company's 2000 Class A Equity Incentive Plan, 1995 Stock Option Plan, and Directors' Plan ("Option Plans") provide options for employees, officers and directors to purchase the Company's Class A common stock. 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 directors, at not less than the fair market value on the date of grant. At the Company's Annual Meeting of Stockholders, held on August 1, 2001, the stockholders elected to amend the 2000 Class A Equity Incentive Plan to increase by 6,000,000 the number of shares of the Company's Class A common stock reserved for issuance under the Plan. Under the Company's stock option plans, 246,000 shares were reissued from treasury stock in fiscal 2000. No shares were distributed from reissued treasury stock in fiscal 2002 or 2001. Together with the Tracking Stock Proposal, the stockholders approved the Electronic Arts Inc. 2000 Class B Equity Incentive Plan. The Class B equity plan allows the award of stock options or restricted stock for up to an aggregate of 6,000,000 shares of Class B common stock. The Class B plan includes a provision for automatic option grants to the Company's outside directors. As of March 31, 2002 there were 225,000 restricted shares issued under the Class B equity plan. The options generally expire ten years from the date of grant and are generally exercisable in monthly increments over 50 66 months. Class B common stock grants will generally vest over 50 months with 2% vesting per month. In the fiscal year 2001, the Board of Directors approved the Key Partner Class B Equity Incentive Program which allows for the issuance of warrants to key business partners to purchase up to 750,000 shares of Class B common stock. As of March 31, 2002, there were 121,000 warrants outstanding under this program. These warrants expire not later than five years from issuance. The Company has an equity compensation stock plan which was adopted without stockholder approval, the Celebrity and Artist Stock Option Plan. The Celebrity and Artist Stock Option Plan was adopted by the Board of Directors in July 1994 and amended in May 1997, October 1997, September 1998 and July 1999. The terms under this plan are substantially similar to the terms of the 2000 Class A Equity Incentive Plan. The Company has adopted the disclosure-only provisions of SFAS 123, "Accounting for Stock Based Compensation". Accordingly, no compensation expense has been recognized for options granted under the Company's employee-based stock option plans. Had compensation expense been determined based on the fair value at the grant dates for awards under those plans in accordance with the provisions of SFAS 123, the Company's pro forma net income (loss) and net income (loss) per share for fiscal 2002, 2001 and 2000 would have been: Consolidated (In thousands, except per share data) - ----------------------------------------------------------------- 2002 2001 2000 - ----------------------------------------------------------------- Net income (loss): As reported $101,509 $(11,082) $116,751 Pro forma $ 27,913 $(69,350) $ 78,380 Earnings per share: As reported - basic N/A N/A $ 0.93 Pro forma - basic N/A N/A $ 0.62 As reported - diluted N/A N/A $ 0.88 Pro forma - diluted N/A N/A $ 0.60 - ----------------------------------------------------------------- Class A Common Stock (In thousands, except per share data) - ----------------------------------------------------------------- 2002 2001 2000 - ----------------------------------------------------------------- Net income (loss): As reported - basic $124,256 $ 11,944 N/A Pro forma - basic $ 51,505 $(45,493) N/A As reported - diluted $101,509 $(11,082) N/A Pro forma - diluted $ 27,913 $(69,350) N/A Earnings (loss) per share: As reported - basic $ 0.91 $ 0.09 N/A Pro forma - basic $ 0.38 $ (0.35) N/A As reported - diluted $ 0.71 $ (0.08) N/A Pro forma - diluted $ 0.20 $ (0.53) N/A - ----------------------------------------------------------------- The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted-average assumptions are used for grants made in 2002, 2001 and 2000 under the stock plans: risk-free interest rates of 2.22% to 4.51% in 2002; 4.59% to 6.55% in 2001; and 4.93% to 6.54% in 2000; expected volatility of 72% in fiscal 2002, 74% in fiscal 2001 and 65% in fiscal 2000; expected lives of 2.25 years in fiscal 2002, 2.32 years in fiscal 2001 and 2.29 years in fiscal 2000 under the Option Plans and one year for the Employee Stock Purchase Plan. No dividends are assumed in the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized when they occur. Class B Common Stock (In thousands, except per share data) - ----------------------------------------------------------------- 2002 2001 2000 - ----------------------------------------------------------------- Net loss: As reported $(22,747) $(23,026) N/A Pro forma $(23,592) $(23,857) N/A Loss per share: As reported - basic $ (3.77) $ (3.83) N/A Pro forma - basic $ (3.92) $ (3.97) N/A As reported - diluted $ (3.77) $ (3.83) N/A Pro forma - diluted $ (3.92) $ (3.97) N/A - ----------------------------------------------------------------- The fair value of each Class B option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The assumptions used were the same as those for Class A. 67 Additional information regarding options outstanding for Class A as of March 31, 2002 is as follows:
Options Outstanding Options Exercisable ----------------------------------------------------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Number of Contractual Exercise Number of Exercise Range of Exercise Prices Shares Life Price Shares Price - ------------------------------------------------------------------------------------------------------------- $ 0.995 - $ 14.938 2,467,771 3.72 $11.88 2,460,911 $11.88 15.000 - 18.563 2,320,347 5.05 17.34 1,444,878 17.00 19.000 - 23.563 2,582,951 6.41 21.81 1,960,239 21.82 23.625 - 28.500 503,344 6.97 26.25 328,980 26.17 28.969 - 29.875 2,848,273 7.40 29.82 1,490,328 29.82 30.844 - 44.500 2,586,540 8.32 39.55 854,492 38.48 44.688 - 46.540 2,796,244 9.33 46.47 377,795 46.33 46.938 - 49.500 3,153,199 8.51 49.30 1,009,540 49.32 49.688 - 57.040 2,888,196 9.17 54.94 215,854 53.91 57.170 - 63.130 670,795 9.39 59.35 81,056 59.23 - ------------------------------------------------------------------------------------------------------------- $ 0.995 - $ 63.130 22,817,660 7.42 $35.51 10,224,073 $26.04 =============================================================================================================
Additional information regarding options outstanding for Class B as of March 31, 2002 is as follows:
Options Outstanding Options Exercisable ----------------------------------------------------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Number of Contractual Exercise Number of Exercise Range of Exercise Prices Shares Life Price Shares Price - ------------------------------------------------------------------------------------------------------------- $ 9.000 2,611,719 8.00 $ 9.00 1,553,510 $ 9.00 10.000 65,275 8.34 10.00 27,952 10.00 12.000 1,484,171 8.96 12.00 425,937 12.00 - ------------------------------------------------------------------------------------------------------------- $ 9.000 - $ 12.000 4,161,165 8.35 $10.09 2,007,399 $ 9.65 =============================================================================================================
68 The following summarizes the activity under the Company's Class A stock option plans during the fiscal years ended March 31, 2002, 2001 and 2000:
---------------------------------------------- Options Outstanding ---------------------------------------------- Weighted-Average Shares Exercise Price ---------------------------------------------- Balance at March 31, 1999 22,878,518 $15.33 Granted 7,815,952 31.92 Canceled (1,721,172) 21.68 Exercised (6,039,390) 12.42 ---------------------------------------------- Balance at March 31, 2000 (8,907,324 shares were exercisable at a weighted average price of $14.93) 22,933,908 21.30 Granted 5,851,961 46.05 Canceled (1,746,449) 15.71 Exercised (5,495,281) 31.15 ---------------------------------------------- Balance at March 31, 2001 (8,902,789 shares were exercisable at a weighted average price of $20.55) 21,544,139 28.66 Granted 6,313,776 51.29 Canceled (1,358,690) 36.14 Exercised (3,681,565) 22.27 ---------------------------------------------- Balance at March 31, 2002 22,817,660 $35.51 ---------------------------------------------- Options available for grant at March 31, 2002 3,510,216
The following summarizes the activity under the Company's Class B stock option plan during the fiscal years ended March 31, 2002 and 2001:
---------------------------------------------- Options Outstanding ---------------------------------------------- Weighted-Average Shares Exercise Price ---------------------------------------------- Balance at March 31, 2000 - $ - Granted 5,785,792 9.62 Canceled (429,310) 9.28 Exercised (250,000) 9.00 ---------------------------------------------- Balance at March 31, 2001 (21,990 shares were exercisable at a weighted average price of $9.57) 5,106,482 9.68 Granted 977,983 12.00 Canceled (1,923,220) 9.99 Exercised (80) 9.00 ---------------------------------------------- Balance at March 31, 2002 4,161,165 $10.09 ---------------------------------------------- Options available for grant at March 31, 2002 2,363,755
69 (11) PROPERTY AND EQUIPMENT Property and equipment at March 31, 2002 and 2001 consisted of: - ----------------------------------------------------------------- 2002 2001 - ----------------------------------------------------------------- (in thousands) Computer equipment and software $ 319,893 $ 310,147 Buildings 97,939 94,784 Land 44,911 44,721 Office equipment, furniture and fixtures 31,915 32,569 Leasehold improvements 15,463 13,483 Warehouse equipment and other 5,396 4,319 - ----------------------------------------------------------------- 515,517 500,023 Less accumulated depreciation and amortization (206,690) (162,824) - ----------------------------------------------------------------- $ 308,827 $ 337,199 - ----------------------------------------------------------------- Depreciation and amortization expenses associated with property and equipment amounted to $67,619,000, $50,345,000 and $34,736,000 for the fiscal years ended March 31, 2002, 2001 and 2000, respectively. (12) ACCRUED AND OTHER LIABILITIES Accrued and other liabilities at March 31, 2002 and 2001 consisted of: - ----------------------------------------------------------------- 2002 2001 - ----------------------------------------------------------------- (in thousands) Accrued income taxes $ 94,444 $ 42,371 Accrued compensation and benefits 87,985 75,603 Accrued expenses 87,104 73,997 Accrued royalties 77,590 55,997 Deferred revenue 13,286 16,967 Warranty reserve 4,010 2,030 - ---------------------------------------------------------------- $364,419 $266,965 - ---------------------------------------------------------------- (13) BUSINESS COMBINATIONS (a) Pogo Corporation On February 28, 2001, EA.com acquired Pogo Corporation (now referred to as "Pogo") for $43,333,000, including an initial investment of $42,000,000 and the redemption of Pogo preferred stock of $1,333,000. Pogo operates an ad-supported games service that reaches a broad consumer market. Pogo's internet-based family games focus on easy-to-play card, board and puzzle games. The acquisition has been accounted for under the purchase method. The results of operations of Pogo and the estimated fair market values of the acquired assets and liabilities have been included in the consolidated financial statements from the date of acquisition. The adjusted allocation of the excess purchase price over the net tangible assets acquired was $40,516,000, of which, based on management's estimates prepared in conjunction with a third party valuation consultant, $2,719,000 was allocated to purchased in-process research and development and $37,797,000 was allocated to other intangible assets. Amounts allocated to other intangibles include goodwill of $16,927,000, existing technology of $12,505,000, and other intangibles of $8,365,000. The allocation of intangible assets is being amortized on a straight-line basis over lives ranging from three to seven years. Purchased in-process research and development includes the value of products in the development stage that are not considered to have reached technological feasibility or to have alternative future use. Accordingly, this non-recurring item was expensed in the Consolidated Statement of Operations upon consummation of the acquisition. The non-recurring charge for in-process research and development increased diluted loss per share by approximately $0.01 and $0.07 in the fiscal year 2001 for Class A and Class B, respectively. Pogo had various projects in progress at the time of the acquisition. As of the acquisition date, costs to complete Pogo projects acquired were expected to be approximately $1,200,000 in future periods. During fiscal 2002, all of these development projects were completed and launched on Pogo gamesites. In conjunction with the acquisition of Pogo, the Company accrued approximately $100,000 related to direct transaction costs and other related costs. The purchase price for the Pogo transaction was allocated to assets acquired and liabilities assumed as set forth below (in thousands): - --------------------------------------------------- Current assets $ 3,048 Fixed assets 4,998 Other long-term assets 1,969 In-process technology 2,719 Goodwill and other intangibles 37,797 Liabilities (7,198) - --------------------------------------------------- Total cash paid $43,333 - --------------------------------------------------- 70 The following table reflects unaudited pro forma combined results of operations of the Company and Pogo on the basis that the acquisition had taken place on April 1, 1999 (in thousands, except per share data): - ---------------------------------------------------------------------- As Reported Pro Forma - ---------------------------------------------------------------------- Fiscal Year Ended March 31, 2001 - -------------------------------- Net revenues $1,322,273 $1,336,654 Class A common stock: Net income (loss): Basic $ 11,944 $ 475 Diluted $ (11,082) $ (26,292) Net income (loss) per share: Basic $ 0.09 $ 0.00 Diluted $ (0.08) $ (0.20) Number of shares used in computation: Basic 131,404 131,404 Diluted 132,056 132,056 Class B common stock: Net loss, net of retained interest in EA.com $ (23,026) $ (26,767) Net loss per share: Basic $ (3.83) $ (4.45) Diluted $ (3.83) $ (4.45) Number of shares used in computation: Basic 6,015 6,015 Diluted 6,015 6,015 - ---------------------------------------------------------------------- Fiscal Year Ended March 31, 2000 - -------------------------------- Net revenues $1,420,011 $1,422,340 Net income $ 116,751 $ 107,285 Net income per share: Basic $ 0.93 $ 0.85 Diluted $ 0.88 $ 0.81 Number of shares used in computation: Basic 125,660 125,660 Diluted 132,742 132,742 - ---------------------------------------------------------------------- In management's opinion, the unaudited pro forma combined results of operations are not indicative of the actual results that would have occurred had the acquisition been consummated at the beginning of fiscal 2000 or of future operations of the combined companies under the ownership and management of the Company. (b) Kesmai On February 7, 2000, the Company acquired Kesmai Corporation (now referred to as "Kesmai") from News America Corporation ("News Corp") in exchange for $22,500,000 in cash and approximately 206,000 shares of its existing common stock valued at $8,650,000. The Company granted 5 percent of the initial equity attributable to EA.com to News Corp, adjusting the total common stock consideration relating to the acquisition by $703,000 to $9,353,000. The Company has contributed Kesmai to EA.com. The Company also agreed to spend $12,500,000 through the period ended June 1, 2002 in advertising with News Corp or any of its affiliates. In addition, if certain conditions are met, including that a qualified public offering of Class B common stock does not occur within twenty-four months of News Corp's purchase of such shares and all of the Class B outstanding shares have been converted to Class A common stock, then (1) News Corp has the right to (i) exchange Class B common stock for approximately 206,000 shares of Class A common stock, and (ii) receive cash from Electronic Arts in the amount of $9,650,000, and (2) the Company will agree to spend an additional $11,675,000 in advertising with News Corp and its affiliates. The acquisition has been accounted for under the purchase method. The results of operations of Kesmai and the estimated fair market values of the acquired assets and liabilities have been included in the consolidated financial statements from the date of acquisition. The adjusted allocation of the excess purchase price over the net tangible liabilities assumed was $32,815,000, of which, based on management's estimates prepared in conjunction with a third party valuation consultant, $3,869,000 was allocated to purchased in-process research and development and $28,946,000 was allocated to other intangible assets. Amounts allocated to other intangibles include goodwill of $18,932,000, existing technology of $3,992,000, amounts attributed to a prior AOL agreement of $3,131,000 and other intangibles of $2,891,000. The allocation of intangible assets is being amortized over lives ranging from two to seven years. As part of the restructuring plan announced in fiscal 2002 for EA.com, the Company evaluated its intangibles for impairment in accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The Company assessed the recoverability of its intangibles by determining whether the carrying amount of the assets was recoverable through estimated future undiscounted net cash flows. The Company calculated the impairment loss as the amount that the carrying value of the asset exceeded the discounted future cash flows. The Company recorded in restructuring and asset impairment charges a write-off of $1,014,000 related to certain other intangibles associated with Kesmai. These intangibles had remaining lives ranging from 15 to 39 months. Purchased in-process research and development includes the value of products in the development stage that are not 71 considered to have reached technological feasibility or to have alternative future use. Accordingly, this non-recurring item was expensed in the Consolidated Statement of Operations upon consummation of the acquisition. The non-recurring charge for in-process research and development reduced diluted earnings per share by $0.02 in the fiscal year 2000. Kesmai had various projects in progress at the time of the acquisition. As of the acquisition date, costs to complete Kesmai projects acquired were approximately $10,550,000 in future periods. During fiscal 2002 and fiscal 2001, all of these development projects were completed and launched on the EA.com gamesites. The resources were redirected to ongoing live game operations or to building the EA.com publishing platform. As a result, the Company does not anticipate incurring significant future development costs in relation to these projects after fiscal 2002. In conjunction with the acquisition of Kesmai, the Company accrued approximately $200,000 related to direct transaction costs and other related costs. The purchase price for the Kesmai transaction was allocated to assets acquired and liabilities assumed as set forth below (in thousands): - ----------------------------------------------------------------- Current assets $ 605 Fixed assets (net of depreciation) 759 In-process technology 3,869 Goodwill and other intangibles 28,946 Liabilities (2,326) - ----------------------------------------------------------------- Total cash and stock paid $31,853 - ----------------------------------------------------------------- The following table reflects unaudited pro forma combined results of operations of the Company and Kesmai on the basis that the acquisition had taken place on April 1, 1999 (in thousands, except per share data): Year Ended March 31, 2000 - ----------------------------------------------------------------- Net revenues $1,421,313 Net income $ 113,996 Net income per share - basic $ 0.91 Net income per share - diluted $ 0.86 Number of shares used in computation - - basic 125,660 Number of shares used in computation - - diluted 132,742 - ----------------------------------------------------------------- In management's opinion, the unaudited pro forma combined results of operations are not indicative of the actual results that would have occurred had the acquisition been consummated at the beginning of fiscal 2000 or of future operations of the combined companies under the ownership and management of the Company. (c) Square Co., Ltd. In May 1998, the Company and Square Co., Ltd. ("Square"), a leading developer and publisher of entertainment software in Japan, completed the formation of two new joint ventures in North America and Japan. In North America, the companies formed Square Electronic Arts, LLC ("Square EA"), which has exclusive publishing rights in North America for future interactive entertainment titles created by Square. Additionally, the Company has the exclusive right to distribute in North America products published by this joint venture. Either party may terminate the existence of Square EA and the distribution agreement effective March 31, 2003. The Company contributed $3,000,000 and owns a 30% minority interest in this joint venture while Square owns 70%. This joint venture is accounted for under the equity method. In Japan, the companies established Electronic Arts Square KK ("EA Square KK"), which will localize and publish in Japan the Company's properties originally created in North America and Europe, as well as develop and publish original video games in Japan. The Company contributed cash and has a 70% majority ownership interest, while Square contributed cash and owns 30%. Accordingly, the assets, liabilities and results of operations for EA Square KK are included in the Company's Consolidated Balance Sheets and Results of Operations since June 1, 1998, the date of formation. Square's 30% interest in EA Square KK has been reflected as "Minority interest in consolidated joint venture" on the Company's consolidated financial statements. (d) Other Business Combinations Additionally, during the fiscal year ended March 31, 2000, the Company acquired two software development companies. In connection with these acquisitions, the Company incurred a charge of $2,670,000 for acquired in-process technology. The charge was made after the Company concluded that the in-process technology had not reached technological feasibility and had no alternative future use after taking into consideration the potential for usage of the software in different products and resale of the software. (14) INCOME TAXES The Company's pretax income (loss) from operations for the fiscal years ended March 31, 2002, 2001 and 2000 consisted of the following components: - ---------------------------------------------------------------- (in thousands) 2002 2001 2000 - ---------------------------------------------------------------- Domestic $ 17,020 $(27,166) $104,096 Foreign 131,267 13,736 65,718 - ---------------------------------------------------------------- Total pretax income (loss) $148,287 $(13,430) $169,814 - ---------------------------------------------------------------- 72 Income tax expense (benefit) for the fiscal years ended March 31, 2002, 2001 and 2000 consisted of: ==================================================================== (in thousands) Current Deferred Total - -------------------------------------------------------------------- 2002: Federal $60,728 $(44,277) $ 16,451 State 1,048 (672) 376 Foreign 4,306 2,295 6,601 Charge in lieu of taxes from employee stock plans for Class A 22,541 - 22,541 - -------------------------------------------------------------------- $88,623 $(42,654) $ 45,969 - -------------------------------------------------------------------- 2001: Federal $(4,233) $(19,975) $(24,208) State 582 (13,809) (13,227) Foreign 6,981 541 7,522 Charge in lieu of taxes from employee stock plans for Class A 25,750 - 25,750 - -------------------------------------------------------------------- $29,080 $(33,243) $ (4,163) - -------------------------------------------------------------------- 2000: Federal $ 2,766 $ 3,231 $ 5,997 State 299 859 1,158 Foreign 15,573 (2,649) 12,924 Charge in lieu of taxes from employee stock plans 32,563 - 32,563 - -------------------------------------------------------------------- $51,201 $ 1,441 $ 52,642 - -------------------------------------------------------------------- The components of the net deferred tax assets as of March 31, 2002 and 2001 consist of: ==================================================================== (in thousands) 2002 2001 - -------------------------------------------------------------------- Deferred tax assets: Accruals, reserves and other expenses $ 53,891 $ 76,603 Net operating loss carryforwards 50,174 6,662 Tax credits 46,118 27,066 - -------------------------------------------------------------------- Total 150,183 110,331 - -------------------------------------------------------------------- Deferred tax liabilities: Undistributed earnings of DISC (913) (1,189) Prepaid royalty expenses (11,342) (44,678) Fixed assets (35,266) (4,456) - -------------------------------------------------------------------- Total (47,521) (50,323) - -------------------------------------------------------------------- Net deferred tax asset $102,662 $ 60,008 - -------------------------------------------------------------------- At March 31, 2002, deferred tax assets of $38,597,000 and $64,065,000 were included in other current assets and other assets, respectively. At March 31, 2002, the Company had Federal net operating loss carryforwards of approximately $127,000,000 for income tax reporting purposes, which expire in 2021 and 2022. The Company also had state net operating loss carryforwards of approximately $177,000,000 for income tax reporting purposes, which expire beginning in 2006. The Company also has research and experimental tax credits aggregating approximately $25,000,000 and $10,000,000 for federal and California purposes, respectively. The federal credit carryforwards expire from 2006 to 2022. The California credits carry over indefinitely until utilized. The Company also has foreign tax credit carryforwards of approximately $10,500,000, which expire from 2003 to 2007. The differences between the statutory income tax rate and the Company's effective tax rate, expressed as a percentage of income (loss) before provision for (benefit from) income taxes, for the years ended March 31, 2002, 2001 and 2000 were as follows: ==================================================================== 2002 2001 2000 - -------------------------------------------------------------------- Statutory Federal tax rate 35.0% (35.0%) 35.0% State taxes, net of Federal benefit 1.5% (10.0%) 1.5% Differences between statutory rate and foreign effective tax rate (3.0%) 20.2% (2.8%) Research and development credits (3.4%) (4.7%) (1.7%) Other 0.9% (1.5%) (1.0%) - -------------------------------------------------------------------- 31.0% (31.0%) 31.0% - -------------------------------------------------------------------- The Company provides for U.S. taxes on an insignificant portion of the undistributed earnings of its foreign subsidiaries and does not provide taxes on the remainder. The Company has not provided for Federal income tax on approximately $259,000,000 of undistributed earnings of its foreign subsidiaries, since the Company intends to reinvest this amount in foreign subsidiary operations indefinitely. At March 31, 2002, the Company believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. The Company's U.S. income tax returns for the years 1992 through 1995 have been examined by the Internal Revenue Service (IRS). In 1998, the Company received a notice of deficiencies from the IRS. These deficiencies relate primarily to operations in Puerto Rico, which the Company is contesting in Tax Court. The Company substantially prevailed with respect to the principal issues at the Tax Court level. The time for the IRS to appeal has not yet expired. The Company believes that additional liabilities, if any, that arise from the outcome of this examination will not be material to the Company's consolidated financial statements. 73 (15) INTEREST AND OTHER INCOME, NET Interest and other income, net for the years ended March 31, 2002, 2001 and 2000 consisted of: ================================================================= (in thousands) 2002 2001 2000 - ----------------------------------------------------------------- Interest income $16,691 $17,903 $13,744 Gain (loss) on disposition of assets, net (131) (1,778) 8,339 Foreign currency losses (412) (888) (1,781) Foreign currency cost of hedging (3,032) - - Equity in net gain of affiliates 2,999 820 1,138 Other income (expense), net (3,267) 829 (5,412) - ----------------------------------------------------------------- $12,848 $16,886 $16,028 - ----------------------------------------------------------------- (16) Comprehensive Income Statement of Financial Accounting Standards No. 130 ("SFAS 130") requires classification of other comprehensive income in a financial statement and display of other comprehensive income separately from retained earnings and additional paid-in capital. Other comprehensive income includes primarily foreign currency translation adjustments and unrealized gains (losses) on investments. The change in the components of comprehensive income, net of tax, is summarized as follows (in thousands): ================================================================== Foreign Unrealized Accumu- currency gains lated other translation (losses) on comprehen- adjustments investments sive loss - ------------------------------------------------------------------ Balance at March 31, 1999 $ (5,841) $ 3,274 $ (2,567) Other comprehensive loss (339) (3,455) (3,794) - ------------------------------------------------------------------ Balance at March 31, 2000 (6,180) (181) (6,361) Other comprehensive income (loss) (9,439) 3,097 (6,342) - ------------------------------------------------------------------ Balance at March 31, 2001 (15,619) 2,916 (12,703) Other comprehensive income (loss) 1,453 (3,474) (2,021) - ------------------------------------------------------------------ Balance at March 31, 2002 $(14,166) $ (558) $(14,724) - ------------------------------------------------------------------ Change in unrealized gains (losses) on investments, net are shown net of taxes of $(1,561,000), $1,391,000 and $(1,553,000) in fiscal 2002, 2001 and 2000, respectively. The currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries. (17) 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, cash equivalents, short-term investments, receivables, accounts payable and accrued liabilities - the carrying amount approximates fair value because of the short maturity of these instruments. Long-term investments, investments classified as held-to-maturity and marketable securities - fair value is based on quoted market prices. (18) SEGMENT INFORMATION Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures About Segments of an Enterprise and Related Information", establishes standards for the reporting by public business enterprises of information about product lines, geographic areas and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company's chief operating decision maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region and by product lines for purposes of making operating decisions and assessing financial performance. The Company operates in two principal business segments globally: . EA Core business segment: creation, marketing and distribution of entertainment software. . EA.com business segment: creation, marketing and distribution of entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising. Please see the discussion regarding segment reporting in the MD&A. 74 Information about Electronic Arts business segments is presented below for the fiscal years ended March 31, 2002, 2001 and 2000 (in thousands):
- ------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2002 ---------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ------------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,647,502 $ 77,173 $ - $1,724,675 Group sales 4,016 - (4,016)/(a)/ - ---------------------------------------------------------------------- Total net revenues 1,651,518 77,173 (4,016) 1,724,675 ---------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 794,738 12,873 - 807,611 Group cost of goods sold - 4,016 (4,016)/(a)/ - ---------------------------------------------------------------------- Total cost of goods sold 794,738 16,889 (4,016) 807,611 ---------------------------------------------------------------------- Gross profit 856,780 60,284 - 917,064 Operating expenses: Marketing and sales 202,749 20,496 17,864 /(c)/ 241,109 General and administrative 96,919 10,140 - 107,059 Research and development 257,762 59,892 70,082 /(b)/ 387,736 Network development and support - 59,483 (59,483)/(b)/ - Customer relationship management - 10,599 (10,599)/(b)/ - Carriage fee - 17,864 (17,864)/(c)/ - Amortization of intangibles 12,888 12,530 - 25,418 Restructuring and asset impairment charges - 20,303 - 20,303 ---------------------------------------------------------------------- Total operating expenses 570,318 211,307 - 781,625 ---------------------------------------------------------------------- Operating income (loss) 286,462 (151,023) - 135,439 Interest and other income (expense), net 13,472 (624) - 12,848 ---------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 299,934 (151,647) - 148,287 Provision for income taxes 45,969 - - 45,969 ---------------------------------------------------------------------- Income (loss) before minority interest 253,965 (151,647) - 102,318 Minority interest in consolidated joint venture (809) - - (809) ---------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 253,156 $ (151,647) $ - $ 101,509 ========================================================================================================================= Interest income $ 16,641 $ 50 $ - $ 16,691 Depreciation and amortization 51,673 59,228 - 110,901 Identifiable assets 1,529,422 169,952 - 1,699,374 Capital expenditures 38,406 13,112 - 51,518
75
- ------------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2001 -------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ------------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,280,172 $ 42,101 $ - $ 1,322,273 Group sales 2,658 - (2,658)/(a)/ - -------------------------------------------------------------------- Total net revenues 1,282,830 42,101 (2,658) 1,322,273 -------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 640,239 12,003 - 652,242 Group cost of goods sold - 2,658 (2,658)/(a)/ - -------------------------------------------------------------------- Total cost of goods sold 640,239 14,661 (2,658) 652,242 -------------------------------------------------------------------- Gross profit 642,591 27,440 - 670,031 Operating expenses: Marketing and sales 163,928 12,475 8,933 /(c)/ 185,336 General and administrative 93,885 10,156 - 104,041 Research and development 248,534 77,243 63,151 /(b)/ 388,928 Network development and support - 51,794 (51,794)/(b)/ - Customer relationship management - 11,357 (11,357)/(b)/ - Carriage fee - 8,933 (8,933)/(c)/ - Amortization of intangibles 12,829 6,494 - 19,323 Charge for acquired in-process technology - 2,719 - 2,719 -------------------------------------------------------------------- Total operating expenses 519,176 181,171 - 700,347 -------------------------------------------------------------------- Operating income (loss) 123,415 (153,731) - (30,316) Interest and other income, net 16,659 227 - 16,886 -------------------------------------------------------------------- Income (loss) before benefit from income taxes and minority interest 140,074 (153,504) - (13,430) Benefit from income taxes (4,163) - - (4,163) -------------------------------------------------------------------- Income (loss) before minority interest 144,237 (153,504) - (9,267) Minority interest in consolidated joint venture (1,815) - - (1,815) - ------------------------------------------------------------------------------------------------------------------------- Net income (loss) before retained interest in EA.com $ 142,422 $ (153,504) $ - $ (11,082) ========================================================================================================================= Interest income $ 17,809 $ 94 $ - $ 17,903 Depreciation and amortization 45,382 33,219 - 78,601 Identifiable assets 1,167,846 211,072 - 1,378,918 Capital expenditures 51,460 68,887 - 120,347
76
- ----------------------------------------------------------------------------------------------------------------------- Year Ended March 31, 2000 -------------------------------------------------------------------- EA Core Adjustments and (excl. EA.com) EA.com Eliminations Electronic Arts - ----------------------------------------------------------------------------------------------------------------------- Net revenues from unaffiliated customers $ 1,399,093 $ 20,918 $ - $ 1,420,011 Group sales 2,014 - (2,014)/(a)/ -------------------------------------------------------------------- Total net revenues 1,401,107 20,918 (2,014) 1,420,011 -------------------------------------------------------------------- Cost of goods sold from unaffiliated customers 700,024 4,678 - 704,702 Group cost of goods sold - 2,014 (2,014)/(a)/ - -------------------------------------------------------------------- Total cost of goods sold 700,024 6,692 (2,014) 704,702 -------------------------------------------------------------------- Gross profit 701,083 14,226 - 715,309 Operating expenses: Marketing and sales 185,714 2,897 - 188,611 General and administrative 87,513 4,905 - 92,418 Research and development 205,933 34,716 21,317 /(b)/ 261,966 Network development and support - 17,993 (17,993)/(b)/ - Customer relationship management - 3,324 (3,324)/(b)/ - Amortization of intangibles 10,866 1,123 - 11,989 Charge for acquired in-process technology 2,670 3,869 - 6,539 -------------------------------------------------------------------- Total operating expenses 492,696 68,827 - 561,523 -------------------------------------------------------------------- Operating income (loss) 208,387 (54,601) - 153,786 Interest and other income, net 16,017 11 - 16,028 -------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 224,404 (54,590) - 169,814 Provision for income taxes 52,642 - - 52,642 -------------------------------------------------------------------- Income (loss) before minority interest 171,762 (54,590) - 117,172 Minority interest in consolidated joint venture (421) - - (421) - ----------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 171,341 $ (54,590) $ - $ 116,751 ======================================================================================================================= Interest income $ 13,733 $ 11 $ - $ 13,744 Depreciation and amortization 39,818 6,907 - 46,725 Identifiable assets 1,085,411 106,901 - 1,192,312 Capital expenditures 97,279 37,605 - 134,884
(a) Represents elimination of intercompany sales of Electronic Arts packaged goods products to EA.com; and represents elimination of royalties paid to Electronic Arts by EA.com for intellectual property rights. (b) Represents reclassification of Network Development and Support and Customer Relationship Management to Research and Development. (c) Represents reclassification of amortization of the Carriage Fee to Marketing and Sales. 77 Information about Electronic Arts' operations in the North America and foreign areas for the fiscal years ended March 31, 2002, 2001 and 2000 is presented below:
- ---------------------------------------------------------------------------------------------------------------------------------- Asia (in thousands) Pacific North (excluding America Europe Japan) Japan Eliminations Total ---------------------------------------------------------------------------------------- Fiscal 2002 Net revenues from unaffiliated customers $ 1,093,244 $ 519,458 $ 53,376 $ 58,597 $ - $ 1,724,675 Intercompany revenues 2,411 37,533 8,755 55 (48,754) - --------------------------------------------------------------------------------------- Total net revenues 1,095,655 556,991 62,131 58,652 (48,754) 1,724,675 ======================================================================================= Operating income 8,328 121,058 2,277 3,401 375 135,439 Interest income 14,440 2,010 241 - - 16,691 Depreciation and amortization 95,395 13,768 1,091 647 - 110,901 Capital expenditures 39,259 10,350 1,038 871 - 51,518 Identifiable assets 1,325,939 333,825 21,435 18,175 - 1,699,374 Long-lived assets 348,120 158,500 4,469 4,428 - 515,517 Fiscal 2001 Net revenues from unaffiliated customers $ 831,924 $ 386,728 $ 51,039 $ 52,582 $ - $ 1,322,273 Intercompany revenues 11,915 30,996 13,040 3,802 (59,753) - --------------------------------------------------------------------------------------- Total net revenues 843,839 417,724 64,079 56,384 (59,753) 1,322,273 ======================================================================================= Operating income (loss) (31,996) (8,914) 2,962 7,437 195 (30,316) Interest income 14,230 3,271 402 - - 17,903 Depreciation and amortization 71,501 6,510 275 315 - 78,601 Capital expenditures 103,048 15,535 1,104 660 - 120,347 Identifiable assets 1,034,625 300,196 20,364 23,733 - 1,378,918 Long-lived assets 334,398 154,832 3,807 3,806 - 496,843 Fiscal 2000 Net revenues from unaffiliated customers $ 846,637 $ 486,816 $ 53,187 $ 33,371 $ - $ 1,420,011 Intercompany revenues 28,701 30,440 9,059 - (68,200) - --------------------------------------------------------------------------------------- Total net revenues 875,338 517,256 62,246 33,371 (68,200) 1,420,011 ======================================================================================= Operating income 101,919 50,828 1,498 1,921 (2,380) 153,786 Interest income 11,775 1,755 214 - - 13,744 Depreciation and amortization 35,114 9,968 473 1,170 - 46,725 Capital expenditures 78,298 54,379 1,447 760 - 134,884 Identifiable assets 734,626 418,034 18,019 21,633 - 1,192,312 Long-lived assets 244,845 154,475 3,306 3,975 - 406,601
Electronic Arts had sales to one customer which represented 14% of total net revenues in fiscal 2002 and 12% of total net revenues in fiscal 2001 and 2000. 78 Information about Electronic Arts' net revenues by product line for the fiscal years ended March 31, 2002, 2001 and 2000 is presented below (in thousands): - ----------------------------------------------------------------------------- 2002 2001 2000 - ----------------------------------------------------------------------------- PlayStation 2 $ 482,882 $ 258,988 $ - PC 456,292 405,256 395,522 Affiliated label 269,010 222,278 275,333 PlayStation 189,535 309,988 586,821 Xbox 78,363 - - Nintendo Gamecube 51,740 - - Game Boy Advance 43,653 - - Game Boy Color 38,026 - - Advertising 38,024 6,175 - Online Subscriptions 30,940 28,878 16,771 License, OEM and Other 24,762 20,468 22,894 N64 18,152 67,044 120,415 Online Packaged Goods 3,296 3,198 2,255 - ----------------------------------------------------------------------------- $1,724,675 $1,322,273 $1,420,011 - ----------------------------------------------------------------------------- 79 (19) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES In October 2001, the Company announced a restructuring plan for EA.com. The restructuring initiatives involved strategic decisions to discontinue certain product offerings and focus only on key online priorities that align with its fiscal 2003 operational objectives. The workforce reduction resulted in the termination of approximately 270 positions. During fiscal 2002, the Company recorded restructuring charges of $20,303,000, consisting of $4,173,000 for workforce reductions, $3,312,000 for consolidation of facilities and other administrative charges, and $12,818,000 for the write-off of non-current assets and facilities. The estimated costs for workforce reduction included severance charges for terminated employees and costs for certain outplacement service contracts. The consolidation of facilities resulted in the closure of EA.com's San Diego studio and consolidation of its San Francisco and Virginia facilities. The estimated costs for consolidation of facilities included contractual rental commitments under real estate leases for unutilized office space offset by estimated future sub-lease income, costs to close or consolidate facilities, and costs to write off a portion of the assets from these facilities. The Company recorded restructuring charges for EA.com in accordance with Emerging Issues Task Force No. 94-03, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)", Emerging Issues Task Force No. 95-03, "Recognition of Liabilities in Connection with a Purchase Business Combination", and Staff Accounting Bulletin No. 100, "Restructuring and Impairment Charges". Adjustments to the restructuring reserves will be made in future periods, if necessary, based upon current events and circumstances. As part of the restructuring efforts, the Company assessed the remaining useful lives of goodwill, purchased intangible assets and other long-lived assets and tested the recoverability of its long-lived assets in accordance with SFAS 121. Management evaluated the impact of consolidating or abandoning certain EA.com technologies and processes and reviewed the effect of changes to EA.com's subscription product offerings in relation to EA.com's asset base. Based on computations of estimated future net cash flows attributable to these assets and product offerings, it was determined that there was a need to reduce the value of certain assets on our balance sheet to reflect their estimated fair value. Impairment charges on long-lived assets amounted to $12,818,000 and included $11,177,000 relating to consolidated or abandoned technologies for the EA.com infrastructure and $1,641,000 of goodwill and intangibles impairment charges relating to the EA.com's San Diego and Kesmai studios. There are no assurances that the impairment factors evaluated by management will not change in subsequent periods and accordingly, this could result in additional impairment charges in future periods. The pre-tax restructuring charge of $20,303,000 consisted of $6,836,000 in cash outlays and $13,467,000 in non-cash charges related to the write-offs of non-current assets and facilities. As of March 31, 2002, an aggregate of $4,016,000 in cash had been paid out under the restructuring plan. Of the remaining cash outlay of $2,820,000, $1,590,000 is expected to occur in fiscal 2003 while the remaining $1,230,000 will occur in fiscal years 2004 and beyond. The following table summarizes the activity in the accrued restructuring account in fiscal 2002 (in thousands):
- ----------------------------------------------------------------------------------------------------------- Non-Current Workforce Facilities Assets Total - ----------------------------------------------------------------------------------------------------------- Charged to operations in fiscal 2002 $ 4,173 $ 3,312 $ 12,818 $ 20,303 Charges utilized in cash in fiscal 2002 (3,499) (517) - (4,016) Charges utilized in non-cash in fiscal 2002 - (581) (12,818) (13,399) --------------------------------------------------------- Accrual balance as of March 31, 2002 $ 674 $ 2,214 $ - $ 2,888 =========================================================
The restructuring accrual is included in accrued expenses in Note 12 of the Notes to Consolidated Financial Statements. 80 ELECTRONIC ARTS AND SUBSIDIARIES QUARTERLY FINANCIAL AND MARKET INFORMATION (UNAUDITED) (In thousands, except per share data)
Quarter Ended Year June 30 Sept. 30 Dec. 31 March 31 Ended - ------------------------------------------------------------------------------------------------------------------------- Fiscal 2002 Consolidated Net revenues $ 181,950 $ 240,156 $ 832,878 $ 469,691 $ 1,724,675 Operating income (loss) (68,378) (52,057) 188,501 67,373 135,439 Net income (loss) (45,254)/(a)/ (32,824)/(a)/ 132,292/(b)/ 47,295/(c)/ 101,509 Class A Stockholders Net income (loss) per share - basic $ (0.29) $ (0.20) $ 1.01 $ 0.38 $ 0.91 Net income (loss) per share - diluted $ (0.33) $ (0.24) $ 0.92 $ 0.33 $ 0.71 Common stock price per share High $ 63.04 $ 60.60 $ 66.01 $ 62.95 $ 66.01 Low $ 48.31 $ 44.50 $ 42.40 $ 51.16 $ 42.40 Class B Stockholders Net loss per share - basic $ (0.98) $ (0.93) $ (1.11) $ (0.76) $ (3.77) Net loss per share - diluted $ (0.98) $ (0.93) $ (1.11) $ (0.76) $ (3.77) Common stock price per share High N/A N/A N/A N/A N/A Low N/A N/A N/A N/A N/A Fiscal 2001 Consolidated Net revenues $ 154,799 $ 219,900 $ 640,319 $ 307,255 $ 1,322,273 Operating income (loss) (64,377) (60,154) 125,368 (31,153) (30,316) Net income (loss) (42,271)/(d)/ (38,909)/(e)/ 87,978/(d)/ (17,880)/(f)/ (11,082) Class A Stockholders Net income (loss) per share - basic $ (0.30) $ (0.27) $ 0.72 $ (0.07) $ 0.09 Net income (loss) per share - diluted $ (0.33) $ (0.30) $ 0.63 $ (0.13) $ (0.08) Common stock price per share High $ 39.06 $ 54.47 $ 55.38 $ 56.13 $ 56.13 Low $ 26.59 $ 37.06 $ 35.19 $ 29.84 $ 26.59 Class B Stockholders Net loss per share - basic $ (0.61) $ (0.67) $ (1.24) $ (1.31) $ (3.83) Net loss per share - diluted $ (0.61) $ (0.67) $ (1.24) $ (1.31) $ (3.83) Common stock price per share High N/A N/A N/A N/A N/A Low N/A N/A N/A N/A N/A Fiscal 2000 Net revenues $ 186,120 $ 338,887 $ 600,691 $ 294,313 $ 1,420,011 Operating income (loss) (849) 23,697 129,536 1,402 153,786 Net income 2,326/(g)/ 18,132/(g)/ 92,861/(g)/ 3,432/(h)/ 116,751 Net income per share - basic $ 0.02 $ 0.15 $ 0.73 $ 0.03 $ 0.93 Net income per share - diluted $ 0.02 $ 0.14 $ 0.69 $ 0.03 $ 0.88 Common stock price per share High $ 27.41 $ 38.10 $ 60.47 $ 51.10 $ 60.47 Low $ 22.82 $ 26.44 $ 33.22 $ 34.50 $ 22.82
(a) Net loss includes goodwill amortization of $4.5 million, net of taxes. (b) Net income includes restructuring and asset impairment charges of $9.7 million, net of taxes, as well as goodwill amortization of $4.3 million, net of taxes. (c) Net income includes restructuring and asset impairment charges of $4.3 million, net of taxes, as well as goodwill amortization of $4.2 million, net of taxes. (d) Net income (loss) includes goodwill amortization of $3.2 million, net of taxes. 81 (e) Net loss includes goodwill amortization of $3.3 million, net of taxes. (f) Net loss includes one-time acquisition related charges of $1.9 million, net of taxes, incurred in connection with the acquisition of Pogo as well as goodwill amortization of $3.6 million, net of taxes. (g) Net income includes goodwill amortization of $1.8 million, net of taxes. (h) Net income includes one-time acquisition related charges of $4.5 million, net of taxes, incurred in connection with the acquisition of Kesmai and other business combinations made during the quarter as well as goodwill amortization of $2.9 million, net of taxes. The Company's common stock is traded in the over-the-counter market under the Nasdaq Stock Market symbol ERTS. The closing prices for the common stock in the table above represent the high and low closing prices as reported on the Nasdaq National Market. 82 Item 9: Changes In and Disagreements With Accountants on Accounting and Financial Disclosure Not applicable. 83 PART III Item 10: Directors and Executive Officers of the Registrant The information regarding directors who are nominated for election required by Item 10 is incorporated herein by reference to the information in our definitive Proxy Statement for the 2002 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 "Compensation of Executive Officers" specifically excluding the "Compensation Committee Report on Executive Compensation". Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by Item 12 is incorporated herein by reference to the information in the Proxy Statement under the captions "Principal Stockholders" and "Equity Compensation Plan Information". 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". 84 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 53 Consolidated Balance Sheets as of March 31, 2002 and 2001 54 Consolidated Statements of Operations for the Years Ended March 31, 2002, 2001 and 2000 55 Consolidated Statements of Stockholders' Equity for the Years Ended March 31, 2002, 2001 and 2000 56 Consolidated Statements of Cash Flows for the Years Ended March 31, 2002, 2001 and 2000 58 Notes to Consolidated Financial Statements for the Years Ended March 31, 2002, 2001 and 2000 59- 82
2. Financial Statement Schedule. ---------------------------- The following financial statement schedule of Electronic Arts for the years ended March 31, 2002, 2001 and 2000 is filed as part of this report and should be read in conjunction with the Consolidated Financial Statements of Electronic Arts. Schedule II - Valuation and Qualifying Accounts Other financial statement schedules are omitted because the information called for is not required or is shown either in the Consolidated Financial Statements or the notes thereto. 3. Exhibits. -------- The following exhibits are filed as part of, or incorporated by reference into, this report: Number Exhibit Title ------ ------------- 3.01 Registrant's Certificate of Incorporation, as amended to December 1, 1992. (1) 3.02 Registrant's Certificate of Amendment of Certificate of Incorporation. (2) 3.03 Registrant's By-Laws, as amended to date. (3) 3.04 Amended and Restated Certificate of Incorporation of Electronic Arts Inc. (35) 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 2003 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) 85 Number Exhibit Title ------ ------------- 10.06 Lease by and between Registrant and H.G.C. Associates, dated June 24, 1992, for the Registrant's warehouse and production facilities. (10) 10.07 Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated March 22, 1991. (11) 10.08 Registrants' 1991 Stock Option Plan and related documents as amended. (6) (12) 10.09 Form of Indemnity Agreement with Directors. (13) 10.10 Registrants' Employee Stock Purchase Plan and related documents as amended. (6) (14) 10.11 Lease Agreement by and between Registrant and The Canada Life Assurance Company, dated December 20, 1991, for the Registrant's Canadian facilities. (15) 10.13 Amendment to Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated March 22, 1991. (17) 10.14 Agreement between Registrant and Sega Enterprises, Ltd., dated July 14, 1992. (18) (19) 10.15 Lease Agreement by and between Registrant and Century Centre II Associates, dated July 27, 1992. (19) 10.16 Amendment to Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated October 1, 1992. (19) 10.17 Amendment to Lease Agreement by and between Registrant and Century Centre II Associates, dated February 2, 1993. (19) 10.18 Amendment to Lease Agreement by and between Registrant and Century Centre II Associates, dated February 22, 1993. (19) 10.19 Directors and Officers and Company Reimbursement Indemnity Policy by and between Registrant and certain underwriters at Lloyd's, London and Continental Insurance Company, dated June 20, 1993. (19) 10.20 Lease by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated August 27, 1992 for additional space at corporate headquarters. (10) 10.22 Lease by and between Registrant, Electronic Arts Limited and Heron Slough Limited, dated June 12, 1992, for the Registrant's U.K. facilities. (20) 10.23 Lease by and between Registrant and the Travelers Insurance Company, dated April 14, 1993, for the Registrant's production facilities. (21) 10.24 Amendment to Lease Agreement by and between Registrant and 1450 Fashion Island Boulevard Associates, L.P., dated June 1, 1993. (22) 10.25 Amendment to Lease Agreement by and between Registrant and the Travelers Insurance Company, dated November 30, 1993. (23) 10.26 Amendment to Lease Agreement by and between Registrant and the Travelers Insurance Company, dated November 30, 1993. (23) 10.27 Lease Agreement by and between Registrant and Arthur J. Rogers & Co., dated January 14, 1994. (24) 10.28 Lease Agreement by and between Registrant and the Prudential Insurance Company of America, dated January 10, 1994. (24) 10.29 Agreement for Lease between Flatirons Funding, LP and Electronic Arts Redwood, Inc. dated February 14, 1995. (25) 10.30 Guarantee from Electronic Arts Inc. to Flatirons Funding, LP dated February 14, 1995. (25) 86 Number Exhibit Title ------ ------------- 10.31 Lease Agreement by and between Registrant and Dixie Warehouse & Cartage Co., dated April 10, 1995. (25) 10.32 Commercial Earnest Money Contract between Novell, Inc. and ORIGIN Systems, Inc. dated April 13, 1995. (26) 10.33 First Amendment to Commercial Earnest Money Contract between Novell, Inc. and ORIGIN Systems, Inc. dated June 1, 1995. (27) 10.34 Amendment No. 1 to Agreement between Registrant and Sega Enterprises, Inc. effective December 31, 1995. (28) 10.35 Lease Agreement by and between Registrant and Don Mattrick dated October 16, 1996. (29) 10.36 Amended and Restated Guaranty from Electronic Arts Inc. to Flatirons Funding, LP dated March 7, 1997. (30) 10.37 Amended and Restated Agreement for Lease between Flatirons Funding, LP and Electronic Arts Redwood Inc. dated March 7, 1997. (30) 10.38 Amendment No. 1 to Lease Agreement between Electronic Arts Redwood Inc. and Flatirons Funding, LP dated March 7, 1997. (30) 10.39 Employment Agreement by and between the Registrant and John Riccitiello dated August 29, 1997. (31) 10.40 Lease Agreement by and between Registrant and John Riccitiello dated August 29, 1997. (31) 10.41 Employment Agreement by and between Registrant and James "Rusty" Russell Rueff, Jr. dated September 9, 1998. (32) 10.42 Lease Agreement by and between Registrant and Louisville Commerce Realty Corporation, dated April 1, 1999. (32) 10.43 Option agreement, agreement of purchase and sale, and escrow instructions for Zones 2 and 4, Electronic Arts Business Park, Redwood Shores California, dated April 5, 1999. (32) 10.44 Lease Agreement by and between Registrant and Spieker Properties, L.P., dated September 3, 1999. (33) 10.45 Master Lease and Deed of Trust by and between Registrant and Selco Service Corporation, dated December 6, 2000. (34) 10.46 Amendment No. 1 to Amended and Restated Credit Agreement by and among Flatirons Funding LP and The Dai-Ichi Kangyo Bank, Limited, New York Branch, dated February 21, 2001. (36) 10.47 Residential Purchase Agreement by and between Registrant and John Riccitiello, dated August 14, 2000. (36) 10.48 Office Service Agreement by and between Pogo.com Inc and 300 California Associates, LLC, dated September 17, 1999. (36) 10.49 Office Lease Agreement by and between Pogo.com Inc and Fifth Avenue LLC, dated May 5, 2000. (36) 10.50 Office Lease Agreement by and between Registrant and California Plaza of Walnut Creek, Inc., dated February 1, 2001. (36) 10.51 Assignment and Assumption of Lease by and between Registrant and Leap Wireless International, Inc., dated January 29, 2002. 10.52 Amendment No. 2 to Lease Agreement by and between Electronic Arts Redwood, Inc. and Flatirons Funding, LP dated July 16, 2001. 87 10.53 Participation Agreement among Electronic Arts Redwood, Inc., Electronic Arts, Inc., Flatirons Funding, LP, Selco Service Corporation and Selco Redwood, LLC, Victory Receivables Corporation, The Bank of Toyko-Mitsubishi, Ltd., various Liquidity Banks and Tranche B Banks and Keybank National Association dated July 16, 2001. 21.01 Subsidiaries of the Registrant. 23.01 Consent of KPMG, LLP, Independent Auditors. 23.02 Consent of Ernst & Young LLP, Independent Auditors (32) 99.01 Report of Ernst & Young LLP, Independent Auditors (32) ------------------------------------------------------------------ (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. (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. 88 (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 reference to Exhibit 10.02 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995. (28) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 1996 (the "1996 Form 10-K"). (29) Incorporated by reference to Exhibit 10.35 to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1996. (30) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 1997 (the "1997 Form 10-K"). (31) Incorporated by reference to similarly numbered exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 1997. (32) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 1999 (the "1999 Form 10-K"). 89 (33) Incorporated by reference to similarly numbered exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. (34) Incorporated by reference to similarly numbered exhibits to Registrant's Quarterly Report on Form 10-Q for the quarter ended December 31, 2000. (35) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 2000 (the "2000 Form 10-K"). (36) Incorporated by reference to similarly numbered exhibits to Registrant's Annual Report on Form 10-K for the year ended March 31, 2001 (the "2001 Form 10-K"). (b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended March 31, 2002. (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 92. 90 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 28, 2002 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 28th of June 2002. Name Title ---- ----- /s/ Lawrence F. Probst III Chairman of the Board - ------------------------------------ and Chief Executive Officer (Lawrence F. Probst III) /s/ E. Stanton McKee, Jr. Executive Vice President and Chief - ------------------------------------ Financial and Administrative Officer (E. Stanton McKee, Jr.) /s/ David L. Carbone Senior Vice President, Finance - ------------------------------------ (Principal Accounting Officer) (David L. Carbone) Directors: /s/ M. Richard Asher Director - ------------------------------------ (M. Richard Asher) /s/ William J. Byron Director - ------------------------------------ (William J. Byron) /s/ Leonard S. Coleman Director - ------------------------------------ (Leonard S. Coleman) /s/ Gary M. Kusin Director - ------------------------------------ (Gary M. Kusin) /s/ Timothy J. Mott Director - ------------------------------------ (Timothy J. Mott) /s/ Linda J. Srere Director - ------------------------------------ (Linda J. Srere) 91 ELECTRONIC ARTS INC. AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years Ended March 31, 2002, 2001 and 2000 (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, 2002 Allowance for doubtful accounts and returns $ 89,833 $ 183,847 $ (3,947) $ 153,863 $ 115,870 ========= ========= ========= ========= ========= Year Ended March 31, 2001 Allowance for doubtful accounts and returns $ 65,067 $ 212,263 $ (3,126) $ 184,371 $ 89,833 ========= ========= ========= ========= ========= Year Ended March 31, 2000 Allowance for doubtful accounts and returns $ 72,850 $ 179,952 $ 39 $ 187,774 $ 65,067 ========= ========= ========= ========= =========
(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) and other reclassification adjustments. 92 ELECTRONIC ARTS INC. 2002 FORM 10-K ANNUAL REPORT EXHIBIT INDEX EXHIBIT NUMBER EXHIBIT TITLE - ------ ------------- 10.03 Description of Registrant's FY 2003 Executive Bonus Plan 10.51 Assignment and Assumption of Lease by and between Registrant and Leap Wireless International, Inc., dated January 29, 2002. 10.52 Amendment No. 2 to Lease Agreement by and between Electronic Arts Redwood, Inc. and Flatirons Funding, LP dated July 16, 2001. 10.53 Participation Agreement among Electronic Arts Redwood, Inc., Electronic Arts, Inc., Flatirons Funding, LP, Selco Service Corporation and Selco Redwood, LLC, Victory Receivables Corporation, The Bank of Toyko-Mitsubishi, Ltd., various Liquidity Banks and Tranche B Banks and Keybank National Association dated July 16, 2001. 21.01 Subsidiaries of the Registrant 23.01 Consent of KPMG, LLP, Independent Auditors - ---------- 93 EX-10.03 3 dex1003.txt DESCRIPTION OF REGISTRANT'S FY2003 EXEC BONUS PLAN EXHIBIT 10.03 ELECTRONIC ARTS INC. AND SUBSIDIARIES DESCRIPTION OF REGISTRANT'S FISCAL YEAR 2003 EXECUTIVE BONUS PLAN Target annual bonuses are set for each executive based upon a percentage of base salary. Bonuses are generally paid in two parts, one of which relates only to the Company's earnings results, and one of which is discretionary and is measured against each individual executive's contributions. Some executives may have a third part which relates to a specific business unit's or product's financial performance. Bonuses are paid after the end of the fiscal year. If profits in any period are less than 85% of the Company's plan, no bonus based on the Company's performance may be paid for that period. If profits exceed plan during a period, the bonus rate is accelerated for the incremental profits above plan, with a maximum of 200% payout of the bonus target. EX-10.51 4 dex1051.txt ASSIGNMENT AND ASSUMPTION OF LEASE DTD 1/29/2002 EXHIBIT 10.51 ASSIGNMENT AND ASSUMPTION OF LEASE This Assignment and Assumption of Lease (the "Assignment") is made on January 29, 2002 by and between Leap Wireless International, Inc., a Delaware corporation, with a place of business at 10307 Pacific Center Ct., San Diego, California 92121 ("Leap" or "Assignee"), and Electronic Arts Inc., a Delaware corporation, with a place of business at 209 Redwood Shores Parkway, Redwood City, California 94065 ("Electronic Arts" or "Assignor"). Leap and EA may be referred to from time to time in this Agreement individually as a "Party" and collectively as the "Parties." RECITALS: This Assignment is made with regard to the following facts: A. Landlord, (as successor in interest to Spieker Properties, L.P.) as landlord, and Assignor, as tenant, are parties to that certain Office Lease dated September 3, 1999 (the "Office Lease"), as amended by that certain First Amendment to Lease dated February 14, 2000 (the "First Amendment") (collectively, the "Lease") pursuant to which Landlord has leased to Assignor certain premises containing approximately 10,981 rentable square feet (the "Premises") known as Suite No. 200 on the 2nd floor of the building commonly known as Pacific Ridge Corporate Centre and located at 5790 Fleet Street, Carlsbad, CA 92008 (the "Building"). A copy of the Office Lease and the First Amendment are attached hereto as Exhibit A and are incorporated by reference; and B. Assignor desires to assign its rights, title, and interest in, to, and under the Lease and the Premises to Assignee, and Assignee desires to accept that assignment on, and subject to, all of the terms and conditions in this Assignment and the Landlord's Consent to Assignment and Assumption Agreement. C. Landlord has agreed to the terms of this Assignment and has agreed to execute a written consent agreement (the "Consent Agreement") for this Assignment. NOW THEREFORE, in consideration of the mutual covenants contained in this Agreement, and for valuable consideration, the receipt and sufficiency of which are acknowledged by the parties, the parties agree as follows. 1. Assignment and Assumption. Assignor assigns to Assignee all of its rights, title and interest to, and under the Lease and the Premises (including all of Assignor's rights, title, and interest in and to any prepaid rents that have been paid by Assignor under the Lease for any period before or after the Effective Date (as defined in Section 10 below) of this Assignment). Subject to Section 10 hereof, Assignee accepts this assignment, assumes all of Assignor's rights and obligations under the Lease from and after the Effective Date of the assignment, and agrees 1 to be bound by all of the provisions of the Lease and to perform all of the obligations of the tenant under the Lease as a direct obligation to Landlord from and after the Effective Date of the assignment. This assignment and assumption is made on, and is subject to, all of the terms, conditions, and covenants of this Assignment. 2. Condition of Premises. The Premises will be delivered by Assignor to Assignee in good condition and repair, ordinary wear-and-tear excepted, and in broom-clean condition including all Tenant Improvements constructed under the Improvement Agreement under the Lease and any Alterations thereafter. All Tenant Improvements and Alterations shall become the property of Assignee on the Effective Date of this Assignment, subject to the terms of the Lease. 3. Assignor's Representations and Warranties. Assignor represents and warrants that the Premises, the Tenant Improvements and the Alterations are not subject to any liens, conditional sales contracts, or other encumbrances, except for any rights the Landlord may have in the Premises, as provided in the Lease. Assignor further represents and warrants that: . Assignor is not in default under the Lease as of the time of the Effective Date of the Assignment; . Assignor has not stored, deposited or used any toxic or hazardous materials on the Premises; . All Tenant Improvements and Alterations on the Premises have been approved by the Landlord. . The Lease attached hereto as Exhibit A is a true, accurate, complete and up-to-date copy of the lease and all amendments and modifications thereto 4. Obligations of Assignor and Assignee. a) Assignor agrees to provide keys and/or cards to the Premises and the Building on the Effective Date of the Assignment, to pay for all charges for Operating Expenses (including, but not limited to, CAM's, insurance, taxes and repairs) up to the Effective Date of the Assignment, and to pay all costs of the assignment in accordance with the terms of the Lease. Assignor shall promptly remove its signs from the Premises and from the Building and shall pay for and repair any damage resulting from said removal. Assignor also agrees to transfer and assign to Assignee all of its rights, title, and interest in the security deposit held by the Landlord. b) Assignee agrees to reimburse Assignor for Assignee's pro-rata portion of the January 2002 rent, including the pro rata portion of January Operating Expenses, for the period of time between the Effective Date and January 31, 2002. Assignee's pro-rata share of the January rent for the Premises shall be computed based on a monthly rent amount of $22,270.00 and a 31-day month. Assignee also agrees to reimburse Assignor for the Security Deposit paid by Assignor in the amount of nineteen thousand five hundred dollars ($19,500.00). Assignee shall pay the Security Deposit and the pro-rata share of the rent within thirty (30) days from the Effective Date. 2 c) Assignor agrees to defend, indemnify and hold harmless Assignee, its officers, directors, agents and employees (the "Indemnitees"), from and against any and all claims, costs and expenses (including reasonable attorney fees) resulting or arising from any claims by or on behalf of any person(s) or entity(s), due to the following events or actions occurring prior to the Effective Date of this Assignment: . Assignor's use, occupancy, or conduct, or any work or thing whatsoever done by Assignor in or about, the Premises; . Assignor's use, occupancy, or conduct relating to the Common Areas; . Claims or causes of action arising from any condition of the Premises created by Assignor, or arising from any breach or default on the part of Assignor in the performance of any covenant pursuant to the terms of the Lease; . Claims or causes of action (including, but not limited to, accidents, bodily injury (including death) or property damage) arising from any acts or omissions of Assignor, or any of Assignor's agents, contractors, servants, employees or licensees. In the event that any action or proceeding is brought against Assignee by reason of any of the above, Assignee shall promptly notify Assignor, and Assignor covenants to resist or defend such action or proceeding at Assignor's sole cost, including settlement costs; provided, however, that Assignee shall have the right, but not the obligation, to participate in its defense with its own counsel to the extent Assignee desires and deems appropriate in its sole discretion. 5. Further Assurances. Each party to this Assignment will, at its own cost and expense, execute and deliver such further documents and instruments and will take such other actions as may be reasonably required or appropriate to evidence or carry out the intent and purposes of this Assignment. 6. Entire Assignment; Waiver. This Assignment constitutes the final, complete and exclusive statement between the parties to this Assignment pertaining to the terms of Assignor's assignment of the Lease and the Premises to Assignee, supersedes all prior and contemporaneous understandings or agreements of the parties, and is binding on and inures to the benefit of their respective heirs, representatives, successors and assigns. Neither party has been induced to enter into this Assignment by, nor is either party relying on any representation or warranty outside those expressly set forth in this Assignment. Any agreement made after the date of this Assignment is ineffective to modify, waive, or terminate this Assignment, in whole or in part, unless that agreement is in writing, is signed by the parties to this Assignment, and specifically states that the agreement modifies this Assignment. 7. Governing Law. This Assignment will be governed by, and construed in accordance with, California Law. 3 8. Captions. Captions to the sections in this Assignment are included for convenience only and do not modify any of the terms of this Assignment. 9. Severability. If any term or provision of this Assignment is, to any extent, held to be invalid or unenforceable, the remainder of this Assignment will not be affected, and each term or provision of this Assignment will be valid and be enforced to the fullest extent permitted by law. If the application of any term or provision of this Assignment to any person or circumstances is held to be invalid or unenforceable, the application of that term or provision to persons or circumstances other than those as to which it is held invalid or unenforceable, will not be affected, and each term or provision of this Assignment will be valid and be enforced to the fullest extent permitted by law. 10. Effective Date and Consent of Landlord. The Landlord's and the Parties' execution of the Consent Agreement is a condition precedent to the effectiveness and validity of this Assignment. The date of execution by Landlord and the Parties of Landlord's Consent Agreement shall be the effective date of this Assignment (the "Effective Date"). If the Landlord and the Parties do not execute the Consent Agreement, then this Assignment shall not become effective and shall be null and void. 11. Capitalized Terms. All terms spelled with initial capital letters in this Assignment that are not expressly defined in this Assignment will have the respective meanings given such terms in the Lease. 12. Brokers. The Parties to this Assignment represent and warrant to each other that neither party dealt with any broker or finder in connection with the consummation of this Assignment and each Party agrees to protect, defend, indemnify, and hold the other Party harmless from and against any and all claims or liabilities for brokerage commissions or finder's fees arising out of that Party's acts in connection with this Assignment. The provisions of this Section 12 shall survive the expiration or earlier termination of this Assignment and the Lease. 13. Notices. Any notice that may or must be given by either Party under this Assignment will be delivered (i) personally, (ii) by certified mail, return receipt requested, or (iii) by a nationally recognized overnight courier, addressed to the Party to whom it is intended. Any notice given to Assignor or Assignee shall be sent to the respective address set forth on the signature page below, or to such other address as that Party may designate for service of notice by a notice given in accordance with the provision of this Section 13. A notice sent pursuant to the terms of this Section 13 shall be deemed delivered (A) when delivery is attempted, if delivered personally, (B) three (3) business days after deposit into the United States mail, or (C) the day following deposit with a nationally recognized overnight courier. 14. Execution in Counterparts. This Assignment may be executed in any number of counterparts, each of which when so executed shall be deemed an original and all of which shall constitute together one and the same instrument, and shall be effective upon execution by all of the Parties 4 IN WITNESS WHEREOF, Assignor and Assignee have executed this Assignment on the date first written above: ASSIGNOR: ASSIGNEE: ELECTRONIC ARTS INC. LEAP WIRELESS INTERNATIONAL, INC. By:_______________________________ By:_________________________ Its:______________________________ Its:________________________ Address of Assignor: Address of Assignee: 209 Redwood Shores Parkway Redwood City, CA 94065 10307 Pacific Center Court San Diego, CA 92121 Attn: General Counsel Attn: General Counsel Telephone (858) 882-6000 Telephone: (650) 628-1500 5 EXHIBIT A [Attach Lease and any amendments or modifications] 6 LANDLORD CONSENT TO ASSIGNMENT AND ASSUMPTION This Consent is entered into as of the ____ day of ___________, 2002 by and among EOP-PACIFIC RIDGE CORPORATE CENTRE, L.L.C., a Delaware limited liability company ("Landlord"), ELECTRONIC ARTS INC., a Delaware corporation ("Assignor") and LEAP WIRELESS INTERNATIONAL, INC., a Delaware corporation ("Assignee"). RECITALS: A. Landlord, (as successor in interest to Spieker Properties, L.P.) as landlord, and Assignor, as tenant, are parties to that certain Office Lease dated September 3, 1999 (the "Office Lease"), as amended by that certain First Amendment to Lease dated February 14, 2000 (the "First Amendment) (collectively, the "Lease") pursuant to which Landlord has leased to Assignor certain premises containing approximately 10,981 rentable square feet (the "Premises") known as Suite No. 200 on the 2nd floor of the building commonly known as Pacific Ridge Corporate Centre and located at 5790 Fleet Street, Carlsbad, CA 92008 (the "Building"). B. Assignor and Assignee have entered into that certain Assignment and Assumption of Lease dated January ________, 2002 ("Assignment Agreement") attached hereto as Exhibit A whereby Assignor assigned all of its right, title and interest in and to the Lease to Assignee. C. Assignor and Assignee have requested Landlord's consent to the Assignment Agreement and the transaction described therein. D. Landlord has agreed to give such consent upon the terms and conditions contained in this Consent. NOW THEREFORE, in consideration of the foregoing recitals which by this reference are incorporated herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Landlord, Assignor and Assignee agree and represent as follows: 1. Assignment Agreement. Assignor and Assignee hereby represent and warrant that: (a) a true, complete and correct copy of the Assignment Agreement is attached hereto as Exhibit A; and (b) the Assignment Agreement fully assigns all of Assignor's right, title and interest in the Lease to Assignee (the "Transfer"). 2. Representations. Assignor hereby represents and warrants that Assignor (i) has full power and authority to assign its entire right, title and interest in the Lease to Assignee; (ii) has not transferred or conveyed its interest in the Lease to any person or entity, collaterally or otherwise; (iii) has full power and authority to enter into the Assignment Agreement and this Consent; and (iv) has assigned the entire Security Deposit, if any, as described in the Basic Lease Information Section and Section 5 of the Office Lease, to Assignee, and Assignor has full power and authority to do the same. Assignee hereby represents and warrants that Assignee has full power and authority to enter into the Assignment Agreement and this Consent. 1 3. Assumption. Notwithstanding anything to the contrary contained in the Assignment Agreement, Assignee, for itself and its successors and assigns, hereby assumes and agrees to perform and be bound by all of the covenants, agreements, provisions, conditions and obligations of the tenant under the Lease, including but not limited to, the obligation to pay Landlord for all adjustments of rent and other additional charges payable pursuant to the terms of the Lease. Nothing contained in the Assignment Agreement shall be deemed to amend, modify or alter in any way the terms, covenants and conditions set forth in the Lease. 4. No Release. Nothing contained in the Assignment Agreement or this Consent shall be construed as relieving or releasing the Assignor from any of its obligations under the Lease, and it is expressly understood that Assignor shall remain liable for such obligations notwithstanding the subsequent assignment(s), sublease(s) or transfer(s) of the interest of the tenant under the Lease. Accordingly, notwithstanding anything in the Assignment Agreement to the contrary (including, without limitation, the effective date thereof), Assignor and Assignee hereby acknowledge and agree that both Assignor and Assignee shall be fully responsible for all obligations of the tenant under the Lease (regardless of whether such obligations accrue prior to or following the effective date of the assignment). 5. Review Fee. Upon Assignor's execution and delivery of this Consent, Assignor shall pay to Landlord the sum of $500.00 in consideration for Landlord's review of the Assignment Agreement and preparation of this Consent. In addition, within 5 business days of demand by Landlord, Assignor shall also pay to Landlord an amount equal to all costs incurred by Landlord in connection with considering the request for consent to the Assignment Agreement, including without limitation, reasonable attorneys' fees. 6. Landlord's Consent. In reliance upon the agreements and representations contained in this Consent, Landlord hereby consents to the Transfer. This Consent shall not constitute a waiver of the obligation of the tenant under the Lease to obtain the Landlord's consent to any subsequent assignment, sublease or other transfer under the Lease, nor shall it constitute a waiver of any existing defaults under the Lease. Landlord hereby waives Landlord's right to recapture the Premises and cancel the Lease under Section 9.2 of the Lease with respect to the assignment of the Lease pursuant to the Assignment Agreement. 7. Insurance. Landlord hereby acknowledges and agrees that so long as the coverage afforded Landlord, the other additional insureds and any designees of Landlord shall not be reduced or otherwise adversely affected, all or part of Tenant's insurance may be carried under a blanket policy covering the Premises and any other of Tenant's locations, or by means of a so called "Umbrella" policy. 8. Notice Address. Any notices to Assignee shall be effective when served to Assignee at the Premises in accordance with the terms of the Lease. From and after the effective date of the Assignment, notices to Assignor shall be served at the following address: 209 Redwood Shores Parkway, Redwood City, California 94065, Attention: General Counsel. 2 9. Deletions. Section 22.1 of the Office Lease (Option to Renew) is hereby deleted in its entirety and is of no further force or effect. 10. Signage. Leap Wireless International, Inc. (i.e., the Assignee named herein) and any assignee of the Assignee named herein permitted pursuant to the terms of the Lease (and not any sublessee or other transferee of the Tenant's interest in the Lease) only shall have the non-exclusive right to have a sign ("Tenant's Signage") on the existing monument located in the front of the Building (the "Monument"); provided that (i) the location of Tenant's Signage shall be for the location of Assignee's sign as of the date hereof, (ii) the size, materials, design and all other specifications of Tenant's Signage shall be subject to Landlord's prior written consent, which consent may be withheld in Landlord's reasonable discretion; (iii) Tenant's Sign shall comply with all applicable governmental rules and regulations; and (iv) Assignee's continuing right to Tenant's Signage shall be contingent on Assignee occupying the entire Premises. Landlord shall be responsible for the cost of the Monument, and Assignee shall be responsible for all costs incurred in connection with the design, construction, installation, maintenance and repair, compliance with laws, and removal of Tenant's Signage. Notwithstanding anything in the Lease to the contrary, except as specifically set forth herein, the tenant under the Lease shall have no signage rights at the Building or the Project. 11. Counterparts. This Consent may be executed in counterparts and shall constitute an agreement binding on all parties notwithstanding that all parties are not signatories to the original or the same counterpart provided that all parties are furnished a copy or copies thereof reflecting the signature of all parties. 3 IN WITNESS WHEREOF, Landlord, Assignor and Assignee have executed this Consent on the day and year first above written. LANDLORD: EOP-PACIFIC RIDGE CORPORATE CENTRE, LLC, a Delaware limited liability company By: EOP Operating Limited Partnership, a Delaware limited partnership, its sole member By: Equity Office Properties Trust, a Maryland real estate investment trust, its general partner By: ____________________________ Name:___________________________ Title:__________________________ ASSIGNOR: ELECTRONIC ARTS INC., a Delaware corporation By:____________________________________ Name:__________________________________ Title:_________________________________ By:____________________________________ Name:__________________________________ Title:_________________________________ 4 ASSIGNEE: LEAP WIRELESS INTERNATIONAL, INC., a Delaware corporation By:________________________________ Name:______________________________ Title:_____________________________ By:________________________________ Name:______________________________ Title:_____________________________ 5 EXHIBIT A COPY OF ASSIGNMENT AGREEMENT [ATTACHED] 6 EX-10.52 5 dex1052.txt AMENDMENT #2 LEASE AGREEMENT DTD JULY 16, 2001 EXHIBIT 10.52 AMENDMENT NO.2 TO LEASE AGREEMENT Dated as of July 16,2001 by and between FLATIRONS FUNDING, LIMITED PARTNERSHIP, as Lessor and ELECTRONIC ARTS REDWOOD, INC., as Lessee Property located in Redwood City, San Mateo County, California The Lease Agreement and all amendments thereto, including this Amendment No.2 to Lease Agreement and is subject to a lien in favor of KeyBank National Association, as the Agent ("Agent") under the Credit Agreement. This Amendment No.2 to Lease Agreement has been executed in several counterparts. To the extent, if any, that the Lease Agreement and this Amendment No.2 to Lease Agreement constitute chattel paper (as such term is defined in the Uniform Commercial Code as in effect in any applicable jurisdiction), no lien on the Lease Agreement or on this Amendment No.2 to Lease Agreement may be created through the transfer or possession of any counterpart other than the original counterpart containing the receipt therefore executed by the Agent on or following the signature page hereof. This counterpart is the original counterpart. AMENDMENT NO.2 TO LEASE AGREEMENT THIS AMENDMENT NO.2 TO LEASE AGREEMENT (this "Amendment"), dated as of July 16, 2001, is entered into by and among: (1) FLATIRONS FUNDING, LIMITED PARTNERSHIP, a Delaware limited partnership (the "Lessor"); and (2) ELECTRONIC ARTS REDWOOD, INC., a Delaware corporation (the "Lessee"). RECITALS A. The Lessee and the Lessor are parties to that certain Lease Agreement dated as of February 14, 1995, for which a Memorandum of Lease was recorded on February 15, 1995, in the Official Records of San Mateo County, California, as Document No. 95015509, for which an Amended and Restated Memorandum Lease Agreement was recorded March 27, 1997, as Document No. 97034604, which Lease Agreement was amended by that certain Amendment No.1 to Lease Agreement dated as of March 7, 1997, and supplemented by that certain AFL Unit Leasing Record dated December 1, 1998, which memorandum of lease was further amended by that certain Second Amended and Restated Memorandum Lease Agreement dated as of August 31,1998, recorded on September 2, 1998, as Document No. 98141934, and further amended by that certain Third Amended and Restated Memorandum of Lease Agreement dated as of May 5, 1999, and recorded on May 5, 1999, as Document No. 99078944, and further amended by that certain Fourth Amended and Restated Memorandum of Lease Agreement dated as of December 6,2000, and recorded on December 8, 2000, as Document No. 2000-155930 (the Lease Agreement, together with all memoranda thereto, as so amended and modified, the "Lease Agreement") affecting certain real property and improvements located in San Mateo County, California, more specifically described in Exhibit A attached hereto and made a part hereof. B. The Lessor, the Lessee, and certain other parties have entered into that certain Credit Agreement dated as of July 16,2001 (the "Credit Agreement"). C. The Lessor and the Lessee have now agreed to amend the Lease Agreement upon the terms and subject to the conditions set forth below. AGREEMENT NOW, THEREFORE, in consideration of the above recitals and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Lessee and Lessor hereby agree as follows: 2 1. Definitions. Interpretation. All capitalized terms defined above and elsewhere in this Amendment shall be used herein as so defined. Unless otherwise defined herein, all other capitalized terms shall have the respective meanings given to those terms in Section 1 of the Lease Agreement, as amended by this Amendment. 2. Amendments to Lease Agreement. Subject to the satisfaction of the conditions set forth in paragraph 4 below, the Lease Agreement is hereby amended as follows: (a) Section 1 of the Lease Agreement is hereby amended by: (i) deleting therefrom in their entirety the following terms: "Acquisition Cost" "Additional General Partner" "Adjusted Acquisition Cost" "Cash Proceeds" "Computation Period" "Lease Rate Date" "Level 1" "Level 2" "Level 3" "Level 4" "Level 5" "Monthly Rent Component" "Variable Component of Basic Rent" (ii) deleting therefrom in their entirety the definitions of the terms "Merrill", "Merrill Leasing", and "Merrill Lynch." Wherever these terms appear in the Lease Agreement, they shall be interpreted to refer to the Agent wherever the context requires; (iii) adding thereto in the appropriate alphabetical order the following new definitions: "Adverse Environmental Condition" means the occurrence of any Hazardous Condition or any of the matters referred to in the definition of Environmental Claim. "Agent" means KeyBank National Association, and its permitted successors and assigns. "Alternate Rate" means, on any day, the greater of (i) the Prime Rate in effect on such date and (ii) the Federal Funds Rate for such day plus one-half percent (0.50%). "Applicable Law" means all existing and future applicable laws, rules, regulation (including Environmental Laws), statutes, treaties, codes, ordinance, permits, certificates, orders and licenses of and 3 interpretations by, any Governmental Authority, and applicable judgments, decrees, injunctions, writs, orders or like action of any court, arbitrator or other administrative, judicial or quasi judicial tribunal or agency of competent jurisdiction (including those pertaining to health, safety or the environment, those pertaining to the use or occupancy of the Property and those which in any way limit the use or enjoyment thereof), or common law, in each case affecting the Lessee, the Guarantor or the Property, and any restrictive covenant or deed restriction or easement of record encumbering the Property. "Applicable Margin" means the spread over the one (1) month LIBOR rate determined by reference to the Guarantor's Total Consolidated Debt/Tangible Net Worth Ratio set forth in the following pricing grid: Total Consolidated Debt/ Liquidity Loan Tranche B Loan - ------------------------ --------------- --------------- Consolidated Tangible Net Worth LIBOR Margin LIBOR Margin - -------------------------------- ------------ ------------ *0.33 1.25% 1.50% *0.50 1.50% 1.75% *0.65 1.75% 2.00% **0.65 2.00% 2.25% * Less Than or Equal to. ** Greater Than. "Conduit Agent" means The Bank of Tokyo-Mitsubishi, Ltd., New York Branch, and its permitted successors and assigns. "Consenting Parties" shall have the meaning specified in Section 11.1(b) of the Credit Agreement. "CP Rate" means, with respect to the Note Purchaser, the all-in- cost of funding its acquisition of the Notes and the funding of the advances thereunder to the extent such funding is being provided by the Note Purchaser's issuance of Commercial Paper (including discount, dealer commissions and such other amounts as the Conduit Agent determines to be appropriate). The determination of the Note Purchaser's CP Rate, as well as the determination of which maturities of Commercial Paper to issue, will be made by the Conduit Agent, whose determination shall be binding for all purposes absent manifest error; provided, however, that the Conduit Agent shall consult with the Lessee concerning Commercial Paper maturities. Accrued discount on the Commercial Paper maturing between Basic Rent Payment Dates will be capitalized. "Credit Documents" means, collectively, this Lease, the Credit Agreement, the Guaranty, the Note Purchase Agreement, and any other documents contemplated hereby or thereby. 4 "Default" means any event or condition which, with the lapse of time or the giving of notice, or both, would constitute an Event of Default. "Environmental Audit" means a written report from an environmental consultant selected by the Lessee and approved by the Lessor Parties, documenting that such environmental consultant has performed a review of the environmental condition of and compliance of the Property and that such review contains, at a minimum, site assessment information that generally meets or exceeds applicable industry standards and practices and the most current ASTM Standard Practice for Environmental Site Assessments: Phase One Environmental Site Assessment. "Environmental Claim" means any legal obligation or notice of violation, claim, action, proceeding, demand, abatement, lien or other order or direction (conditional or otherwise) by any Governmental Authority or any Person relating to personal injury (including sickness, disease or death), tangible or intangible property damage, damage to the environment, nuisance, pollution, contamination or other adverse effects on the environment, or for fines, penalties or restrictions, resulting from or based upon (i) the existence (whether currently known or unknown), or the continuation of the existence, of a Release (including sudden or non- sudden, accidental or nonaccidental Releases) of, or exposure to, any Hazardous Substance, odor or audible noise or other release or emission in, into or onto the environment (including the air, ground, water or any surface) at, in, by, from, or related to (a) the Property or (b) the transportation, storage, treatment or disposal of materials in connection with the operation of the Property, or (ii) the violation, or alleged violation, of any Environmental Laws or Permits of, or from, any Governmental Authority relating to environmental matters connected with the Property. "Environmental Law" means all present and future Applicable Laws relating to the environment, including without limitation, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, the Hazardous Material Transportation Act, as amended, the Resource Conservation and Recovery Act, as amended, the Federal Clean Water Act, as amended, the Federal Clean Air Act as amended, the Toxic Substances Control Act as amended, the Superfund Amendments and Reauthorization Act of 1986, as amended and the Occupational Safety and Health Act, as amended, and any other federal, state or local statutes, present or future, relating to health, safety, or the environment, including, without limitation, transfer of ownership notification statutes and the regulations promulgated pursuant thereto. "ERISA" means the Employee Retirement Income Security Act of 1974 (or any successor legislation thereto), as amended from time to time, 5 and any regulations promulgated thereunder. "ERISA Reportable Event" means a reportable event with respect to a Guaranteed Pension Plan within the meaning of ss. 4043 of ERISA and the regulations promulgated thereunder as to which the requirement of notice has not been waived. "Equity Investment" means the equity investment to be made pursuant to Article III of the Credit Agreement. "Event of Loss" means, with respect to the Property, any of the following events: (i) any casualty that renders the Property unsuitable for continued use as property of its type immediately prior to such casualty, (ii) any casualty that is so substantial in nature that restoration of the Property to substantially its condition as existed immediately prior to such casualty would be impracticable or impossible, (iii) any casualty which results in an insurance settlement with respect to the Property on the basis of a total loss of the improvements; (iv) any Taking that involves the taking of the Lessor's entire title to the Property, (v) any Taking that is such that restoration of the Property to substantially its condition as existed immediately prior to such Taking would be impracticable or impossible, or (vi) any Taking whereby the use or occupancy of the Property by the Lessee thereof shall have been prohibited, directly or indirectly, for a period equal to the lesser of (vii) ninety (90) consecutive days and (y) the remaining Lease Term. "Fair Market Value" means, with respect to the Property, the amount, which in any event shall not be less than zero, that would be paid in cash in an arm's-length transaction between an informed and willing purchaser and an informed and willing seller, neither of whom is under any compulsion to purchase or sell, respectively, for the ownership of the Property. The Fair Market Value shall be determined based on the assumption that (x) the Property is in the condition and state of repair required under Section 9 of this Lease and (y) the Lessee is in compliance with the other requirements of the Credit Documents relating to the condition of the Property. "Federal Funds Rate" means, for any day, the rate per annum set forth in the weekly statistical release designated as H.15(519), or any successor publication, published by the Federal Reserve Board (including any such successor publication, "H.15 (519)") for such day opposite the caption "Federal Funds (Effective)". If on any relevant day, such rate is not yet published in H.15 (519), the rate for such day shall be the rate set forth in the daily statistical release designated as the Composite 3:30 p.m. Quotations for U.S. Government Securities, or any successor publication, published by the Federal Reserve Bank of New York (including any such successor publication, the "Composite 3:30 p.m. Quotations") for such day 6 under the caption "Federal Funds Effective Rate". If on any relevant day, such rate is not yet published in either B.15 (519) or the Composite 3:30 p.m. Quotations, the rate for such day shall be the arithmetic means, as determined by Agent, of the rates quoted to the Agent for such day by three (3) Federal funds brokers of recognized standing selected by the Agent. "Governmental Authority' means any nation or government, any state or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Guaranteed Pension Plan" means any employee pension benefit plan within the meaning of Section (3)(2) of ERISA (other than a Multiemployer Plan) which the Guarantor, any of its Subsidiaries or any ERISA Affiliate maintains, contributes to or has an obligation to contribute to on behalf of participants and which is guaranteed on termination in full or in part by the PBGC pursuant to Title IV of ERISA. "Hazardous Condition" means any condition at the Property that violates or threatens to violate, that results in or threatens noncompliance with, or that creates liability under, any Environmental Law. "Hazardous Substance" means any of the following: (i) any petroleum or petroleum product (or additives thereto, such as, but not limited to, MTBE), explosives, radioactive materials, asbestos, ureaformaldehyde, polychlorinated biphenyls, lead and radon gas; (ii) any substance, material, product, derivative, compound or mixture, mineral, chemical, waste, gas, medical waste, or pollutant, in each case whether naturally occurring, man-made or the by-product of any process, that is toxic or hazardous to the environment or human health or safety, or which is now or hereafter defined or regulated as such under any regulation under any Environmental Law; or (iii) any substance, material, product, derivative, compound or mixture, mineral, chemical, waste, gas, medical waste or pollutant that would support the assertion of any claim under any Environmental Law, whether or not defined as hazardous as such under any Environmental Law. "Imputed Return" means the cost to the Lessor Parties of maintaining their unrecovered investment after the Financing Termination Date or the expected return to such persons, determined as (i) the average daily Outstanding Lease Balance after the Financing Termination Date multiplied by (ii) the number of days from and excluding the Financing Termination Date to and including the date of the sale of the Property multiplied by (iii) the rate equal to the applicable interest rate, with respect to amounts owing to each Note Purchaser and each Tranche B Bank, respectively, multiplied by (iv) 1/365. 7 "Indemnitees" means, collectively, the Lessor Parties and the Program Administrator (as defined in the Credit Agreement), together with their respective Affiliates, successors, assigns, directors, shareholders, partners, members (and direct and indirect owners of its members), officers, managers, employees and agents. "KevBank Financing Term" means a period of five (5) years commencing on (and including) the Initial Funding Date (as defined in the Credit Agreement) and ending on (but excluding) the Maturity Date (as defined in the Credit Agreement). "Lessor Lien" means any Lien on or against the Property, lease or sublease or disposition of title, easement, covenant, restriction or other matter affecting title to the Property arising as a result of (i) any claim against the Lessor not resulting from the transactions contemplated by the Credit Documents, (ii) any act or omission of the Lessor which is not required or expressly permitted by the Credit Documents, requested by the Lessee or is in violation of any of the terms of the Credit Documents, (iii) any claim against the Lessor with respect to Taxes or Transaction Expenses against which neither the Guarantor nor the Lessee is required to indemnify the Lessor pursuant to the Participation Agreement or the other Credit Documents or (iv) any claim against the Lessor arising out of any transfer by the Lessor of all or any portion of its interest in the Property or the Credit Documents other than the transfer of title to or possession of the Property by the Lessor pursuant to and in accordance with the Credit Documents. "Lessor Parties" means collectively, the Transaction Parties (as defined in the Credit Agreement), except for the Lessee Parties (as defined in the Credit Agreement). "LIBOR " means, with respect to a Rent Period, the rate for deposits in Dollars for a period comparable to such Rent Period appearing on the Telerate Page 3750 (or any successor publication) as of 11 :00 A.M. (London time) two (2) Business Days preceding the applicable Basic Rent Payment Date; provided, however, that if such rate is not reasonably available, then "LIBOR" shall mean the arithmetic means of the rates, expressed in decimal, quoted to the Agent at such time on such day by two or more major banks in the London interbank market selected in good faith by the Agent as a rate per annum for such deposit, for such period commencing on such first day and in such amount that the Agent reasonably determines is representative for a single transaction on such market on such day. "Liquidity Agreement" means the Liquidity Agreement, dated as of July 16,2001, among the Note Purchaser, Bankers Trust Company, The Bank of Tokyo-Mitsubishi, Ltd. and the Banks (as defined therein), as the 8 same may be amended, modified and in effect from time to time. "Liquidity Banks" mean the banks defined in the introductory paragraph of the Credit Agreement. "Liquidity Documentation" means any other contract, instrument or documentation pursuant to which one or more Liquidity Banks agree, from time to time, to provide liquidity, credit, asset purchase and/or cash collateral support to the Note Purchaser's Commercial Paper notes issued to fund its acquisition of the Notes and the funds advanced thereunder. "Liquidity Loans" means "Loans" as defined in Section 1.1 of the Liquidity Agreement. "Material Adverse Environmental Condition" shall mean an Adverse Environmental Condition with respect to which the Remediation Costs will exceed Six Million Dollars ($6,000,000). "Material Subsidiary" means (a) the Lessee and (b) at any time during any Fiscal Year of the Guarantor, any Subsidiary of the Guarantor whose assets equal or exceed ten percent (10%) of the total consolidated assets of the Guarantor at such time. "Maximum Lessor Risk Payment" has the meaning as set forth in the Credit Agreement. "Maximum Recourse Amount" has the meaning as set forth in the Credit Agreement. "Modifications" has the meaning set forth in Section 12.1 of this Lease. "Note Purchase Agreement" means the Note Purchase Agreement, dated as of July 16,2001, among the Lessor, the Lessee, the Guarantor and the Note Purchaser, as the same may be amended, modified and in effect from time to time. "Note Purchaser" means Victory Receivables Corporation, a Delaware corporation, together with its permitted successors and assigns. "Notes" means the notes to be issued by the Lessor pursuant to the Note Purchase Agreement and Section 3.1 of the Credit Agreement. "Notice of Default" is defined in the Note Purchase Agreement. "Outstanding Lease Balance" means, as of any date of determination, (i) the aggregate outstanding principal amount of the Notes plus (ii) the aggregate outstanding principal amount of the Tranche B 9 Loan plus (iii) the aggregate amount of made but unredeemed Equity Investment. "Overdue Rate" means the rate of interest otherwise applicable to any payment plus two percent (2.00%). "Prime Rate" means the per annum rate publicly announced by KeyBank from time to time at its office in Cleveland, Ohio. The Prime Rate is determined by KeyBank from time to time as a means of pricing credit extensions to some customers and is neither directly tied to any external rate of interest or index nor necessarily the lowest rate of interest charged by KeyBank at any given time for any particular class of customers or credit extensions. Any change in the Prime Rate resulting from a change in the Prime Rate shall become effective on the Business Day on which each change in the Prime Rate occurs. "Release" means, the presence (whether currently known or unknown) of Hazardous Substances or any release, spill, emission, leaking, pumping, injection, deposit, disposal, discharge, dispersal, leaching or migration into the indoor or outdoor environment or into or out of any property, including the movement of Hazardous Substances through or in the air, soil, surface water, ground water or property and/or the threat thereof. "Remedial Action" means all actions, including corrective actions, equipment upgrades or relocation, or building demolition, repair or reconstruction necessary or appropriate to (i) investigate, clean up, remove, treat or in any other way address any Hazardous Substances or other substance in the indoor or outdoor environment, (ii) prevent the Release or threat of Release or minimize the further Release of any Hazardous Substances or other substance so it does not migrate or endanger or threaten to endanger public health or welfare or the indoor or outdoor environment, or (iii) perform pre-remedial studies and investigations, remedial designs and actions and post-remedial monitoring and care including, without limitation, any such actions performed pursuant to any voluntary cleanup program or similar program administered by any Governmental Authority for the purposes of addressing any Hazardous Conditions. "Remediation Costs" means all costs and expenses associated with Remedial Action. "Rent Period" means the period beginning on each Basic Rent Payment Date and ending as of (but excluding) the following Basic Rent Payment Date. "Subsidiary" means, with respect to any Person, any corporation, 10 partnership or other business entity (including business trusts) of which an aggregate of more than 50% of the outstanding stock, having ordinary voting power to elect or appoint a majority of the members of the board of directors, trustees or members of a similar governing body of such corporation, partnership or other entity (irrespective of whether, at the time, stock of any other class or classes of such corporation, partnership or other entity shall have or might have voting power by reason of the happening of any contingency), is, or of which an aggregate of more than 50% of the interests in which are, at the time, directly or indirectly, owned by such Person and/or one or more Subsidiaries of such Person. "Tranche B Banks" is defined in the introductory paragraph of the Credit Agreement. . "Tranche B Loan" means the loan to be made by the Tranche B Banks pursuant to Article III of the Credit Agreement. (iv) amending and restating the following definitions to be read in their entirety as follows: "Basic Rent" means, with respect to any Parcel of Property or Unit of Equipment, an amount equal to the sum of the Note Interest Amount, the Tranche B Interest Amount, and the Yield Amount calculated as follows: (a) The Note Interest Amount portion of Basic Rent with respect to the outstanding principal amount of the Notes shall be computed based upon one of the rates set forth below: (i) To the extent that the Note Purchaser is funding advances under the Notes by issuance of Commercial Paper, the Note Interest Amount portion of Basic Rent with respect to the amounts outstanding under the Notes shall be computed based upon the CP Rate as in effect from time to time plus fifteen one hundredths of one percent (.15%); and (ii) To the extent the Note Purchaser is not funding advances under the Notes by issuance of Commercial Paper or the Notes have been purchased by the Liquidity Banks pursuant to the Liquidity Documentation, the Note Interest Amount portion of Basic Rent with respect to the amounts outstanding under the Notes shall be computed as follows: (A) until such time as a Liquidity Loan based upon a one (1) month LIB OR rate can be advanced by the Liquidity Banks pursuant to the Liquidity Documentation, the Alternate Rate, and (B) thereafter, one of the following two rates as selected by the Note Purchaser (or if the Notes have been purchased by the Liquidity Banks pursuant to the Liquidity Documentation, the Agent) in its reasonable 11 discretion: (x) the one (1) month LIBOR rate as in effect from time to time (adjusted for reserve requirements in effect on the first day of each period for which a payment is due) plus the Applicable Margin; or (y) if the one (1) month LIBOR rate is not available for any reason, the Alternate Rate. The aggregate amount payable in accordance with this clause (a) with respect to all Notes as of any Basic Rent Payment Date shall be the "Note Interest Amount" payable as of such date. (b) The Tranche B Interest Amount portion of Basic Rent with respect to the outstanding principal amount of the Tranche B Loan shall be computed based upon either (i) the one (1) month LIBOR rate as in effect from time to time, adjusted for reserve requirements in effect on the first day of each period for which a payment is due, plus the Applicable Margin or (B) if the one (1) month LIBOR rate is not available or cannot be determined for the reasons set forth in Section 4.5 of the Credit Agreement, the Alternate Rate. Notwithstanding the foregoing, for the period beginning on the Initial Funding Date and ending on the first Basic Rent Payment Date, the Tranche B Interest Amount portion of Basic Rent payable with respect to the outstanding Tranche B Loan shall be computed based upon the Alternate Rate or such other rate as agreed upon between the Lessee and the Lessor immediately prior to the Initial Funding Date. The aggregate amount payable in accordance with this clause (b) with respect to the Equity Investment as of any Basic Rent Payment Date shall be the "Tranche B Interest Amount" payable as of such date. (c) The Yield Amount portion of Basic Rent payable with respect to the Equity Investment shall be computed based upon either (i) the one (1) month LIBOR rate as in effect from time to time, adjusted for reserve requirements in effect on the first day of each period for which a payment is due, plus two percent (2.00%) or (ii) if the one (1) month LIBOR rate is not available or cannot be determined for the reasons set forth in Section 4.5 of the Credit Agreement, the Alternate Rate. Notwithstanding the foregoing, for the period beginning on the Initial Funding Date and ending on the first Basic Rent Payment Date, the Yield Amount portion of Basic Rent payable with respect to the outstanding Equity Investment shall be computed based upon the Alternate Rate or such other rate as agreed upon between the Lessee and the Lessor immediately prior to the Initial Funding Date. The aggregate amount payable in accordance with this clause (b) with respect to the Equity Investment as of any Basic Rent Payment Date shall be the "Yield Amount" payable as of such date. "Business Day" means any day on which (i) commercial banks are not authorized or required to close in San Francisco, California or New 12 York, New York and (ii) if such Business Day is related to a LIBOR rate, dealings in Dollar deposits are carried out in the London interbank market. "Commercial Paper" means commercial paper issued by the Note Purchaser to fund its purchase of the Notes and the advances to be funded thereunder. "Credit Agreement" means the Participation Agreement, dated as of July 16, 2001, by and among the Lessee, the Guarantor, the Lessor, the Note Purchaser, Agent, and certain other parties, as the same may be amended, restated, modified or supplemented from time to time, or any subsequent credit or loan agreement entered into between the Lessor and a lender or lenders related to financing the Property or Equipment. "Guaranty" means the guaranty agreement, dated as of July 16, 2001, by Guarantor in favor of the Lessor and the Beneficiaries as identified therein, as the same may be amended, restated, modified or supplemented from time to time. (v) amending the definition of the term "Additional Rent" by inserting after the word "hereof' the following words, preceded by a comma: "and shall also include all 'Supplemental Rent' as defined in the Credit Agreement"; (vi) amending the definition of the term "Affiliate" by inserting after the word "foregoing" the following words, preceded by a comma: "and shall also include any 'Affiliate' as defined in the Credit Agreement"; (vii) amending and restating the first sentence in the definition of the term "Appraisal Procedure" to be read in its entirety as follows: "Appraisal Procedure" means the following procedure whereby an independent appraiser shall be appointed by the Lessor and the Lessee, with the consent of the Assignee, to determine the fair market value of any Property or Equipment to be leased, if such determination is required under paragraph (a) of Section 12 or paragraph (d) of Section 13 of this Lease.; (viii) deleting from the definition of the term "Assignee" the words "clauses (i), (iv) and (v) of' and the words "and subsection 9.6 and 12 of the Agreement for Lease,"; (ix) deleting from the definition of the term "Assignee" the word "a" preceding the term "Credit Agreement" and inserting in place thereof the word "the"; (x) deleting from the definition of the term "Basic Rent Payment Date" the number "20" and inserting in place thereof the number "12"; (xi) amending the definition of the term "Moody's" by inserting after the word "Inc." the words "or any successor agency thereto."; 13 (xii) amending the definition of the term "S&P" by deleting the word "Corporation" and substituting therefor the words "Rating Services, a division of The McGraw Hill Companies Inc., or any successor agency thereto"; (b) Subparagraph 5(e) of the Lease Agreement is hereby amended by (i) inserting the words "OTHER THAN LESSOR LIENS" at the end of paragraph (C), after the word "EQUIPMENT"; (ii) inserting the words "EXCEPT AS OTHERWISE PROVIDED IN SECTIONS 15 AND 16 OF THIS LEASE," at the beginning of paragraph (D), before the word "ANY"; (c) Subparagraphs 7(a) and 7(b) of the Lease Agreement are hereby amended and restated to be read in their entirety as follows: (a) On each Basic Rent Payment Date during the Lease Term, the Lessee shall pay directly for the account of the Lessor, or as otherwise directed by the Lessor, the accrued and unpaid Basic Rent then due. The Lessor hereby irrevocably directs that the proceeds of all Basic Rent allocable to the Notes and the Equity Investment shall be paid to Agent in accordance with the provisions of the Credit Agreement. (b) [Intentionally Omitted.]; (d) Subparagraph 7(d) of the Lease Agreement is hereby amended by deleting the words "decimal equivalent of the percentage referred to in paragraph (a)(iii) of the definition of `Basic Rent' as most recently furnished by the Lessor" and inserting in the place thereof the words "Overdue Rate"; (e) Subparagraph 7(f) of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: (f) All calculations of Basic Rent shall be performed by the Lessor (or by the Agent). Such information shall be provided to the Lessee and the Guarantor no later than 5 :00 p.m., New York time, on the third (3rd) Business Day prior to the relevant Basic Rent Payment Date, together with reasonable detail supporting the calculations made. The Lessee and the Guarantor shall promptly acknowledge receipt of such calculations in writing to the Agent. Such calculations shall be deemed final in the absence of manifest error. The Guarantor and the Lessee shall be entitled to rely on any calculation of Basic Rent performed by the Agent, and to deal directly with the Agent in connection with the verification of such calculations. (f) Section 7 of the Lease Agreement is hereby amended by adding a new clause (g) thereto to read in its entirety as follows: (g) If the Lessee fails to pay any Basic Rent or Additional Rent when due, the Lessee shall pay to the Lessor or the Person entitled thereto, as Additional Rent, among other things, on demand, to the extent permitted by applicable law, interest at the 14 applicable Overdue Rate on any installment of Basic Rent and on any payment of any Additional Rent not paid when due or demanded by the Lessor or any Indemnitee for the period from and including the due date thereof to but excluding the date paid. The expiration or other termination of the obligations of the Lessee to pay Basic Rent hereunder shall not limit or modify the obligations of the Lessee with respect to accrued Additional Rent. Unless expressly provided otherwise in this Lease or the Credit Agreement, in the event of any failure on the part of the Lessee to pay and discharge any Basic Rent or any Additional Rent as and when due, the Lessee shall also promptly pay and discharge any fine, penalty, interest or cost which may be assessed or added under the Credit Agreement or any document related thereto for nonpayment or late payment of such Basic Rent or Additional Rent, all of which shall also constitute Additional Rent. (g) Subparagraph 8(c) of the Lease Agreement is hereby amended by inserting into the last sentence thereof after the words "Property to comply" the words "in all material respects"; (h) Subparagraph 8(h) of the Lease Agreement is hereby amended by capitalizing the first letter of the words "governmental" and "authority" therein to be read in their entirety as "Governmental Authority"; (i) Subparagraph 9(e) of the Lease Agreement is hereby amended by amending and restating the last sentence thereof to be read in its entirety as follows: Notwithstanding anything contained herein, the Lessee shall not make any addition or alteration which the Lessee reasonably expects will cost greater than $2,000,000 unless the Lessee shall have delivered to the Agent on behalf of the Lessor Parties a brief written narrative of the work to be performed in connection with such additions or alterations and the Lessee shall have received the written consent of Agent on behalf of the Consenting Parties to the making of such additions or alterations, which consent shall not unreasonably be withheld.; (j) Subparagraph 9(f) of the Lease Agreement is hereby amended by capitalizing the first letter of the words "governmental" and "authority" therein to be read in their entirety as "Governmental Authority"; (k) Subparagraph lO(c) of the Lease Agreement is hereby amended by (i) deleting from clause (i) the term "Adjusted Acquisition Cost" and inserting in place thereof the term "Outstanding Lease Balance"; (ii) adding to the end of clause (i) new sentences to be read in their entirety as follows: The deductible or self-insured retention shall not exceed $100,000 per occurrence. Such insurance shall include coverage for flood and earthquake to the extent available on commercially reasonable terms for the Lessee. 15 (iii) deleting from clause (ii) the number "15,000,000" and inserting in place thereof the number "50,000,000"; (iv) adding to the end of clause (ii) after the word "negligence" the following words, preceded by a comma: "and in the annual aggregate, with a deductible or self-insured retention which shall not exceed $1,000,000 per occurrence without the prior written approval of the Consenting Parties; and in no event shall such insurance be provided on a claims made coverage basis"; (v) amending and restating the language following clause (v) to be read in its entirety as follows: The insurance required under this paragraph (c) shall be written by companies that are recognized national or international insurers having claims paying ability ratings of at least "A minus" in the most recent edition of Best's Key Rating Guide, or similar ratings by other rating services and BBB by S&P. Such insurance may provide for such deductibles and the Lessee may self-insure with respect to the required coverage except as otherwise provided in this paragraph (c) only to the extent approved in writing by the Lessor. All insurance proceeds in respect of any loss or occurrence for which the proceeds related thereto, in the absence of the occurrence and continuance of a Default or an Event of Default, which are payable to the Lessee, shall be adjusted by the Lessee and such proceeds (other than liability insurance proceeds) shall be made available by the Lessor to the Lessee (with the endorsement of the Agent as co-payee) for the sole purpose of reconstruction, repair or refurbishment of the Property; provided, however, that in the event that (i) such reconstruction, repair or refurbishment cannot be completed prior to the end of the KeyBank Financing Term, or (ii) the Lessee shall elect not to use such proceeds for the reconstruction, repair or refurbishment of the Property, or (iii) if a Default or an Event of Default has occurred and is continuing, then such proceeds shall be adjusted solely by the Lessor and held by the Agent for application in accordance with Article XIV or XVII of the Credit Agreement, as applicable.; (1) Subparagraph 10 (f) of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: (f) Additional lnsureds; Notice. The insurance referred to in clause (c) (i) for the Property (as appropriate) may be a blanket policy and shall (i) at all times be in an amount at least equal to the full replacement cost of the Improvements, without any deduction for depreciation; (ii) name the Agent as loss payee and the other Lessor Parties as additional insureds (collectively, the "Insured Loan Parties") as their respective interests may appear; (iii) provide that the interests of the Insured Loan Parties shall be insured regardless of any intentional or willful breach or violation by the Lessee or the Guarantor of any warranties, declarations or conditions contained in such insurance; 16 (iv) provide that such insurance shall not be invalidated by any act, omission or negligence of the Lessee, the Guarantor, the Lessor, or the Insured Loan Parties nor by any foreclosure or other proceedings or notices thereof relating to the Property (as appropriate) or any part thereof, nor by legal title to, or ownership of the Property or any part thereof becoming vested in or by the Lessor or its agents, nor by occupancy or use of the Property or any part thereof for purposes more hazardous than permitted by such policy; and (v) subject to paragraph (c) above, provide that all partial loss insurance claims pertaining to the Property (as appropriate) or any part thereof shall be adjusted by the insurers thereunder with the Lessee. All policies of insurance required to be maintained pursuant to clause (c)(ii) which cover liability for bodily injury or property damage shall provide that all provisions of such insurance, except the limits of liability (which shall be applicable to all insureds as a group) and insurance premiums (which shall be solely a liability of the Lessee), shall operate in the same manner as if there were a separate policy covering each such insured and/or additional insured, without right of contribution from any other insurance which may be carried by an insured and/or additional insured. Every policy required under paragraph (c) above shall (i) expressly provide that it will not be canceled or terminated except upon thirty (30) days' written notice (or in the case of non-payment of premium, ten (10) days' written notice) to the Lessor, and the Insured Loan Parties; (ii) name the Insured Loan Parties as additional insureds, as their respective interests may appear; (iii) provide that the interests of the Lessor and the Insured Loan Parties shall be insured regardless of any intentional or willful breach or violation by the Lessee or the Guarantor of any warranties, declarations or conditions contained in such insurance; (iv) provide that such insurance shall not be invalidated by any act, omission or negligence of the Lessee, the Guarantor, the Lessor or any of the other Lessor Parties, nor by any foreclosure or other proceedings or notices thereof relating to the Property or any part thereof, nor by legal title to, or ownership of, the Property or any part thereof becoming vested in or by the Lessor or its agents, nor by occupancy or use of the Property or any part thereof for purposes more hazardous than permitted by such policy; (v) except for liability coverage and workers' compensation insurance, include a waiver of all rights of subrogation against the Lessor and the Insured Loan Parties and any recourse against the Lessor and the Insured Loan Parties for payment of any premiums or assessments under any policy; (vi) provide that such insurance is primary with respect to any other policies of insurance covering the Improvements or any part thereof carried by or available to the Lessor or the Insured Loan Parties; (vii) expressly provide that all payments of insurance proceeds shall be made payable to the Lessee and the Agent for the benefit of the Lessor Parties as co-payees. The Lessee shall advise the Lessor promptly of any policy cancellation or any change adversely affecting the coverage provided thereby. (m) Subparagraph 10(g) of the Lease Agreement is hereby amended by deleting the first word ("As") following the title thereof, and inserting in place thereof the following words: "Except as otherwise provided in the Credit Agreement, as"; (n) Subparagraph 10(h) of the Lease Agreement is hereby amended by deleting the 17 first word ("As") following the title thereof, and inserting in place thereof the following words: "Except as otherwise provided in the Credit Agreement, as "; (o) Subparagraph 10(k) of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: (k) Certificates. etc. The Lessee shall deliver to the Lessor the certificate of insurance evidencing the existence of all insurance which is required to be maintained by the Lessee hereunder, such delivery to be made (i) as provided in Sections 6.1(p) of the Credit Agreement, (ii) within thirty (30) days after the issuance of any additional policies or amendments or supplements to any of such insurance, and (iii) upon issuance of any such insurance. The Lessee shall notify the Lessor and the other Insured Loan Parties of any nonrenewal of any policy required hereunder and shall cause each insurer under each policy required hereunder to give the Lessor notice of any lapse under any such policy. The Lessee shall not obtain or carry separate insurance concurrent in form, or contributing in the event of loss, with that required by this Section 10 unless the Agent is named as loss payee and the Lessor and the other Insured Loan Parties are named as additional insureds therein. The Lessee shall immediately notify the Lessor and the other Insured Loan Parties whenever any such separate insurance is obtained and shall deliver to the Lessor the certificates of insurance and any other documentation (other than blanket policies) required by the Lessor evidencing the same as is required hereunder.; (p) Section 10 of the Lease Agreement is hereby amended by adding two new subparagraphs (n) and (0) to be read in their entirety as follows: (n) No Negation of Certain Other Obligations. The requirements of this Section 10 shall not be construed to negate or modify any obligations of the Lessee and the Guarantor under the Credit Agreement or any other agreement related thereto. (o) No Insurance bv the Lessor. Note Purchaser. the Conduit Agent or the Agent. At any time, each of the Lessor Parties may at its own expense carry insurance with respect to its interest in the Improvements; except that such insurance shall not interfere with the Lessee's ability to insure the Improvements as required by this Section 10 or adversely affect the Lessee's insurance or the cost thereof, or the ability of the Lessee to collect a claim under any such insurance policy. Any insurance payments received from policies maintained by any of the Lessor Parties pursuant to the previous sentence shall be retained by such Lessor Party, as the case may be, without reducing or otherwise affecting the Lessee's obligations hereunder. (q) Section 12 of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: SECTION 12. LESSEE'S RIGHT TO TERMINATE. Section 12.1 Remarketing Option. Subject to the fulfillment of each of the conditions set forth in this Section 12.1 and in Section 12.2 hereof (all of such conditions, collectively, the "Surrender Conditions"), the Lessee may elect to remarket all, but not 18 less than all, of the Property (such election being referred to as the "Remarketing Option"). The effective exercise and consummation of the Remarketing Option by the Lessee shall be subject to the due and timely fulfillment of each of the following provisions as of the dates set forth below (the date of the closing of such sale or other transfer of the Property following remarketing referred to herein as the "Financing Termination Date"). (a) Not later than three hundred and sixty-four (364) days prior to the expiration date of the KeyBank Financing Term or of the non-cancelable term of any substitute or replacement financing under any successor Credit Agreement, the Lessee shall have given to the Lessor and the other Lessor Parties written notice (a "Remarketing Notice") of the Lessee's exercise of the Remarketing Option, which exercise shall be irrevocable. Within thirty (30) days following the date of the Remarketing Notice, the Lessor and the Lessee shall determine the fair market value rental of the Property under this Lease which shall become effective on the Financing Termination Date for the remainder of the Lease Term. The fair market value rental shall be as agreed by the Lessor and the Lessee or, if they are unable to agree within such thirty (30) day period, pursuant to the Appraisal Procedure. Upon determination of such fair market value rental, the Lessor and the Lessee shall execute an amendment to this Lease reflecting such rental change and the effective date thereof. (b) On the date of the Lessee's notice to the Lessor of the Lessee's exercise of the Remarketing Option, no Event of Default or Default under this Lease or Acceleration Event or Unmatured Acceleration Event (as such terms are defined in the Credit Agreement) shall exist, and thereafter, no Event of Default or Default under this Lease or Acceleration Event or Unmatured Acceleration Event shall occur. (c) Not later than sixty (60) days prior to the Financing Termination Date, the Lessee shall deliver to the Lessor and the other Lessor Parties (x) an Environmental Audit for the Property and (y) a current ALTA/ ACSM land title survey (prepared in accordance with 1999 standards for an urban survey) with respect to the Property. Each Environmental Audit described in this clause (c) shall be prepared by an environmental consultant selected by the Agent in the Agent's reasonable discretion and shall contain conclusions reasonably satisfactory to the Agent as to the environmental status of the Property. If any such Environmental Audit indicates any exceptions, the Lessee shall have also delivered prior to the Financing Termination Date a Phase Two environmental assessment by such environmental consultant and a written statement by such environmental consultant indicating that all such exceptions have been remedied in compliance with Applicable Law. Each ALTA Survey delivered pursuant to this clause( c} shall be reasonably satisfactory to the Agent. (d) The Lessee shall have completed all modifications, restoration and rebuilding (collectively, "Modifications") of the Property required pursuant to Sections 9 and 15 hereof (as the case may be) and shall have fulfilled all of the conditions and requirements in connection therewith pursuant to such Sections, in each case prior to the 19 date on which the Lessee delivers its Remarketing Notice (time being of the essence), regardless of whether the same shall be within the Lessee's control. The Lessee shall have also paid the cost of all Modifications commenced prior to the Financing Termination Date. All Modifications shall have been completed in compliance with all Applicable Laws and Insurance Requirements. The Lessee shall not be relieved pursuant to Section 28 from complying with any Applicable Law relating to the Property that involved the extension of the ultimate imposition of such Applicable Law beyond the Financing Termination Date. All Liens (other than Permitted Liens) on the Property or any part thereof shall have been removed. (e) During the Marketing Period, the Lessee shall, as nonexclusive agent for the Lessor, use best commercial efforts to obtain cash bids for the acquisition of all of the Lessor's interest in and to the Property and will attempt in good faith to obtain the highest purchase price for the Property and for not less than the Fair Market Value of the Property (taking into account, and subject to, the continuing leasehold interest of the Lessee under this Lease at fair market value rental as determined under Section 12.I(a) above); Provided, however that the Lessor or the Agent may, but shall be under no obligation to, market the Property during the Marketing Period. In the event that the Lessee receives any bid(s) for the Property, the Lessee shall, within five (5) Business Days after its receipt thereof and at least twenty (20) Business Days prior to the Financing Termination Date, certify to the Lessor and the Agent in writing the amount and terms of such bid(s), and the name and address of the party or parties submitting such bid. The Lessee shall bear its own expenses and pay, as Additional Rent, the expenses of the Lessor, the Note Purchaser, the Agent and the Liquidity Banks in connection with any such bidding and sale process pursuant to this Section 12.1, as well as all costs and expenses incurred by any Person (including a buyer or potential buyer) to cause the Property to be in the condition required by this Section 12.1 and all costs of repairs, modifications or improvements desired by any such buyer(s). (f) The Lessee shall promptly upon request permit inspection of the Property and any maintenance records relating to the Property by the Lessor and any potential purchaser(s), and shall otherwise do all things reasonably necessary to sell and deliver possession of the Property to any purchaser(s) thereof. (g) The Lessee shall use all efforts reasonably requested by the Agent to procure bids from one or more bona fide prospective purchasers and deliver the same, if any, to the Lessor (with a copy to the Agent) not less than twenty (20) days prior to the Financing Termination Date. No such purchaser shall be the Lessee or any Subsidiary or Affiliate of the Lessee or any Person with whom the Lessee has an understanding or arrangement regarding the future use of the Property by the Lessee or such Subsidiary or Affiliate, but such purchaser may be any Lessor Party or any Affiliate of the foregoing or any Person contacted by the Lessor, the Agent, the Note Purchaser or any Liquidity Bank. Each written offer must specify the Financing Termination Date as the effective date of the sale unless the Lessor, the Agent, and the Note Purchaser shall otherwise agree, each in its sole discretion. 20 (h) The Lessee shall submit all bids, if any, to the Lessor (with a copy to the Agent) and any Lessor Party will have the right to submit anyone or more bids. Any sale by the Lessee shall be for the highest cash bid submitted to the Lessor. The determination of the highest bid shall be made by the Agent prior to the end of the Marketing Period, but in no event shall the Agent have any obligation to approve any bid unless such bid, together with the Maximum Recourse Amount, if funded, equals or exceeds the sum of the Outstanding Lease Balance and all accrued and unpaid Basic Rent and Additional Rent. All bids shall be on an all-cash basis unless the Agent, the Lessor and the other Lessor Parties shall otherwise agree. (i) In connection with any such sale of the Lessor's interest in and to the Property, the Lessee will provide to the purchaser all customary "seller's" indemnities and representations and warranties regarding title (subject to the Lessee's rights and obligations under this Lease), absence of Liens (other than Permitted Liens) and the condition of the Property as reasonably required by the Lessor, including, without limitation, an environmental indemnity, to the extent the same are reasonably requested by the purchaser and factually accurate. The Lessee shall have obtained, at no cost or expense to the Lessor, all required governmental and regulatory consents and approvals and shall have made all filings as required by Applicable Law in order to carry out and complete the transfer of the Property. As to the Lessor, any such sale shall be made on an "as is, with all faults" basis without representation or warranty by the Lessor other than as to the absence of Lessor Liens. Any agreement as to such sale shall be made subject to the Lessor's rights to receive the proceeds of such sale in cash up to an amount equal to the Outstanding Lease Balance on the date of such sale, plus all accrued and unpaid Basic Rent plus any Additional Rent due and owing (including any amounts due under the Credit Agreement). (j) The Lessee shall pay directly, and not from the sale proceeds, all prorations, credits, costs and expenses of any such sale of the Property, whether incurred by the Lessor or the Lessee, including the cost of all title insurance, surveys, Environmental Audits and other environmental reports, appraisals, transfer taxes, the reasonable attorneys' fees of the Lessor, commissions, escrow fees, recording fees and all applicable documentary' and other transfer taxes. (k) On or prior to the Financing Termination Date, the Lessee shall, whether or not any or all of the Property has been sold, pay or cause to be paid to the Agent for repayment of the outstanding balance of the Notes and the Equity investment in the manner and priority specified in Article XI of the Credit Agreement (or in the case of Additional Rent, to the Person entitled thereto) on a Basic Rent Payment Date an amount equal to the sum of (i) all unpaid Basic Rent due on or prior to the Financing Termination Date, plus (ii) the gross sale proceeds, if any, from the sale of the Property, as adjusted for any prorations of property taxes and utility charges ("Gross Sales Proceeds"), less any marketing, closing or other costs, including sales commissions, plus (iii) the excess, if any, of the Outstanding Lease Balance over the Gross Sales Proceeds; provided, that so long as no Default, Event of Default, Acceleration Event or Unmatured Acceleration Event shall have occurred and be continuing, the amount of such excess so payable shall not be greater than the Maximum Recourse Amount, plus (y) without 21 duplication, all Additional Rent due and owing on the Financing Termination Date after giving effect to such payment plus (z) all other amounts under the Credit Documents which have accrued or will accrue prior to or as of the Financing Termination Date. (1) The Lessee shall pay to the Lessor on or prior to the Financing Termination Date the amounts, if any, required to be paid pursuant to the Credit Agreement. (m) The sale of the Property shall be consummated on the Financing Termination Date and the Gross Sales Proceeds of the sale of the Property shall be paid directly to the Lessor. (n) To the extent that the Gross Sales Proceeds from such sale exceeds the Outstanding Lease Balance, any Additional Rent then due and owing, and together with any unpaid Basic Rent, then the excess arising hereunder (the "Excess Remarketing Proceeds"), shall be paid to the Lessee on the Financing Termination Date (provided that the Lessee shall have paid all amounts due pursuant to clause (k) above). If the Property has not been sold on or prior to the Financing Termination Date and any such sale is consummated at any time thereafter, then, if after giving effect to such sale there would be any Excess Remarketing Proceeds, the Lessor shall remit to the Lessee, promptly after the consummation of such sale, an amount equal to the Excess Remarketing Proceeds minus the Imputed Return, determined as of the date of such sale. Section 12.2 Procedures. If No Sale During Marketing Period. If the Lessee effectively elects the Remarketing Option and each of the conditions and requirements set forth in Section 12.1 hereof shall have been satisfied, but, nevertheless, the Lessee is unable to obtain bids for the Property satisfactory to the Agent pursuant to Section 12.1(h) above and the Property remains unsold at the end of the Marketing Period, then the Lessee shall, in addition to making the payments required pursuant to Sections 12.1(k) and 12.1(1) above, surrender the Property to the Lessor (or to any other Person specified by the Lessor). In connection with such surrender of the Property, the Lessee shall, at its own cost and expense, do each of the following or otherwise comply with this Section 12.2: (a) the Lessee shall, on or prior to the Financing Termination Date, execute and deliver to the Lessor (or to the Lessor's designee) (A) a certificate of the Lessee containing representations and warranties regarding the absence of Liens (other than Permitted Liens), (B) if applicable or required, a bill of sale with respect to all equipment and other personal property comprising part of the Property and (C) a deed or other conveyance instrument of the Lessee's entire interest in the Property (which shall include an assignment of all of the Lessee's right, title and interest in and to any insurance or loss proceeds with respect to the Property and an assignment of all leases and subleases the Property), in each case in recordable form and otherwise in conformity with local custom and free and clear of any Liens attributable to the Lessee; (b) the Lessee shall execute and deliver to the Lessor and the Lessor's title insurance company an affidavit in customary form as to the absence of any Liens 22 (other than Permitted Liens), and shall execute and deliver to the Lessor a statement of termination of this Lease; (c) the Lessee shall, on the Financing Termination Date, (i) vacate the Property and, at the request of the Lessor, cause any subtenant or other sublessee of the Property to vacate the Property, and (ii) transfer possession of the Property to the Lessor or any Person designated by the Lessor, in each case by surrendering the same into the possession of the Lessor or such Person, as the case may be, in the condition required by the Surrender Conditions and in compliance with Applicable Law; (d) on or prior to the Financing Termination Date, the Lessee shall deliver to the Lessor or any Person designated by the Lessor copies of all books and records in any Lessee Parties' possession or control regarding the maintenance and ownership of the Property, a current copy of the plans and specifications for the Property and an assignment of all assignable licenses necessary for the operation and maintenance of the Property; (e) the Lessee shall, for so long as the Lessor shall own the Property, cooperate reasonably with the Lessor and/or any Person designated by the Lessor to receive the Property, which cooperation shall include seeking and obtaining all necessary Governmental Action. The obligations of the Lessee under this paragraph shall survive the expiration or termination of this Lease; and (f) in the event that the Lessor disposes of the Property after the Remarketing Period, the Lessee shall be entitled to receive the surplus, if any of (i) the sum of (A) all amounts paid to the Lessor pursuant to Sections 12.1(k) and 12.1(1) above plus (B) the net sales proceeds of the disposition of the Property, over (ii) the sum of (A) the Outstanding Lease Balance plus (B) any costs incurred by the Lessor in respect of the Property which have not been otherwise paid by the Lessee or the Guarantor plus (C) any unpaid Basic Rent or Additional Rent plus (D) the Imputed Return. Section 12.3 Failure to Comply with Remarketing Conditions. If the Lessee effectively elects the Remarketing Option but if one or more of the provisions of the Surrender Conditions shall not be fulfilled as of the applicable date set forth in such provision (time being of the essence), then the Lessor (without prejudice by any delay in doing so) shall declare by written notice to the Lessee the Remarketing Option to be null and void, in which event all of the rights of the Lessee under Section 12.1 above shall immediately terminate and, as a consequence of the Lessee's failure to comply with such Remarketing Conditions, the Lessee shall be deemed to have exercised its Purchase Option with respect to the Property and the Lessee shall purchase all of the Property on the Financing Termination Date in accordance with the provisions of Section 13(b) below. Section 12.4 Sales. Except as expressly set forth in Section 12.1 above, the Lessee shall not have the right, power or authority to bind the Lessor in connection with any proposed sale of any Property. The Lessor shall have the right, but shall be under no 23 duty, to solicit bids, to inquire into the efforts of the Lessee to obtain bids or otherwise to take action in connection with any such sale. Section 12.5 Certain Obligations Continue. During the Marketing Period, the obligations of the Lessee to pay Basic Rent and Additional Rent with respect to the Property (including any installment of Rent due on the Financing Termination Date) shall continue undiminished.; (r) Section 13 of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: SECTION 13. LESSEE'S RIGHTS OF PURCHASE AND RENEWAL. Section 13.1 Purchase Option. Subject to the conditions contained herein, the Lessee shall have the option ("Purchase Option") to purchase from the Lessor all of the Lessor's interest in and to the Property for the price ("Purchase Option Price") set forth below. (a) Purchase of Property. The Lessee shall have the irrevocable option to acquire all, but not less than all, of the Lessor's interest in and to the Property on (x) any Basic Rent Payment Date or (y) the expiration date of the KeyBank Financing Term or of the non-cancelable term of any substitute or replacement financing under any successor Credit Agreement, at a Purchase Option Price equal to the Outstanding Lease Balance of this Lease plus all accrued and unpaid Basic Rent and any Additional Rent due and owing under this Lease and any other amounts due under the Credit Agreement and the other Credit Documents, with the amount of such Outstanding Lease Balance, Basic Rent and Additional Rent to be determined as of such date of purchase. The Lessee's exercise of its option pursuant to this clause (a) shall be subject to the following conditions: (i) if the purchase date is not the expiration date of the KeyBank Financing Term or of the non-cancelable term of any substitute or replacement financing under any successor Credit Agreement, then the Lessee shall have delivered a Purchase Notice at least sixty (60) days prior to such purchase date; and (ii) if the Purchase Option is exercised by the Lessee following the occurrence of an Event of Default, (A) such exercise by the Lessee of the Purchase Option shall not require the Lessor to cease exercising its rights and remedies under this Lease unless and until the Lessee completes the purchase of the Property pursuant to this Section 13.1, and (B) the Lessee completes the purchase of the Property pursuant to this Section 13.1 prior to the earlier of the Financing Termination Date and the date the Lessor completes any judicial or non-judicial foreclosure sale of the Property or similar action terminating the Lessee's possessory interest in the Property. Any Purchase Notice delivered in connection with an acquisition of the Lessor's fee interest in and to the Property pursuant to this clause (a) shall be irrevocable upon delivery thereof. Provided that no Default, Event of Default, Acceleration Event or Unmatured Acceleration Event shall have occurred and be continuing, the Lessor shall 24 act in good faith to accommodate any refinancing activities undertaken by the Lessee which are scheduled to take effect within ninety (90) days prior to the expiration date of the KeyBank Financing Term. (b) Procedures Upon Exercise of a Purchase Option. If the Lessee exercises the Purchase Option pursuant to this Section 13.1 then, upon the receipt by the Lessor of the Purchase Option Price and all other amounts due in connection therewith and the satisfaction of any additional conditions specified in Section 13.1(a) hereof, the Lessor shall transfer to the Lessee or its designee all of the Lessor's right, title and interest in and to the Property "AS IS" and in its then present physical condition, such transfer to be effective as of the date specified in the Purchase Notice. The Lessor shall execute and deliver to the Lessee (or to the Lessee's designee), at the Lessee's cost and expense, a grant deed and a bill of sale or other appropriate conveyance document with respect to all buildings and containing representations and warranties of grantor regarding the absence of Lessor Liens and a conveyance of the Lessor's entire interest in the Property (which shall include an assignment of all of the Lessor's right, title and interest in and to any net insurance proceeds with respect to the Property not previously received by the Lessor and an assignment and assumption of leases of such Property), in each case in recordable form and otherwise in conformity with local custom and free and clear of Liens created by the Credit Documents that are attributable to the Lessor Parties, and any Lessor Liens. The Lessor shall, at the Lessee's sole cost and expense, execute and deliver to the Lessee and the Lessee's title insurance company an affidavit as to the Lessor's title to the Property and the absence of Lessor Liens attributable to the Lessor on the Property. The Lessee may designate, in a notice given to the Lessor not less than ten (10) Business Days prior to the closing of such purchase (time being of the essence), the transferee or transferees to whom the conveyance shall be made (if other than to the Lessee), in which case such conveyance shall (subject to the terms and conditions set forth herein) be made to such designee; Provided, however, that such designation of a transferee or transferees shall not cause the Lessee to be released, fully or partially, from any of its Obligations, including, without limitation, the obligation to pay to the Lessor the Purchase Option Price on the date specified in the Purchase Notice. (c) So long as no Event of Default has occurred and is continuing, the Lessee shall have the right, upon ninety (90) days' written notice to the Lessor, to renew the lease of any Parcel of Property or Unit of Equipment for a term (the "Renewal Term") equal to the number of calendar months set forth opposite such Parcel of Property or type of Equipment under the heading "Renewal Term" in Exhibit A hereto, commencing on the first day of the calendar month following the last day of the Lease Term thereof, at the fair market value rental. (d) The fair market value of any Parcel of Property or Unit of Equipment for purposes of paragraph (c) of this Section 13 shall be as agreed by the Lessor and the Lessee or, if they are unable to agree, pursuant to the Appraisal Procedure.; (s) Subparagraph 14(a) of the Lease Agreement is hereby amended by: 25 (i) deleting the word "a" preceding the first three occurrences of the term "Credit Agreement" and inserting in place thereof the word "the"; (ii) deleting the word "or" preceding clause (iii) and inserting in place thereof a comma; (iii) adding new clauses (iv).(v). and (vi), preceded by a comma, to be read in their entirety as follows: (iv) the Lessor cannot arrange for bank borrowings to extend the term of the KeyBank Financing Term or to refinance the purchase of such Property or Equipment upon terms reasonably acceptable to the Lessee; (v) an Event of Loss occurs; or (vi) a Material Adverse Environmental Condition exists.; (t) Subparagraph 14(b) of the Lease Agreement is hereby amended by: (i) deleting the words "at its Adjusted Acquisition Cost" and inserting in place thereof the words "equal to the Outstanding Lease Balance of this Lease"; (ii) deleting the words "Basic Rent payable, the Variable Component of Basic Rent accrued" and inserting in place thereof the words "accrued and unpaid Basic Rent and any Additional Rent due and owing under this Lease and any other amounts due under the Credit Agreement and the other Credit Documents"; (iii) deleting the final occurrence of words "Additional Rent and" therein; (u) Subparagraph 14(c) of the Lease Agreement is hereby amended by: (i) deleting both occurrences of the term "Adjusted Acquisition Cost" and inserting in place thereof the term "Outstanding Lease Balance"; (ii) deleting the words "Basic Rent payable, the Variable Component of Basic Rent accrued" and inserting in place thereof the words "accrued and unpaid Basic Rent and any Additional Rent due and owing under this Lease and any other amounts due under the Credit Agreement and the other Credit Documents"; (iii) deleting the final occurrence of words "Additional Rent and" therein; (v) Section 14 of the Lease Agreement is hereby amended by adding a new subparagraph (d) to be read in its entirety as follows: (d) Upon any such transfer of the Property or Equipment from the Lessor to the Lessee pursuant to this Section 14, the memorandum of lease covering this Lease shall terminate and concurrently with the Lessor's receipt of such payment, (i) the Lessor shall execute and deliver to the Lessee (or to the Lessee's designee), at the Lessee's cost and expense, a grant deed and a bill of sale or other appropriate conveyance instrument with respect to the Property containing representations and warranties of grantor regarding the absence of Lessor Liens and an assignment of the Lessor's entire interest in 26 the Property (which shall include an assignment of all of the Lessor's right, title and interest in and to any net insurance proceeds with respect to the Property not previously received by the Lessor and an assignment and assumption of leases of such Property), in each case in recordable form and otherwise in conformity with local custom and free and clear of the lien of this Lease and the memorandum of lease covering the Property and any Lessor Liens attributable to the Lessor; (ii) the Property shall be conveyed to the Lessee "AS IS" and in its then present physical condition; (iii) the Lessor shall, at the Lessee's sole cost and expense and as a condition to the Lessee's obligation to acquire the Lessor's interest in the Property, (x) execute and deliver to the Lessee a statement of termination of this Lease and the memorandum of lease and releases of any Liens on the Property created by the Credit Documents attributable to the Lessor and (y) obtain terminations of any Liens on the Property which may be held by the Agent or any other Lessor Party, including, in each case, termination statements for any financing statements (to the extent relating to the Property) which are then of record naming the Lessor, the Agent or any other Lessor Party, as the case may be, as the secured party with respect to the Property; and (iv) in the case of a termination pursuant to an Event of Loss, the Lessor shall convey to the Lessee any net insurance proceeds therefor received by the Lessor or assign the Lessor's right to receive all insurance proceeds with respect to the casualty or Taking giving rise to the termination of this Lease or at the request of the Lessee, such amounts shall be applied against sums due hereunder.; (w) Section 15 of the Lease Agreement is hereby amended by (i) inserting directly following the Section title, so as to precede the subparagraphs, the words "Except as otherwise provided in the Credit Agreement:"; (ii) deleting both occurrences of the term "Adjusted Acquisition Cost" and inserting in place thereof the term "Outstanding Lease Balance"; (iii) deleting the only occurrence of the words "the Variable Component of Basic Rent" with the comma preceding such words, and inserting in place thereof the word "and"; (x) Section 16 of the Lease Agreement is hereby amended by (i) deleting the word "Unit" and inserting in place thereof the word "Parcel"; (ii) deleting the term "Adjusted Acquisition Cost" and inserting in place thereof the term "Outstanding Lease Balance"; (y) Section 18 of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: SECTION 18. EVENTS OF DEFAULT. Any of the following events of default shall constitute an "Event of Default" and shall give rise to the rights on the part of the Lessor described in Section 19 hereof: 27 (a) (i) Failure to comply with paragraph (b) of Section 14; (ii) failure of the Lessee to pay amounts due to the Lessor at the time of any scheduled sale or attempted sale of any Parcel of Property or Unit of Equipment hereunder (including, without limitation, (as applicable) the Outstanding Lease Balance, the Purchase Option Price, the Maximum Recourse Amount or the Gross Sales Proceeds) for more than five (5) Business Days, (iii) failure of the Lessee to pay Basic Rent for more than five (5) Business Days after such payment is due pursuant to Section 7 hereof, or (iv) failure of the Lessee to pay Additional Rent or any other amount payable by the Lessee hereunder or under any other Credit Document to which it is a party for more than five (5) Business Days after receipt of written demand thereof from the Lessor or any assignee thereof; or (b) Failure to maintain the insurance required by Section 10 hereof, or default in the performance of the covenant contained in paragraph (1) of Section 10 hereof; provided, however, that the Lessee's failure to maintain the insurance required under Section 10 hereof shall not become an Event of Default if the Lessee corrects such failure within one (1) Business Day following such lapse or failure; or (c) (i) Default in the performance of any term, covenant or condition to be performed by it under Section 12.1 or Section 12.2 hereof, or the Guarantor shall fail to observe or perform any term, covenant or condition to be performed by it under the Guaranty or Sections 8.1. 8.2 or 8.3 of the Credit Agreement; or (ii) default in the performance of any other material obligation or covenant of the Lessee or the Guarantor pursuant to this Lease, the Guaranty or any other Credit Document to which it is a party other than those described in this Section 18 and, in each such case, such failure shall have continued for thirty (30) days or such shorter period as may be specified in such Credit Document after the earlier of (x) the date on which any Responsible Officer of the Lessee having direct responsibility for the Property of the Lessee or the Guarantor, as applicable, shall have actual knowledge thereof and (y) delivery to the Lessee or the Guarantor of written notice thereof from the Lessor; or (d) The entry of a decree or order for relief in respect of the Lessee, the Guarantor or any Material Subsidiary by a court having jurisdiction in the premises or the appointment of a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other similar official) of the Lessee, the Guarantor or any Material Subsidiary or of any substantial part of its property, or ordering the winding up or liquidation of its affairs, in an involuntary case under the Federal bankruptcy laws, as now or hereafter constituted, or any other applicable Federal or state bankruptcy, insolvency or other similar law and such decree or order remains unstayed and in effect for forty-five (45) consecutive days, or the commencement against the Lessee, the Guarantor or any Material Subsidiary of an involuntary case under the Federal bankruptcy laws, as now or hereafter constituted, or any other applicable Federal or state bankruptcy, insolvency or other similar law, and the continuance of any such case unstayed and in effect for a period of forty-five (45) consecutive days; or (e) The suspension or discontinuance of the Lessee's, the Guarantor's or any Material Subsidiary's business operations, the Lessee's, the Guarantor's or any Material Subsidiary's insolvency (however evidenced) or the Lessee's, the Guarantor's or 28 any Material Subsidiary's admission of insolvency or bankruptcy, or the commencement by the Lessee, the Guarantor or any Material Subsidiary of a voluntary case under the Federal bankruptcy laws, as now or hereafter constituted, or any other applicable Federal or state bankruptcy, insolvency or other similar law, or the consent by the Lessee, the Guarantor or any Material Subsidiary to the appointment of or possession by a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other taking, similar official) of the Lessee, the Guarantor, any Material Subsidiary or of any substantial part of the Lessee's, the Guarantor's or any Material Subsidiary's property, or the making by the Lessee, the Guarantor or any Material Subsidiary of an assignment for the benefit of creditors, or the failure of the Lessee, the Guarantor or any Material Subsidiary generally to pay its debts as such debts become due, or the taking of corporate action by the Lessee, the Guarantor or any Material Subsidiary in furtherance of any such action; or (f) A default or event of default, the effect of which is to permit the holder or holders of any Indebtedness, or a trustee or agent on behalf of such holder or holders, to cause such Indebtedness to become due prior to its stated maturity shall occur under the provisions of any agreement pursuant to which such Indebtedness was created or instrument evidencing such Indebtedness in excess of $10,000,000 in the aggregate of the Lessee, the Guarantor, any of the Guarantor's other Subsidiaries or any obligation of the Lessee, the Guarantor or any of the Guarantor's other Subsidiaries for the payment of such Indebtedness shall become or be declared to be due and payable prior to its stated maturity, or shall not be paid when due; or (g) Any representation or warranty made by the Lessee in this Lease or any other Credit Document to which it IS a party proves to be false or inaccurate in any material respect on or as of the date made or deemed made, except for such inaccuracies or misstatements which are not material, and if capable of remedy, shall remain unremedied for thirty (30) days after the earlier of (i) the date on which any Responsible Officer of the Lessee having direct responsibility for the Property shall have actual knowledge thereof, and (ii) delivery to the Lessee of written notice thereof from the Lessor or any permitted assignee thereof; or (h) Final non-appealable judgment or judgments for the payment of money in excess of $10,000,000 in the aggregate shall be rendered against the Lessee, or in excess of $10,000,000 in the aggregate shall be rendered against the Guarantor or any of the Guarantor's Subsidiaries (including the Lessee) by any court of competent jurisdiction and the same shall remain undischarged for a period of sixty (60) days during which execution of such judgment or judgments shall not be effectively stayed; or (i) Any representation or warranty made by the Guarantor in the Guaranty or any other Credit Document proves to be false or inaccurate in any material respect or the Guarantor shall fail to perform or observe any agreement or covenant contained in the Guaranty or any other Credit Document, except for such inaccuracies or misstatements which are not material, and if capable of remedy, shall remain unremedied for thirty (30) days after the earlier of (x) the date on which any Responsible Officer of the Guarantor shall have actual knowledge thereof, and (y) delivery to the Guarantor of written notice thereof from the Lessor or any permitted assignee thereof; or 29 (j) The Guaranty ceases to be in full force and effect or Guarantor denies or disaffirms its obligations under the Guaranty; or (k) The Conduit Agent shall have delivered a Notice of Default to the Lessee; or (1) Any provision under any Credit Document with respect to the Property or the payment obligations of the Lessee or the Guarantor or any Lien granted under any Credit Document shall, in whole or in part, other than solely as the result of an intentional act of a Lessor Party, terminate, cease to be effective against, or cease to be the legally valid, binding and enforceable obligation of, the Lessee or the Guarantor, as the case may be, the effect of which, in any such case, shall deprive any party to such Credit Document of any material benefits and rights intended to be created thereby, or except as permitted under any Credit Document, any Lien securing any Obligation shall, in whole or in part, cease to be a perfected first priority Lien; or (m) The Lessee or the Guarantor shall directly or indirectly contest in any manner the effectiveness, validity, binding nature or enforceability of any Credit Document or any Lien granted under any Credit Document; or (n) With respect to any Guaranteed Pension Plan, an ERISA Reportable Event shall have occurred and the Lessor Parties shall have determined in their reasonable discretion that such event reasonably could be expected to result in liability of the Guarantor or any of its Subsidiaries to the PBGC or such Guaranteed Pension Plan in an aggregate amount exceeding $500,000 and such event in the circumstances occurring reasonably could constitute grounds for the termination of such Guaranteed Pension Plan by the PBGC or for the appointment by the appropriate United States District Court of a trustee to administer such Guaranteed Pension Plan; or a trustee shall have been appointed by the United States District Court to administer such Guaranteed Pension Plan; or the PBGC shall have instituted proceedings to terminate such Guaranteed Pension Plan; or (o) With respect to any Guaranteed Pension Plan, an ERISA Reportable Event shall have occurred and the Lessor Parties shall have determined in their reasonable discretion that such event reasonably could be expected to result in liability of the Guarantor or any of its Subsidiaries to the PBGC or such Guaranteed Pension Plan in an aggregate amount exceeding $500,000 and such event in the circumstances occurring reasonably could constitute grounds for the termination of such Guaranteed Pension Plan by the PBGC or for the appointment by the appropriate United States District Court of a trustee to administer such Guaranteed Pension Plan; or a trustee shall have been appointed by the United States District Court to administer such Guaranteed Pension Plan; or the PBGC shall have instituted proceedings to terminate such Guaranteed Pension Plan. (z) Section 19 of the Lease Agreement is hereby amended by 30 (i) adding immediately after the section title, so as to precede the sentence beginning with the words "Upon the occurrence", two sentences which are to be read in their entirety as follows: Upon the occurrence and continuance of any Event of Default of the type described in clause (d) or (e) of Section 18, the Lessee shall immediately become obligated to pay the then outstanding amount of the Outstanding Lease Balance together with all accrued and unpaid Basic Rent and Additional Rent, without presentment, demand, protest, notice of acceleration or other notice of any kind, all of which are hereby expressly waived, anything in this Lease or any other Credit Document to the contrary notwithstanding. Upon written notice by the Lessor to the Lessee after the occurrence and continuance of any other Event of Default, the Lessee shall immediately become obligated to pay the then outstanding amount of the Outstanding Lease Balance together with all accrued and unpaid Basic Rent and Additional Rent.; (ii) amending clause (c) by inserting "(i)" before the word "sell"; (iii) amending clause (c) by adding a new subclause (ii) to be read in its entirety as follows: and (ii) if the Lessor shall so elect, demand that the Lessee pay to the Lessor, and the Lessee shall pay to the Lessor, on the date of such sale, as liquidated damages for loss of a bargain and not as a penalty (the parties agreeing that the Lessor's actual damages would be difficult to predict, but the aforementioned liquidated damages represent a reasonable approximation of such amount) (in lieu of Basic Rent due for periods commencing after the Basic Rent Payment Date coinciding with such date of sale (or, if the sale date is not a Basic Rent Payment Date, the Basic Rent Payment Date next preceding the date of such sale>>, an amount equal to (A) the excess, if any, of (1) the Outstanding Lease Balance calculated as of such Basic Rent Payment Date (plus all Basic Rent and Additional Rent due and unpaid to and including such Basic Rent Payment Date), over (2) the net proceeds of such sale (that is, after deducting all costs and expenses incurred by the Lessor or incident to such conveyance, including, without limitation, repossession costs, brokerage commissions, prorations, transfer taxes, fees and expenses for counsel, title insurance fees, survey costs, recording fees, and any repair costs); plus (B) interest at the Overdue Rate on the foregoing amount from such Basic Rent Payment Date until the date of payment; (iv) amending clause (d) by deleting the final word "and" with the preceding semicolon and inserting in place thereof a period and new language to be read in its entirety as follows: If the Lessee has breached this Lease and abandoned the Property, this Lease shall continue in effect for so long as the Lessor does not terminate the Lessee's right to possession, and the Lessor may enforce all of the Lessor's rights and remedies under this Lease, including the right to recover the Basic Rent and Additional 31 Rent hereunder as it becomes due under this Lease. The following do not constitute a termination of the Lessee's right to possession: (i) Acts of maintenance or preservation or efforts to relet the Property or any portion thereof; (ii) The appointment of a receiver upon the initiative of the Lessor to protect the Lessor's interest under this Lease; or (iii) Reasonable withholding of consent to an assignment or subletting, or terminating a subletting or assignment by the Lessee; (v) amending clause (e) by deleting the final period and inserting in place thereof a semicolon; (vi) amending clause (f) by adding new language to the end thereof to be read in its entirety as follows: During the continuance of an Event of Default, the Lessor may enter the Property in accordance with applicable law without terminating this Lease and sublet all or any part of the Property for the Lessee's account to any Person, for such term (which may be a period beyond the remaining Lease Term), at such rents and on such other terms and conditions as are commercially reasonable. If the rents received by the Lessor from such subletting, after application as provided above, are insufficient in any period to pay Basic Rent and Additional Rent due and payable hereunder for such period, the Lessee shall pay such deficiency to the Lessor upon demand. Notwithstanding any such subletting for the Lessee's account without termination, the Lessor may at any time thereafter, by written notice to the Lessee, elect to terminate this Lease by virtue of a previous Event of Default; (vii) adding new clauses (g). (h). and (i) to be read in their entirety as follows: (g) Demand in writing that the Lessee surrender the Property promptly to the Lessor in compliance with the Surrender Conditions and in the manner and condition required by, and otherwise in accordance with all of the provisions of, Section 12 hereof as if the Property was being surrendered after the exercise of a Remarketing Option, and the Lessor shall not be liable for the reimbursement of the Lessee for any costs and expenses incurred by the Lessee in connection therewith and without prejudice to any other remedy which the Lessor may have for possession of the Property, and to the extent and in the manner permitted by Applicable Law, enter upon the land and take immediate possession of (to the exclusion of the Lessee) the Property therein or any part thereof and expel or remove the Lessee, by summary proceedings or otherwise, all without liability to the Lessee for or by reason of such entry or taking of possession, whether for the restoration of damage to property caused by such taking or otherwise and, in addition to the other damages of the Lessor, the Lessee shall be responsible for all 32 costs and expenses incurred by the Lessor in connection with any reletting of all or any of the Property (including reasonable brokers' fees) and all costs of any repairs or alterations made by the Lessor; (h) Demand, by written notice to the Lessee, that the Lessee purchase, on the date specified in such notice such date in all cases to be at least twenty (20) days from the date of notice, the Property for the Outstanding Lease Balance plus all other amounts then due and owing hereunder in accordance with the provisions of Section 13 hereof; or (i) Exercise its remedies under any other Credit Document.; (viii) deleting the three occurrences of the term "Adjusted Acquisition Cost" and inserting in place thereof the term "Outstanding Lease Balance"; (aa) Section 20 of the Lease Agreement is hereby amended by (i) deleting the two occurrences of the term "Adjusted Acquisition Cost" and inserting in place thereof the term "Outstanding Lease Balance"; (ii) deleting the words "and Variable Component of Basic Rent" with the preceding comma and inserting in place thereof the word "and"; (bb) Section 23 of the Lease Agreement is hereby amended by amending and restating the language following the phrase "The initial addresses of the parties hereto are as follows:" to be read in its entirety as follows: If to the Lessor: Flatirons Funding, Limited Partnership c/o KeyCorp. Leasing 54 State Street Albany, New York 12207 Attention: Donald Davis Telephone: (518) 486-8984 Telecopy: (518) 487-4635 With a copy of all notices under this Section 23 to be simultaneously given, delivered or served to the following address: KeyBank National Association 601 108th Avenue Northeast, 5th Floor Bellevue, Washington 98004 Attention: Kim Richmond Telephone: (425) 709-4584 Telecopy: (425) 709-4565 33 If to the Lessee: Electronic Arts Redwood, Inc. 209 Redwood Shores Parkway Redwood City, California 94065 Attention: David Carbone President Telephone: (650) 628-7240 Telecopy: (650) 628-1395 With a copy of all notices under this Section 23 to be simultaneously given, delivered or served to the following address: Electronic Arts, Inc. 209 Redwood Shores Parkway Redwood City, California 94065 Attention: General Counsel Telephone: (650) 628-7395 Telecopy: (650) 628-1395 With a copy of all notices under this Section 23 to any Assignee at such address as such Assignee may specify by written notice to the Lessor and the Lessee.; (cc) Section 30 of the Lease Agreement is hereby amended by (i) amending subparagraph 30(b) by inserting after the first occurrence of the word "herein" the words "including, but not limited to, the Credit Documents," preceded by a comma; (ii) amending and restating the bold capitalized language in subparagraph 30(d) to be read in its entirety as follows: THIS LEASE HAS BEEN EXECUTED AND DELIVERED IN THE STATE OF CALIFORNIA. THE LESSEE AND THE LESSOR AGREE THAT, TO THE MAXIMUM EXTENT PERMITTED BY THE LA W OF THE ST ATE OF CALIFORNIA, THIS LEASE, AND THE RIGHTS AND DUTIES OF THE LESSEE AND THE LESSOR HEREUNDER, SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA IN ALL RESPECTS, INCLUDING WITHOUT LIMITATION IN RESPECT OF ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE. THE LESSEE HEREBY IRREVOCABLY SUBMITS, FOR ITSELF AND ITS PROPERTY, TO THE JURISDICTION OF THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA AND THE SUPERIOR COURT OF THE STATE OF CALIFORNIA IN THE COUNTY OF SAN FRANCISCO IN ANY ACTION, SUIT OR PROCEEDING BROUGHT AGAINST IT AND RELATED TO OR IN CONNECTION WITH THIS LEASE OR THE 34 TRANSACTIONS CONTEMPLATED HEREBY, AND TO THE EXTENT PERMITTED BY APPLICABLE LAW, THE LESSEE HEREBY WAIVES AND AGREES NOT TO ASSERT BY WAY OF MOTION, AS A DEFENSE OR OTHERWISE IN ANY SUCH SUIT, ACTION OR PROCEEDING, ANY CLAIM THAT IT IS NOT PERSONALLY SUBJECT TO THE JURISDICTION OF SUCH COURT, THAT THE SUIT, ACTION OR PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM, THAT THE VENUE OF THE SUIT, ACTION OR PROCEEDING IS IMPROPER, OR THAT THIS LEASE OR ANY DOCUMENT OR ANY INSTRUMENT REFERRED TO HEREIN OR THE SUBJECT MATTER HEREOF MAY NOT BE LITIGATED IN OR BY SUCH COURT. TO THE EXTENT PERMITTED BY APPLICABLE LAW, THE LESSEE AGREES NOT TO SEEK AND HEREBY WAIVES THE RIGHT TO ANY REVIEW OF THE JUDGMENT OF ANY SUCH COURT BY ANY COURT OF ANY OTHER NATION OR JURISDICTION WHICH MAY BE CALLED UPON TO GRANT AN ENFORCEMENT OF SUCH JUDGMENT. THE LESSEE AGREES THAT SERVICE OF PROCESS MAY BE MADE UPON IT BY CERTIFIED OR REGISTERED MAIL TO THE ADDRESS FOR NOTICES SET FORTH IN THIS LEASE OR ANY METHOD AUTHORIZED BY THE LAWS OF CALIFORNIA. THE LESSOR AND THE LESSEE EXPRESSLY WAIVE ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM RELATED TO THIS LEASE OR THE TRANSACTIONS CONTEMPLATED HEREBY. THE LESSOR AND THE LESSEE ACKNOWLEDGE THAT THE PROVISIONS OF THIS PARAGRAPH (D) OF SECTION 30 HAVE BEEN BARGAINED FOR AND THAT THEY HAVE BEEN REPRESENTED BY COUNSEL IN CONNECTION THEREWITH.; (iii) deleting the language of subparagraphs 30(g) and 30(h) and inserting in place thereof the words "Intentionally omitted." surrounded by brackets; (iv) amending subparagraph 30(i} by deleting the words "the Agreement for Lease and this Lease" and inserting in place thereof the words "this Lease and of the other Credit Documents"; (dd) Section 31 of the Lease Agreement is hereby amended and restated to be read in its entirety as follows: SECTION 31. NO RECOURSE. The parties hereto agree that neither the Lessor nor any of its general or limited partners shall have any personal liability whatsoever to the Lessee or its respective successors and assigns for any claim based on or in respect of this Lease or any of the other Credit Documents or arising in any way from the transactions contemplated hereby or thereby; provided, however, that the Lessor shall be liable for its own willful misconduct or gross negligence (or negligence in the handling of funds), for liabilities that may result from the incorrectness of any representation or warranty 35 expressly made by it in Section 7.4 of the Credit Agreement or from the failure of the Lessor to perform its covenants and agreements set forth in the Credit Agreement, or for any tax based on or measured by any fees, commission or compensation received by it for acting as a Lessor as contemplated by the Credit Documents. It is understood and agreed that, except as provided in the preceding proviso, neither the Lessor nor any of its general or limited partners shall have any personal liability under any of the Credit Documents as a result of acting pursuant to and consistent with any of the Credit Documents; all obligations of the Lessor to the Lessee are solely nonrecourse obligations except, as to the Lessor, to the extent that the Lessor has received payment from others; all such personal liability of the Lessor and of any of its general or limited partners is expressly waived and released as a condition of, and as consideration for, the execution and delivery of the Credit Documents by the Lessor. (ee) A new Section 33 of the Lease Agreement is hereby added to be read in its entirety as follows: SECTION 33. ENVIRONMENTAL MATTERS (a) Remediation of Environmental Claims. The Lessee shall, at the Lessee's sole cost and expense, promptly and diligently commence any Remedial Action necessary to remove, clean up or remediate all Adverse Environmental Conditions and all Environmental Claims relating to the Property in accordance with Legal Requirements. (b) Notices and Reports Concerning Environmental Matters. The Lessee shall promptly, but in any event within fifteen (15) Business Days from the date the Lessee has actual knowledge thereof, provide to the Agent on behalf of the Lessor Parties written notice of any pending Adverse Environmental Condition or Environmental Claim relating to the Property for which the Remediation Costs could reasonably be expected to exceed, or where the aggregate costs of all such matters could reasonably be expected to exceed, $2,000,000, or of any Release (in quantities or in a manner that may violate applicable Environmental Laws) on, at, under or from the Property. All such notices shall describe in reasonable detail the Adverse Environmental Condition, Environmental Claim, or Release and the nature of the claim, action or proceeding and the Lessee's proposed response thereto. In addition, the Lessee shall provide to Agent on behalf of the Lessor Parties within ten (10) Business Days of receipt, copies of all written communications with any Governmental Authority relating to any Adverse Environmental Condition or Environmental Claim in connection with the Property with respect to which the claims described in the first sentence of this Section 33(b) are pending. The Lessee shall also promptly provide such detailed reports of any Adverse Environmental Condition or Environmental Claims relating to the Property as may reasonably be requested by the Lessor Parties. In the event that the Lessor receives written notice of any Adverse Environmental Condition, Environmental Claim or any Release on or in connection with the Property, the Lessor shall promptly give notice thereof to the Lessee and the other Lessor Parties. Upon completion of any required Remedial Action of such Environmental Claims by the Lessee, the Lessee shall provide to the Agent on behalf of the Lessor 36 Parties (i) a report by a consultant reasonably acceptable to such parties describing such Adverse Environmental Conditions or Environmental Claims and the actions taken by the Lessee (or its agents) in response to such Adverse Environmental Conditions or Environmental Claims, (ii) a statement by the consultant that such Adverse Environmental Conditions or Environmental Claims have been remedied in compliance with all applicable Environmental Law, and (iii) a "No Further Action" letter or similar documentation by an applicable Governmental Authority, if applicable and available in a reasonable time and at reasonable expense. The Lessee shall provide the Agent on behalf of the Lessor Parties with copies of each such document promptly following its preparation or receipt by the Lessee. Each Environmental Claim and Adverse Environmental Condition relating to the Property shall, regardless of the cost of its remediation, be remedied in accordance with Legal Requirements hereof prior to the Financing Termination Date unless the Property shall have been purchased by the Lessee (or its designee) in accordance with Sections 13 or 14 hereof. (c) Upon the request of the Lessor, at any time and from time to time after the occurrence of an Event of Default hereof or at such other time as the Lessor has reasonable grounds to believe that Hazardous Substances have been Released, stored (in quantities or a manner that may violate Environmental Laws) or disposed of on or around the Property or that the Property may be in violation of the Environmental Laws, the Lessee shall provide, at the Lessee's sole expense, an inspection or audit of the Property prepared by a hydro geologist or environmental engineer or other appropriate consultant reasonably approved by the Agent on behalf of the Lessor indicating the presence or absence of Hazardous Substances on the Property. If the Lessee fails to provide such inspection or audit within thirty (30) days after such request, the Lessor may order the same, and the Lessee hereby grants to the Lessor access to the Property and an irrevocable license to undertake such inspection or audit. The cost of such inspection or audit shall be paid by the Lessee. (d) No Reduction of Other Obligations. Nothing in this Section 33 shall reduce or limit the Lessee's other obligations under this Lease or in the other Credit Documents. (ff) A new Section 34 of the Lease Agreement is hereby added to be read in its entirety as follows: SECTION 34. RIGHTS OF THE LESSEE. Subject to the terms of the other Credit Documents to which the Lessee is a party, during the Lease Term at any time when no Event of Default shall exist, the Lessee shall be entitled to receive, enjoy, distribute and otherwise dispose of the income, royalties, payments, recoveries and other proceeds with respect to (or included as a part of) the Property without the consent or joinder of the Lessor. (gg) A new Section 35 of the Lease Agreement is hereby added to be read in its entirety as follows: 37 SECTION 35. EXCESS PROCEEDS Notwithstanding anything to the contrary contained in this Lease, after the occurrence and during the continuance of an Event of Loss, a Default, Event of Default, Acceleration Event or Unmatured Acceleration Event other than an Event of Default pursuant to clause (a), (d) or (e) of Section 18 of this Lease, the Lessee shall have the right to pay an amount equal to the Outstanding Lease Balance of this Lease plus all accrued and unpaid Basic Rent plus any Supplemental Rent due and owing hereunder and under the Credit Agreement or any other Credit Document, with the amount of such Outstanding Lease Balance, Basic Rent and Supplemental Rent to be determined as of such date of payment, and upon such payment, the Property shall be reconveyed to the Lessee or its designee in accordance with the provisions of Section 13 of this Lease; provided, however, that such right of the Lessee shall terminate on the earliest of (i) the date occurring thirty (30) days after notice to the Lessee from the Lessor or any assignee thereof of the applicable Event of Default, (ii) the date occurring thirty (30) days after the Lessor has commenced its exercise of remedies under Section 18 of this Lease and (iii) the occurrence of any Event of Default under clause (a), (d) or (e) of Section 18 hereof. 3. Property Leased. The Lessor and the Lessee each acknowledge and agree that the only property currently leased under the Lease Agreement is the property described in AFL Unit Leasing Record dated December 1, 1998, consisting of an eight-story office building, a six- story office building, a four-story parking structure, and a two-story conference center, situated on the real property commonly known as Lot 3 and 4 and Parcels A and C, as shown on the map entitled "ELECTRONICS ARTS" filed March 27, 1997, Book 127 of Maps, pages 86 through 89, San Mateo County Records, together with appurtenant easements, as is more specifically described on Exhibit A attached hereto. 4. Initial Term: Extended Term. The Lessor and the Lessee each acknowledges and agrees that the Initial Term commenced on December 1, 1998, and expires on November 30,2001, and that the Extended Term commences on December 1, 2001 and shall expire on November 30, 2038. 5. Effective Date. The amendments effected by Paragraph 2 above shall become effective on July 16, 2001 (the "Effective Date"), subject to receipt by the Lessor, on or prior to the Effective Date of the following, each in form and substance satisfactory to the Lessor and the Lessor's counsel: (a) This Amendment duly executed by the Lessor and the Lessee; (b) Each of the conditions set forth in the Credit Agreement shall have been satisfied; and (c) Such other evidence as the Lessor may reasonably request to establish the accuracy and completeness of the representations and warranties and the compliance with the terms and conditions contained in this Amendment and the other Credit Documents. 38 6. Effect of this Amendment. On and after the Effective Date, each reference in the Lease Agreement and the other Credit Documents shall mean the Lease Agreement as amended hereby. Except as specifically amended above, (a) the Lease Agreement shall remain in full force and effect and is hereby ratified and affirmed and (b) the execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power, or remedy of the Lessor, nor constitute a waiver of any provision of the Lease Agreement, Credit Agreement or any other Credit Document. 7. Conflicts with Credit Documents in General. The parties hereto acknowledge and agree that in the event there is deemed to be any conflict or ambiguity between the terms and provisions of the Lease Agreement and the terms and provisions of the other Credit Documents, the terms and provisions of the other Credit Documents shall control. 8.Miscellaneous. (a) Counterparts. This Amendment may be executed in any number of identical counterparts, any set of which signed by all the parties hereto shall be deemed to constitute a complete, executed original for all purposes. (b) Headings: Headings in this Amendment are for convenience of reference only and are not part of the substance hereof. (c) Governing Law. This Amendment shall be governed by and construed in accordance with the laws of the State of California without reference to conflicts of law rules. [The signature page follows.] 39 IN WITNESS WHEREOF, Lessee and Lessor have caused this Amendment to be executed as of the day and year first above written. LESSEE: ELECTRONIC ARTS REDWOOD, INC. By: /s/ Khuyen Dang ----------------------------------- Name: Khuyen Dang Title: Chief Financial Officer LESSOR: FLA TIRONS FUNDING, LIMITED PARTNERSHIP, a Delaware limited partnership By: SELCO Redwood, LLC, a Delaware limited liability company, its general partner By: SELCO Service Corporation, an Ohio corporation doing business in California as Ohio SELCO Service Corporation, its sole member By: ___________________________________ Name: Donald Davis Title: Vice President 40 IN WITNESS WHEREOF, Lessee and Lessor have caused this Amendment to be executed as of the day and year first above written. LESSEE: ELECTRONIC ARTS REDWOOD, INC. By:__________________________________ Name: Title: LESSOR: FLATIRONS FUNDING, LIMITED PARTNERSHIP. a Delaware limited partnership By: SELCO Redwood, LLC, a Delaware limited liability company, its general partner By: SELCO Service Corporation, an Ohio corporation doing business in California as Ohio SELCO Service Corporation, its sole member By: /s/ Donald Davis ----------------------------------- Name: Donald Davis Title: Vice President 40 - -Amendment No.2 to Lease Agreement- THIS COUNTERPART IS THE ORIGINAL EXECUTED COUNTERPART. Receipt of this original counterpart of the foregoing Amendment No.2 to Lease Agreement is hereby acknowledged as of the date hereof. KEYBANK NATIONAL ASSOCIATION, as the Agent By: /s/ Thomas A. Crandell ---------------------------------------- Name: Thomas A. Crandell Title: Senior Vice President 41 Exhibit A The land is situated in the State of California, County of San Mateo, City of Redwood City and is described as follows: PARCEL I: Lots 3 and 4 and Parcels A and C as shown on the map entitled "ELECTRONICS ARTS" filed March 27,1997, Book 127 of Maps, pages 86 through 89, San Mateo County Records. PARCEL II: Non-exclusive easements appurtenant to Parcel I above for the purposes as defined in that certain Easement and Covenants Agreement dated March 27, 1997, by and between Shores Business Center Association and Flatirons Funding, Limited Partnership, recorded March 27, 1997, Document No. 97034607, San Mateo County Records, as amended by First Amendment to Easement and Covenants Agreement dated August 31, 1998, recorded September 2, 1998, Document No. 98141940, San Mateo County Records, and by Second Amendment to Easements and Covenants Agreement dated June 13,2000, and recorded July 10, 2000, Document No. 2000- 084044 ("Second Amendment") over under and across those areas described as "Utility Easement No.3-Lot D", "Covered Walkway Easement No.4-Lot D", "Utility Easement No.5-Lot D", "Utility and Covered Walkway Easement No.6-Lot E" and "Utility Easement No.7-Lot E" in Exhibit D of the Second Amendment. PARCEL III: Easements appurtenant to Parcels I and II above for the purposes set forth in Sections 11.4(a), 11.4( c), 11.5( a) and 11.6 in the Declaration of Covenants, Conditions, Easements and Restrictions, Electronic Arts Business Park recorded September 18, 1998, Document No. 98150182, San Mateo County Records. A.P.No.: 095-481-040 JPN 127 086 000 0003 T 095-481-050 127 086 000 0004 T 095-481-080 127 086 000 0007 T 095-482-020 127 086 000 0008 T 42 EX-10.53 6 dex1053.txt PARTICIPATION AGREEMENT DTD JULY 16, 2001 EXHIBIT 10.53 PARTICIPATION AGREEMENT Dated as of July 16, 2001 among ELECTRONIC ARTS REDWOOD, INC., as the Lessee, ELECTRONIC ARTS, INC., as the Guarantor, FLATIRONS FUNDING, LIMITED PARTNERSHIP as the Lessor, SELCO SERVICE CORPORATION and SELCO REDWOOD, LLC, as the New Partners of the Lessor, VICTORY RECEIVABLES CORPORATION, as the Note Purchaser, THE BANK OF TOKYO-MITSUBISHI, LTD., NEW YORK BRANCH, as the Conduit Agent, THE VARIOUS LIQUIDITY BANKS, THE VARIOUS TRANCHE B BANKS, and KEYBANK NATIONAL ASSOCIATION as the Agent TABLE OF CONTENTS
Page ARTICLE I DEFINITIONS; INTERPRETATION 2 Section 1.1 Definitions; Interpretation 2 ARTICLE II DOCUMENTATION DATE; FUNDING DATES 3 Section 2.1 Documentation Date (a) Participation Agreement 3 (b) Partnership Interests Purchase Agreement 3 (c) Master Termination Agreements 3 (d) Note Purchase Agreement 3 (e) Liquidity Documentation 3 (f) The Lessee's Resolutions and Incumbency Certificate, etc 3 (g) The Guarantor's Resolutions and Incumbency Certificate, etc. 3 (h) Resolutions and Incumbency Certificate, etc on behalf of the Lessor. 4 (i) The New Partners' Resolutions and Incumbency Certificate, etc. 4 Section 2.2 Funding Dates 4 ARTICLE III ISSUANCE OF NOTES, FUNDING OF THE TRANCHE B LOAN AND FUNDING OF THE EQUITY INVESTMENT; PURCHASES OF NOTES; APPLICATION OF PROCEEDS OF NOTES, THE TRANCHE B LOAN AND THE EQUITY INVESTMENT 5 Section 3.1 Commitment of the Lessor to Issue Notes. 5 Section 3.2 Commitment to Make Note Purchases 6 Section 3.3 Commitment of the Tranche B Banks to Fund the Tranche B Loan. 6 Section 3.4 Commitment of the New Partners to Fund the Equity Investment. 6 Section 3.5 Notice Procedures with respect to the Funding of Advances under the Notes, the Tranche B Loan and the Equity Investment 7 Section 3.6 Use of Proceeds of Notes, Tranche B Loan and Equity Investment 8 Section 3.7 Commitment of the Liquidity Banks 8 ARTICLE IV CALCULATION OF BASIC RENT AND SUPPLEMENTAL RENT; DETERMINATION OF NOTE RATE; BREAKAGE EXPENSES, INCREASED COSTS, ETC.; TAXES; FEES 9 Section 4.1 Rent 9 Section 4.2 Calculation of Basic Rent 10 Section 4.3 Breakage Expenses; Yield Maintenance Premium 12 Section 4.4 Increased Costs, Etc. 13
-i- TABLE OF CONTENTS (continued) Section 4.5 Change of Circumstances. 14 Section 4.6 Taxes 14 Section 4.7 Replacement of Affected Parties 16 Section 4.8 Fees 17 Section 4.9 Calculation of Interest and Fees 17 Section 4.10 Method of Payment 18 Section 4.11 Non-Business Day Payments 18 Section 4.12 Assignment of Basic Rent and Other Payments 18 ARTICLE V CERTAIN INTENTIONS OF THE PARTIES 18 Section 5.1 Nature of Transaction 18 Section 5.2 Amounts Due Hereunder and Under the Master Lease 19 Section 5.3 Allocation of Payment Obligations; Payment to Agent 20 ARTICLE VI CONDITIONS PRECEDENT TO FUNDING DATES 21 Section 6.1 Conditions Precedent to the Initial Funding Date 21 (a) Funding Notice 21 (b) Operative Documents to be Delivered on the Initial Funding Date 21 (c) Precautionary Deed of Trust 22 (d) Deed of Trust 22 (e) Opinion of Counsel to Lessee and Guarantor 22 (f) Initial Appraisal 22 (g) Environmental Audit 23 (h) Conveyance Instruments 23 (i) The Lessee's Responsible Officer's Certificate 23 (j) Guarantor's Responsible Officer's Certificate 23 (k) UCC Financing Statements 23 (l) Recordation of Conveyance Instruments and Financing Statements 23 (m) Property Survey 24 (n) Title Policies 24 (o) Evidence of Property Insurance 24 (p) Governmental Approvals 24 (q) Requirements of Law 24 (r) No Event of Default 24
-ii- TABLE OF CONTENTS (continued) (s) Administration Agreement 25 (t) Representation and Warranties 25 (u) Litigation 25 (v) Available Commitments; Maximum Amount of Notes and Equity Investment 25 (w) Taxes 25 (x) No Material Adverse Effect. 25 (y) Fees. 25 (z) Opinion of Counsel to the Lessor and the New Partners 25 (aa) The Lessor's Responsible Officer's Certificate 26 (bb) The New Partners' Responsible Officer's Certificates 26 (cc) Other Documents 26 Section 6.2 Conditions Precedent to all Accretion Funding Dates 26 (a) Representations and Warranties 26 (b) No Event of Default. 27 (c) Operative Documents 27 Section 6.3 Closing 27 ARTICLE VII REPRESENTATIONS 27 Section 7.1 Representations and Warranties of the Lessee and the Guarantor 27 (a) Corporate Authority 27 (b) Litigation, etc. 28 (c) Burdensome Obligations; Compliance with Other Instruments, Laws; No Defaults; Permits 28 (d) Government Regulation 29 (e) Margin Regulations 29 (f) Certain Tax Matters 30 (g) Liens 30 (h) Financial Matters 30 (i) Changes, etc 31 (j) Employee Benefit Plans 31 (k) Insurance 32 (l) Labor Matters 32
-iii- TABLE OF CONTENTS (continued) (m) Environmental Protection 32 (n) Copyrights, Patents and Trademarks 33 (o) Title 33 (p) Full Disclosure; Pro Forma Effect of Overall Transaction 33 (q) Seniority 33 (r) Compliance of Property with Requirements of Law 34 (s) Plans and Specifications, Utilities, etc. 34 (t) No Adverse Proceedings 34 (u) Master Lease 34 (v) Conveyance Instruments 34 (w) Private Offering 34 Section 7.2 Representations and Warranties of the Guarantor and the Lessee as of each Funding Date after the Initial Funding Date 35 (a) Representations and Warranties 35 (b) Liens 35 (c) Absence of Default, Etc. 35 Section 7.3 Representations and Warranties of the Note Purchaser 35 (a) ERISA 35 (b) Corporate Existence 35 (c) Corporate and Governmental Authorization; No Contravention 35 (d) No Lessor Liens 35 (e) Validity 35 (f) Private Offering 36 Section 7.4 Representations and Warranties of the New Partners 36 (a) ERISA 36 (b) Corporate and Governmental Authorization; No Contravention 36 (c) Validity 36 (d) Litigation 36 (e) Private Offering 37 Section 7.5 Representations and Warranties of the Lessor 37 (a) Jurisdiction of Organization, Chief Executive Office, Etc. 37 (b) Corporate Existence 37
-iv- TABLE OF CONTENTS (continued) (c) Corporate and Governmental Authorization; No Contravention 37 (d) No Lessor Liens 37 (e) Validity 37 (f) Litigation 38 (g) Private Offering 38 (h) Certain Tax Matters 38 Section 7.6 Representations and Warranties of each Tranche B Bank and each Liquidity Bank 39 (a) Existence 39 (b) Authorization; Validity 39 (c) Private Offering 39 ARTICLE VIII COVENANTS 39 Section 8.1 Affirmative Covenants of Guarantor and Lessee 39 (a) Conduct of Business 39 (b) Insurance 40 (c) Records and Accounts 40 (d) Reports 40 (e) Right to Inspect Premises and Records 42 (f) Payment of Liabilities 43 (g) Payment of Charges and Indebtedness 43 (h) Material Change in Business 43 (i) Compliance with Securities Laws 43 (j) Application of Proceeds 43 (k) Environmental Protection 44 (l) Ownership of the Lessee 44 (m) Notice of Change in Name, Identity or Address 44 (n) Further Assurances 44 (o) No Disposition of the Property 45 (p) Defense of Title 45 Section 8.2 Negative Covenants 45 (a) Limitations on Indebtedness 45 (b) Limitation on Liens, Etc 45
-v- TABLE OF CONTENTS (continued) (c) Asset Dispositions 45 (d) Mergers, Acquisitions, Etc 46 (e) Investments. 46 (f) Dividends, Redemptions, Etc 47 (g) Employee Benefit Plans 47 (h) Prohibited Uses of Proceeds 48 (i) Transactions with Affiliates 48 (j) Additional Activities Prohibited 48 Section 8.3 Financial Covenants 48 (a) Consolidated Net Worth 48 (b) Fixed Charge Coverage Ratio. 49 (c) Total Consolidated Debt to Total Consolidated Capital. 49 (d) Quick Ratio. 49 ARTICLE IX COVENANTS OF THE LESSOR, THE NEW PARTNERS, THE NOTE PURCHASER, THE TRANCH B BANKS AND THE LIQUIDITY BANKS 49 Section 9.1 General Covenants of the New Partners, the Lessor and the Note Purchaser 49 Section 9.2 Specific Covenants of the Lessor 50 Section 9.3 Specific Covenants of the New Partners 50 Section 9.4 Specific Covenant of the Note Purchaser 51 Section 9.5 Other Covenants of the Lessor Parties 51 Section 9.6 Notices Under the Note Purchase Agreement and the Liquidity Documentation 52 ARTICLE X PAYMENT OF CERTAIN EXPENSES; OPTIONAL APPRAISALS 52 Section 10.1 Transaction Expenses 52 Section 10.2 Stamp Taxes 52 Section 10.3 Note Purchase Agreement and Related Obligations 52 Section 10.4 Optional Appraisals 52 ARTICLE XI APPLICATION OF PAYMENTS 53 Section 11.1 Consenting Parties; Voting Rights of Lessor Parties in Connection with Direction of the Agent 53
-vi- TABLE OF CONTENTS (continued) Section 11.2 Application of Payments made by the Lessee and Guarantor Pursuant to the Operative Documents prior to the Occurrence and Continuance of any Event of Default 53 Section 11.3 Application of Funds Upon the Occurrence and Continuance of any Event of Default 54 Section 11.4 Application of Funds Upon Exercise of the Remarketing Option 54 Section 11.5 Casualty or Condemnation Proceeds 55 Section 11.6 Construction of Local Laws 55 ARTICLE XII ASSIGNMENTS AND TRANSFERS BY LESSOR, TRANCHE B BANKS, LIQUIDITY BANKS AND NOTE PURCHASER 55 Section 12.1 Acknowledgment of Grant of Security Interest to the Agent; Assignments 55 Section 12.2 Assignments by Note Purchaser, etc 56 Section 12.3 Participations and Sub-Participations 57 Section 12.4 Disclosure of Information 57 Section 12.5 Limitation on Assignment 57 ARTICLE XIII INDEMNIFICATION 57 Section 13.1 General Indemnification: 57 Section 13.2 Environmental Indemnity 60 Section 13.3 Proceedings in Respect of Claims 61 Section 13.4 General Tax Indemnity 62 (a) Indemnification 62 (b) Contests 62 (c) Reimbursement 65 (d) Payments 66 (e) Reports 66 (f) Verification 66 (g) Tax Ownership 67 (h) Structural Impositions and Prior Impositions 68 (i) Lessor as Indemnitee 68 Section 13.5 Indemnity Payments in Addition to Master Lease Obligations 68 ARTICLE XIV AGENT; PLEDGED PROPERTY 69 Section 14.1 Appointment and Duties of the Agent 69
-vii- TABLE OF CONTENTS (continued) Section 14.2 Rights of the Agent 69 Section 14.3 Lack of Reliance on the Agent 71 Section 14.4 Resignation of the Agent 71 Section 14.5 Successor Agent by Merger 71 Section 14.6 Eligibility of the Agent 72 Section 14.7 Collection of Payments 72 Section 14.8 Pledged Property 72 ARTICLE XV MISCELLANEOUS 73 Section 15.1 Survival of Agreements 73 Section 15.2 No Broker, etc. 73 Section 15.3 Notices 73 Section 15.4 Counterparts 74 Section 15.5 Amendments 74 Section 15.6 Headings, etc. 75 Section 15.7 Parties in Interest 75 Section 15.8 Governing Law 75 Section 15.9 Severability 75 Section 15.10 Liability Limited 76 Section 15.11 Further Assurances 76 Section 15.12 Submission to Jurisdiction. 76 Section 15.13 Waiver of Jury Trial 76 Section 15.14 No Bankruptcy Petition Against the Note Purchaser 77 Section 15.15 Limited Recourse to the New Partners, the Note Purchaser and the Lessor 77 Section 15.16 Confidentiality. 78 Section 15.17 Renewal of Commitment under the Liquidity Agreement. 78 Section 15.18 Tax Representation; Tax Forms 78 ARTICLE XVI RELATIONSHIP BETWEEN MASTER LEASE AND OTHER OPERATIVE DOCUMENTS 79 Section 16.1 Conflicts with Master Lease in General 79 Section 16.2 Specific Provisions of the Master Lease 79
-viii- PARTICIPATION AGREEMENT THIS PARTICIPATION AGREEMENT (as amended, restated or otherwise modified and in effect from time to time, this "Participation Agreement"), dated as of July 16,2001, is entered into by and among ELECTRONIC ARTS REDWOOD, INC., a Delaware corporation, as the lessee (in such capacity, together with its permitted successors and assigns, the "Lessee"); ELECTRONIC ARTS, INC., a Delaware corporation, as the guarantor (in such capacity, together with its permitted successors and assigns, the "Guarantor"); FLATIRONS FUNDING, LIMITED PARTNERSHIP, a Delaware limited partnership, as the lessor (in such capacity, together with its permitted successors and assigns, the "Lessor"); SELCO SERVICE CORPORATION, an Ohio corporation doing business in California as Ohio SELCO Service Corporation, and SELCO REDWOOD, LLC, a Delaware limited liability company, as the new partners of the Lessor (in such capacity, together with their permitted successors and assigns, the "New Partners"); VICTORY RECEIVABLES CORPORATION, a Delaware corporation, as the note purchaser (in such capacity, together with its permitted successors and assigns, the `Note Purchaser"); THE BANK OF TOKYO-MITSUBISHI, LTD., NEW YORK BRANCH, as the agent for the Note Purchaser and the administrative agent for the Liquidity Banks (in such capacities, together with its permitted successors and assigns, the "Conduit Agent"); the financial institutions (including, without limitation, those certain financial institutions denoted as "Liquidity Banks" appearing on the signature pages hereof) which are parties to this Participation Agreement and the Liquidity Documentation from time to time (such financial institutions to be referred to collectively as the "Liquidity Banks"); the financial institutions (including, without limitation, those certain financial institutions denoted as "Tranche B Banks" appearing on the signature pages hereof) which are parties to this Participation Agreement from time to time (such financial institutions to be referred to collectively as the "Tranche B Banks"); and KEYBANK NATIONAL ASSOCIATION, as the agent for the Lessor, the Note Purchaser, the Conduit Agent, the Liquidity Banks and the Tranche B Banks (in such capacity, together with its permitted successors and assigns, the "Agent"). Capitalized terms used herein and not otherwise defined herein shall have the meanings specified in Appendix A. WITNESSETH: WHEREAS, the Lessee, the Guarantor, the Lessor, the New Partners, the Note Purchaser, the Conduit Agent, the Liquidity Banks, the Tranche B Banks and the Agent have entered into this Participation Agreement for the purpose of setting forth the terms and conditions pursuant to which the Lessor would continue to provide a lease facility to the Lessee; and WHEREAS, in order for the Lessor to continue to provide such lease facility to the Lessee upon the terms and subject to the conditions set forth herein and in the other Operative Documents, (a) the New Partners shall first acquire the entire ownership interest in the Lessor from the Existing Partners pursuant to the Partnership Interests Purchase Agreement with a combination of their own funds through the funding by the New Partners of the Equity Investment and, as necessary, funds advanced by the Note Purchaser to the New Partners under one or more Notes issued by the Lessor on behalf of the New Partners to the Note Purchaser on the Initial Funding Date pursuant to the Note Purchase Agreement and funds advanced by the Tranche B Banks pursuant to this Participation Agreement (which Note and Tranche B Loan funds, if any, shall be disbursed concurrently to the New Partners as a partnership distribution), (b) the Lessor shall refinance all existing Indebtedness owed by the Lessor to the Existing Lenders pursuant to the Existing Credit Agreement by issuing one or more Notes to the Note Purchaser on the Initial Funding Date pursuant to the Note Purchase Agreement and borrowing funds in the form of a Tranche B Loan from the Tranche B Banks pursuant to this Participation Agreement, and using the proceeds of such Notes and Tranche B Loan to repay such existing Indebtedness, (c) the Lessor shall continue to lease the Property (consisting of the land described in Exhibit A (as more fully defined in Appendix A, the "Land") and the ln1provements thereon) owned by the Lessor to the Lessee pursuant to the terms and conditions of the Master Lease (as amended by Amendment No.2 dated as of the date hereof), and (d) the Lessor shall reaffirm its grant to the Lessee of the Lessee's right to purchase such Property upon the terms and conditions set forth in the Master Lease; and WHEREAS, the Lessor and certain of the other Lessor Parties will have certain rights and remedies under the Master Lease, including, without limitation, the right to receive payments of Rent thereunder; and WHEREAS, in order to finance the funds to be advanced under the Notes by the Note Purchaser pursuant to the Note Purchase Agreement, the Note Purchaser, pursuant to the Liquidity Documentation, may from time to time request Loans from the Liquidity Banks or sell Percentage Interests in the obligations evidenced by the Notes to the Liquidity Banks; and WHEREAS, to secure the obligations of the Lessee to the Lessor under the Operative Documents, the Lessee has, under each of the Master Lease, the Precautionary Deed of Trust and the Precautionary Financing Statements, granted a security interest in and Lien on all of its right and interest in and to the Property covered by the Master Lease; and WHEREAS, to secure the obligations of the Lessor pursuant to the Operative Documents, the Lessor has, pursuant to the Deed of Trust, granted a security interest in and a Lien on all of its right and interest in and to the Property and the Master Lease and has assigned all of its right and interest in and to the Precautionary Deed of Trust and the Precautionary Financing Statements to the Agent; and WHEREAS, the Guarantor has agreed to guarantee the Obligations of the Lessee inasmuch as the Guarantor will derive substantial direct and indirect benefits from the continued leasing of the Property by the Lessor to the Lessee. NOW, THEREFORE, in consideration of the mutual agreements contained in this Participation Agreement and the other Operative Documents and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I DEFINITIONS; INTERPRETATION Section 1.1 Definitions: Interpretation Unless the context shall otherwise require, capitalized terms used and not defined herein and in the other Operative Documents shall have 2 the meanings assigned thereto in Appendix A hereto for all purposes hereof, and the rules of interpretation set forth in Appendix A hereto shall apply to this Participation Agreement and the other Operative Documents. ARTICLE II DOCUMENTATION DATE; FUNDING DATES Section 2.1 Documentation Date. The Documentation Date (the "Documentation Date") shall occur on the earliest date on which the following conditions precedent shall have been satisfied or waived: (a) Participation Agreement. This Participation Agreement shall have been duly authorized, executed and delivered by the parties hereto. (b) Partnership Interests Purchase Agreement. The Partnership Interests Purchase Agreement shall have been duly authorized, executed and delivered by the parties thereto. (c) Master Termination Agreements. The Master Termination Agreements shall have been duly authorized, executed and delivered by the parties thereto. (d) Note Purchase Agreement. The Note Purchase Agreement shall have been duly authorized, executed and delivered by the parties thereto. (e) Liquidity Documentation. All Liquidity Documentation shall have been duly authorized, executed and delivered by the parties thereto. (f) The Lessee's Resolutions and Incumbency Certificate, etc. The Lessee shall have delivered to the Lessor Parties (i) a certificate of its Secretary or an Assistant Secretary attaching and certifying as to (A) the resolutions of its Board of Directors duly authorizing the execution, delivery and performance by it of the Operative Documents to which it is a party, (B) its certificate of incorporation and by-laws, and (C) the incumbency and signature of persons authorized to execute and deliver on its behalf the Operative Documents to which it is a party; and (ii) a certificate of good standing with respect to it issued by the Secretary of State of the state of its incorporation and for the jurisdiction in which the Property is located, no earlier than fifteen (15) days prior to the Documentation Date. (g) The Guarantor's Resolutions and Incumbency Certificate, etc. The Guarantor shall have delivered to the Lessor Parties (i) a certificate of its Secretary or an Assistant Secretary attaching and certifying as to (A) the resolutions of its Board of Directors duly authorizing the execution, delivery and performance by it of the Operative Documents to which it is a party, (B) its certificate of incorporation and by-laws, and (C) the incumbency and signature of persons authorized to execute and deliver on its behalf the Operative Documents to which it is a party; and (ii) a certificate of good standing with respect to it issued by the Secretary of State of the state of its incorporation and for the jurisdiction in which the Property is located no earlier than fifteen (15) days prior to the Documentation Date. 3 (h) Resolutions and Incumbency Certificate, etc on behalf of the Lessor. The general partner of the Lessor shall have delivered to the other Lessor Parties a certificate of the Secretary or an Assistant Secretary attaching and certifying as to (i) the resolutions of the Board of Directors of the general partner duly authorizing the execution, delivery and performance by the Lessor of the Operative Documents to which it is a party, (ii) the Lessor's certificate of limited partnership and currently effective Limited Partnership Agreement, and (iii) the incumbency and signature of persons authorized to execute and deliver on behalf of the Lessor the Operative Documents to which the Lessor is a party, no earlier than fifteen (15) days prior to the Documentation Date. (i) The New Partners' Resolutions and Incumbency Certificate, etc. Each New Partner shall have delivered to the other Lessor Parties (as applicable) (i) a certificate of its Secretary or an Assistant Secretary attaching and certifying as to (A) the resolutions of its Board of Directors or Members duly authorizing the execution, delivery and performance by it (on behalf of itself and/or the Lessor) of the Operative Documents to which it and/or the Lessor is a party, (B) its certificate of incorporation and by-laws or operating agreement (as applicable), and (C) the incumbency and signature of persons authorized to execute and deliver on its behalf and/or the Lessor the Operative Documents to which it and/or the Lessor is a party; and (ii) if available, a certificate of good standing with respect to it issued by the Secretary of State of the state of its organization, no earlier than fifteen (15) days prior to the Documentation Date. Section 2.2 Funding Dates. (a) The dates on which the funds are to be advanced under the Notes (and, with respect to the Initial Funding Date, the funding of the Equity Investment and the funding of the Tranche B Loan shall be made) shall be referred to herein and in other Operative Documents as the "Funding Dates" and each, a "Funding Date". (b) The Funding Date with respect to the financing of the acquisition of the Partnership Interests and the refinancing of outstanding Indebtedness under the Existing Credit Agreement (the "Initial Funding Date") shall be July 16, 2001 (or such other Business Day selected by the New Partners with the consent of the Lessee which in no event shall be earlier than the first Business Day after the Documentation Date) subject to the satisfaction (or waiver by the appropriate Lessor Parties) of the conditions set forth in Section 6.1 herein. (c) Subject to Section 3.5(b) below, each Funding Date with respect to the funding of the Accreted Amounts (as defined in Section 3. 1 (a)(ii) below) (each, an "Accretion Funding Date") shall occur on each Basic Rent Payment Date during the Lease Term, subject to the satisfaction (or waiver by the appropriate Lessor Parties) of the conditions set forth in Section 6.2 herein. 4 ARTICLE III ISSUANCE OF NOTES, FUNDING OF THE TRANCHE B LOAN AND FUNDING OF THE EQUITY INVESTMENT; PURCHASES OF NOTES; APPLICATION OF PROCEEDS OF NOTES, THE TRANCHE B LOAN AND THE EQUITY INVESTMENT Section 3.1 Commitment of the Lessor to Issue Notes. (a) Subject to the terms and conditions hereof, and pursuant to the relevant provisions of the Note Purchase Agreement: (i) on the Initial Funding Date, the Lessor shall issue one or more Notes which after application of the Security Deposit set forth in Section 3.1(c) below, shall be in an aggregate principal amount of $96,737,192.60, the proceeds of which (together with the proceeds of the Equity Investment and the Tranche B Loan) shall be used by the New Partners to purchase the Partnership Interests from the Existing Partners pursuant to the Partnership Interests Purchase Agreement and to refinancing the outstanding Indebtedness under the Existing Credit Agreement. Upon the payment by the Note Purchaser of the initial purchase price of the Notes in accordance with Section 3.5(d) hereof, such payment obligation of the Note Purchaser for such initial Notes shall be deemed to have been satisfied in full. (ii) Subject to Section 3.1(b) hereof, on each Accretion Funding Date, and provided that the Lessee shall have paid to the Lessor the Security Deposit as provided in Section 3.1(c) hereof, the Note Purchaser shall advance funds to the Lessor under the Notes in an aggregate principal amount equal to $386,463.46 (each such amount, the "Accreted Amount"). If, as of any Accretion Funding Date, the Aggregate Note Purchase Commitment is insufficient to support such Accreted Amount, the Lessee shall make a non-recourse loan to the Agent (a "Lessee Loan") in a principal amount equal to the amount by which the Aggregate Note Purchase Commitment is insufficient to pay the Accreted Amount then due and payable, whereupon the non-supported Accreted Amount to be paid on such date shall be paid instead from the proceeds of the Lessee Loan. The Agent and the Lessee shall agree upon the rate of interest and the maturity date of each Lessee Loan at the time each such Lessee Loan is made. (b) The maximum aggregate principal amount outstanding under the Notes at any time shall not exceed $105,318,627.45 (such amount, the "Aggregate Note Purchase Commitment"); provided, however, in the event that additional allocated portions of the "Commitments" (as defined in the Liquidity Agreement) of the Liquidity Banks are obtained from time to time in accordance with Section 3.7 hereof, the Aggregate Note Purchase Commitment shall increase to an amount calculated by dividing the then aggregate Liquidity Bank "Commitments" by 1.02 (one and two one-hundredths); and, provided, further, that in no event shall the Aggregate Note Purchase Commitment exceed $119,925,000. In the event that any such increase in the Liquidity Bank "Commitments" are effected by the inclusion of an additional Liquidity Bank, each such additional Liquidity Bank must be an "Eligible Assignee" under, and comply with the provisions with respect to assignee "Banks" and "Purchasers" in, both the Liquidity Agreement and the Asset Purchase Agreement, respectively. Whether or not 5 any such increase in the Liquidity Bank "Commitments" are effected by an increase in the allocated portion of the "Commitments" of existing Liquidity Banks, appropriate amendments to the schedules to the Liquidity Documentation to reflect the changed percentages of the Liquidity Banks shall be agreed to by the Liquidity Banks as one of the conditions to the increase. For accounting purposes, all funds advanced to the Lessor under the Notes pursuant to the Note Purchase Agreement shall constitute debt. (c) On the Initial Funding Date, the Lessee shall make a payment to the Lessor in an amount of $23,187,807.40 (such amount, the "Security Deposit"), the proceeds of which shall be used by the Lessor to retire a portion of the outstanding balance of the Notes (in the aggregate principal amount of such Security Deposit so paid). Upon payment of the Security Deposit by the Lessee pursuant to this Section 3.1 (c), the Agent, on behalf of the Lessor shall apply the proceeds of the Security Deposit to repay funds advanced under the Notes in an aggregate principal amount equal to the amount of the Security Deposit so paid and, thereafter, such repaid funds shall no longer be outstanding for any purpose, including the calculation of the Note Interest Amount under Section 4.2(a) hereof. After such repayment, however, the aggregate principal amount outstanding under the Notes will be increased on each Accretion Funding Date to reflect the funds advanced to the Lessor under the Notes on such Funding Date for the Accreted Amount. Section 3.2 Commitment to Make Note Purchases. Subject to the terms and conditions hereof and the terms and conditions of the Note Purchase Agreement, the Note Purchaser shall purchase the Note or Notes issued on the Initial Funding Date and on each Accretion Funding Date and shall advance funds under the Notes as provided for herein. Notwithstanding the foregoing, the Note Purchaser shall not be required to purchase the Notes to be issued on the Initial Funding Date or to advance funds to be advanced to or for the benefit of the New Partners under such Notes on the Initial Funding Date unless the New Partners simultaneously fund the Equity Investment to be made on the Initial Funding Date and the Tranche B Banks simultaneously advance the Tranche B Loan to be advanced on the Initial Funding Date. Section 3.3 Commitment of the Tranche B Banks to Fund the Tranche B Loan. Subject to the terms and conditions hereof, including, without limitation, the delivery of the Funding Notice, on the Initial Funding Date, the Tranche B Banks shall fund the entire Tranche B Loan in the amount of $20,000,000.00 (such amount, the "Aggregate Tranche B Commitment"). For accounting purposes, the Tranche B Loan made by the Tranche B Banks hereunder shall constitute debt. The proceeds of the Tranche B Loan (together with the proceeds of the Equity Investment and the Notes) shall be used by the New Partners to purchase the Partnership Interests from the Existing Partners pursuant to the Partnership Interests Purchase Agreement and to refinancing the outstanding Indebtedness under the Existing Credit Agreement. Notwithstanding the foregoing, the Tranche B Banks shall not be required to advance the Tranche B Loan on the Initial Funding Date unless the New Partners simultaneously fund the Equity Investment to be made on the Initial Funding Date and the Note Purchaser simultaneously purchases the Notes to be issued by the Lessor on the Initial Funding Date and advances the funds to be advanced under such Notes on the Initial Funding Date. Section 3.4 Commitment of the New Partners to Fund the Equity Investment. Subject to the terms and conditions hereof, including, without limitation, the delivery of the Funding 6 Notice, on the Initial Funding Date, the New Partners shall fund the entire Equity Investment in the amount of $5,075,000 (such amount, the "Aggregate Equity Investment Commitment"). The proceeds of the Equity Investment shall be used by the New Partners to purchase the Partnership Interests from the Existing Partners. For accounting purposes, the Equity Investment made by the Lessor hereunder shall constitute equity. Notwithstanding the foregoing, the New Partners shall not be required to fund the Equity Investment on the Initial Funding Date unless the Note Purchaser simultaneously purchases the Notes to be issued by the Lessor on the Initial Funding Date and advances the funds to be advanced under such Notes on the Initial Funding Date and the Tranche B Banks simultaneously advance the Tranche B Loan to be advanced on the Initial Funding Date; Section 3.5 Notice Procedures with respect to the Funding of Advances under the Notes. the Tranche B Loan and the Equity Investment. (a) With respect to the purchase of the Notes, the funding of the advances to be made under such Notes, the funding of the Tranche B Loan, and the funding of the Equity Investment, the Lessee shall give the Agent, for the benefit of the New Partners, the Lessor, the Tranche B Banks and the Note Purchaser (as applicable), prior written notice delivered not later than 7:30 a.m., New York time, one Business Day prior to the proposed Funding Date specifying: (i) the proposed Funding Date, (ii) the principal amount to be advanced on such Funding Date under the Notes, (iii) with respect to the Initial Funding Date, the principal amount to be advanced in the form of the Tranche B Loan on such Funding Date, (iv) with respect to the Initial Funding Date, the amount of the Equity Investment to be funded on such Funding Date and (v) to the extent the proceeds are not used by the New Partners to acquire the Partnership Interests or to refinancing the outstanding Indebtedness under the Existing Credit Agreement, the application of the proceeds of such funds advanced under the Notes, the Tranche B Loan and the Equity Investment towards payment of the Transaction Expenses. The Funding Notice shall be in the form of Exhibit B. (b) With respect to the funds to be advanced under the Notes on each Accretion Funding Date, provided that the Lessee shall have paid the Security Deposit pursuant to Section 3.1(c) hereof, such funds shall be in the amount set forth in Section 3. 1 (a)(ii) hereof and shall be used to increase the Outstanding Lease Balance such that the Outstanding Lease Balance at the Maturity Date shall be equal to the appraised value of the Property on the Initial Funding Date as set forth in the Initial Appraisal. Unless the Lessee provides the Lessor and the Note Purchaser with ten (10) Business Day's prior written notice to the contrary, the Lessee shall be deemed to have requested the funds to be advanced on each Accretion Funding Date. (c) Upon satisfaction or waiver of the conditions precedent to each advance under the Notes, and with respect to the Initial Funding Date, the funding of the Equity Investment and the Tranche B Loan, set forth in Article VI hereof, the Note Purchaser shall advance such funds under the Notes, the Tranche B Banks shall advance the Tranche B Loan and the New Partners shall fund the Equity Investment, in each case in accordance with the allocation provisions set forth above. (d) All remittances made by the Note Purchaser, the Tranche B Banks and the New Partners on the Initial Funding Date shall be made on such Initial Funding Date in 7 immediately available federal funds by wire transfer to the accounts specified in the Funding Notice and in Schedule 1 hereof. All remittances received by the Conduit Agent from funds advanced under the Notes in the principal amount of the Accreted Amount on each Accretion Funding Date shall be applied to the account of the Note Purchaser for a partial or total offset (in the amount of such remittance) of the Note Interest Amount due on such date. To the extent, if any, that the Accreted Amount on such Accretion Funding Date exceeds the Note Interest Amount due on such date, such excess shall be paid (i) to the Lessee provided no Default or Event of Default has occurred and is continuing, and (ii) upon the occurrence and continuance of any Default or Event of Default, as set forth in Section 11.3(c) hereof. (e) The Funding Notice and each advance of funds made on each Accretion Funding Date shall be irrevocable and binding on the Lessee and the Lessee shall indemnify the Note Purchaser (and each of the Liquidity Banks, if applicable) and, with respect to the Initial Funding Date, the Lessor and each of the Tranche B Banks, against any actual loss or expense incurred by the Note Purchaser (or any Liquidity Bank, if applicable), the Tranche B Banks, the New Partners and/or the Lessor, as a result of the Notes not being issued and/or funds not being advanced thereunder, the Tranche B Loan not being funded in accordance therewith, and the Equity Investment not being funded in accordance therewith (other than as a result of a breach of this Participation Agreement by the Note Purchaser, any Liquidity Bank, any Tranche B Bank, the New Partners and/or the Lessor, as applicable; provided however that any such breach shall not limit or adversely affect the indemnification hereunder of any non-breaching party) including any actual loss or expense incurred by the Note Purchaser, the Liquidity Banks, the Tranche B Banks, the New Partners and/or the Lessor, as the case may be, by reason of the liquidation or reemployment of funds or the termination of any hedging arrangements acquired or requested by the Note Purchaser, the Liquidity Banks, the Tranche B Banks, the New Partners and/or the Lessor, to fund the purchase of such Notes and the funds to be advanced thereunder, the Tranche B Loan and the Equity Investment (as applicable). Section 3.6 Use of Proceeds of Notes. Tranche B Loan and Equity Investment. The proceeds of the funds advanced under the Notes on the Initial Funding Date, the Tranche B Loan funded on the Initial Funding Date and the Equity Investment funded on the Initial Funding Date shall be applied to finance the Acquisition and Refinancing Costs. The proceeds of the funds advanced under the Notes on any Accretion Funding Date shall, in the manner provided in Section 3.5(d) above, be used to repay the then-accreted portion of the Outstanding Lease Balance occurring as a result of the funding by the Lessee of the Security Deposit. Section 3.7 Commitment of the Liquidity Banks. Subject to the terms and conditions set forth herein and in the other Operative Documents, (a) the Liquidity Banks shall severally, but not jointly, make available Loans (as defined in the Liquidity Agreement) in an aggregate principal amount not to exceed (x) as of the Initial Funding Date, $107,425,000 and (y) at any time during which the allocated portion of the "Commitment" (as defined in the Liquidity Agreement) of one or more existing Liquidity Bank shall have been increased and/or one or additional financial institutions shall have agreed to become a Liquidity Bank in accordance with Section 15.5 hereof, $119,925,000, plus all accrued discount on all related Commercial Paper (as such amount may be adjusted pursuant to the Liquidity Agreement) less the aggregate principal amount of outstanding Percentage Interest purchased by the Liquidity Banks pursuant to the Asset Purchase Agreement, and (b) each of the Liquidity Banks shall, at the times set forth 8 therein, duly perform their respective obligations set forth herein and under the applicable Operative Documents to which such Person is a party. ARTICLE IV CALCULATION OF BASIC RENT AND SUPPLEMENTAL RENT; DETERMINATION OF NOTE RATE; BREAKAGE EXPENSES, INCREASED COSTS, ETC.; TAXES; FEES Section 4.1 Rent. (a) Basic Rent shall be equal to the sum of the Note Interest Amount, the Tranche B Interest Amount and the Yield Amount, and shall be payable by Lessee on each Basic Rent Payment Date pursuant to the terms and conditions set forth in the Master Lease. (b) The Lessee shall pay as Supplemental Rent hereunder the following: (i) If the Lessee acquires the Lessor's interest in and to the Property pursuant to clauses (iv) through (vi) of Section 14 of the Master Lease or exercises its Purchase Option pursuant to Section 13.1(a) of the Master Lease, then the Lessee will pay, as Supplemental Rent hereunder and under the other Operative Documents, an amount equal to the Outstanding Lease Balance. (ii) If a third party or parties acquires the Lessor's interest in and to the Property pursuant to Section 12.1 of the Master Lease, then the Lessee shall pay, or cause to be paid, in the case of proceeds received pursuant to Section 12.1 of the Master Lease, as Supplemental Rent, the Gross Sales Proceeds (as determined in accordance with Section 12.1 of the Master Lease). (iii) If the Remarketing Option is exercised pursuant to Section 12.1 of the Master Lease, then the Lessee shall pay, as Supplemental Rent whether or not a sale of the Property occurs, an amount equal to the Maximum Recourse Amount (if any) (determined in accordance with Section 12.1 of the Master Lease). (iv) Without duplication of any of the foregoing, whenever any make whole premium, yield maintenance premium or brokerage cost is due on any of the Notes, the Tranche B Loan, any Liquidity Loans or Equity Investment pursuant to Section 4.3, 4.4, 4.5 or 4.6 hereof or any UpFront Fees, Commitment Fees, Renewal Fees, Structuring Fees, Administrative Fees or other fees due to any Lessor Party under the Operative Documents, the Lessee shall pay to the Lessor the same amount hereunder as Supplemental Rent. (v) Additional Rent (as defined in the Master Lease). (vi) All other amounts (other than Basic Rent, the amounts set forth in clauses (i) -(v) above and interest (if any) on the Lessee Loans) due or to become due (or expressed to be due or to become due) from the Lessee under the Master Lease and the other Operative Documents. 9 The Lessee shall pay to the Lessor or any other Person entitled thereto any and all Supplemental Rent promptly as the same shall become due and payable or, if no date is specified for the payment of any such amount, within five (5) Business Days after written demand of the Lessor or any other Lessor Party to whom such amount is payable. (c) The Lessor Parties hereby acknowledge that the Notes, the Tranche B Loan, any Liquidity Loans and the Equity Investment may be prepaid with the proceeds of the Supplemental Rent payments due pursuant hereto and pursuant to the Master Lease, with the proceeds of such payments applied in accordance with the provisions of Article XI hereof, subject in any event to compliance with Section 4.3 hereof and to the timely application of such Supplemental Rent pursuant to the relevant provisions of Article XI hereof. Section 4.2 Calculation of Basic Rent. (a) The Note Interest Amount portion of Basic Rent with respect to the outstanding principal amount of the Notes shall be computed based upon one of the rates set forth below: (i) To the extent that the Note Purchaser is funding advances under the Notes by issuance of Commercial Paper, the Note Interest Amount portion of Basic Rent with respect to the amounts outstanding under the Notes shall be computed based upon the CP Rate as in effect from time to time plus fifteen one hundredths of one percent (.15 %); and (ii) To the extent the Note Purchaser is not funding advances under the Notes by issuance of Commercial Paper or the Notes have been purchased by the Liquidity Banks pursuant to the Liquidity Documentation, the Note Interest Amount portion of Basic Rent with respect to the amounts outstanding under the Notes shall be computed as follows: (A) until such time as a Liquidity Loan based upon a one (1) month LIBOR rate can be advanced by the Liquidity Banks pursuant to the Liquidity Documents, the Alternate Rate, and (B) thereafter, one of the following two rates as selected by the Note Purchaser (or if the Notes have been purchased by the Liquidity Banks pursuant to the Liquidity Documentation, the Agent) in its reasonable discretion: (x) the one (1) month LIBOR rate as in effect from time to time (adjusted for reserve requirements in effect on the first day of each period for which a payment is due) plus the Applicable Margin; or (y) if the one (1) month LIBOR rate is not available for any reason, the Alternate Rate. The aggregate amount payable in accordance with this Section 4.2(a) with respect to all Notes as of any Basic Rent Payment Date shall be the "Note Interest Amount" payable as of such date. (b) The Tranche B Interest Amount portion of Basic Rent with respect to the outstanding principal amount of the Tranche B Loan shall be computed based upon either (i) the one (l) month LIBOR rate as in effect from time to time, adjusted for reserve requirements in effect on the first day of each period for which a payment is due, plus the Applicable Margin or (B) if the one (1) month LIBOR rate is not available or cannot be determined for the reasons set forth in Section 4.5 herein, the Alternate Rate. The aggregate amount payable in accordance 10 with this Section 4.2(b) with respect to the Equity Investment as of any Basic Rent Payment Date shall be the "Tranche B Interest Amount" payable as of such date. (c) The Yield Amount portion of Basic Rent payable with respect to the Equity Investment shall be computed based upon either (i) the one (1) month LIBOR rate as in effect from time to time, adjusted for reserve requirements in effect on the first day of each period for which a payment is due, plus two percent (2.00%) or (ii) if the one (1) month LIBOR rate is not available or cannot be determined for the reasons set forth in Section 4.5 herein, the Alternate Rate. Notwithstanding the foregoing, for the period beginning on the Initial Funding Date and ending on the first Basic Rent Payment Date, the Yield Amount portion of Basic Rent payable with respect to the outstanding Equity Investment shall be computed based upon the Alternate Rate or such other rate as agreed upon between the Lessee and the Lessor immediately prior to the Initial Funding Date. The aggregate amount payable in accordance with this Section 4.2(b) with respect to the Equity Investment as of any Basic Rent Payment Date shall be the "Yield Amount" payable as of such date. (d) All calculations of Basic Rent shall be performed by the Agent based on the information provided to it pursuant to Section 5.3. Such information shall be provided to the Lessee and the Guarantor no later than 5 :00 p.m., New York time, on the third (3rd) Business Day prior to the relevant Basic Rent Payment Date, together with reasonable detail supporting the calculations made. The Guarantor and Lessee shall promptly acknowledge receipt of such calculations in writing to the Agent. Such calculations shall be deemed final in the absence of manifest error. The Guarantor and the Lessee shall be entitled to rely on any calculation of Basic Rent performed by the Agent, and to deal directly with the Agent in connection with the verification of such calculations. (e) Except with respect to payments made pursuant to Sections 4.3, 4.4, 4.6, 13.1, 13.3 and 13.5, proceeds derived upon exercise of the Remarketing Option (which shall be remitted to the Agent to be distributed as provided in Article XI hereof), to the extent that a payment of Basic Rent or Supplemental Rent is made other than on a Basic Rent Payment Date, upon the request of the Lessee, the proceeds of any such payment (such receipts, "Prepayments") shall be deposited in a special, segregated account which shall be an Eligible Account held in the name of, and under the sole dominion and control of the Agent (the "Prepayment Account"). Funds in the Prepayment Account shall be invested by the Agent, at the direction and for the benefit of the Lessee, in Cash Equivalents maturing no later than the next succeeding Basic Rent Payment Date. The Agent is hereby authorized, in making or disposing of any investment permitted by this Section, to deal with itself (in its individual capacity) or with anyone or more of its Affiliates, whether it or such Affiliate is acting as an agent of the Agent or for any third person or dealing as a principal for its own account; provided, however, that all such dealings between the Agent and anyone or more of its Affiliates shall be conducted on an arm's-length, commercially reasonable basis. The Lessee may, at its discretion, provide written instructions to the Agent as to timing and application of moneys in the Prepayment Account, so long as any money so withdrawn shall be used for the payment of Rent. Absent any written instruction from the Lessee to the Agent or if a Default or an Event of Default shall have occurred and be continuing, 11 the Agent shall withdraw money from the Prepayment Account and apply such amount to the payment of Basic Rent and Supplemental Rent as such Rent becomes due, but only to the extent that such Rent would otherwise, in the ordinary course under the Operative Documents, be paid by the Lessee to the Agent for application and allocation in accordance with the Operative Documents. The Agent acknowledges and agrees that the Lessee and the Guarantor shall be entitled to assume, and rely on such assumption, that the Agent will properly apply and allocate any amount withdrawn from the Prepayment Account pursuant to the Lessee's written instructions (if any, and absent any Default or Event of Default) and the procedures and allocations under the Operative Documents. Any amount remaining in the Prepayment Account upon the Financing Termination Date or the Maturity Date (as applicable) and the full satisfaction of the Obligations under the Operative Documents shall be promptly withdrawn from the Prepayment Account and returned to the Lessee. Section 4.3 Breakage Expenses: Yield Maintenance Premium. (a) If, with respect to the amounts outstanding under the Notes, the Tranche B Loan or the outstanding portion of the Equity Investment, (i) interest or principal is repaid or prepaid (including as a result of acceleration) in each case (A) subject to Section 4.2( e) above, on a date other than a Basic Rent Payment Date applicable thereto (including, without limitation, the Maturity Date) or (B) in an amount other than the amount currently due, or (ii) Lessee shall cancel or otherwise fail to consummate any funding requested under a Funding Notice which has been delivered to the Agent (whether as a result of the failure to satisfy any applicable conditions or otherwise) or shall fail to make any prepayment after notice has been given to the Agent, then the Lessee shall hold such Lessor Parties harmless from, and pay as Supplemental Rent to the Agent for the benefit of such Lessor Parties, as their respective interests may appear, within five (5) Business Days following demand therefor (which demand shall be accompanied by one or more certificates contemplated by Section 4.3( c) below), all actual costs and losses incurred by such Lessor Parties as a result of such payment, cancellation or failure. (b) Without duplication of the foregoing, and subject to Section 4.2(e) above, in the event that any Lessor Party shall incur any loss or expense (including any loss or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such party or the termination of any hedging arrangements) to make, continue or maintain any portion of the principal amount of its investment as the result of a breach by the Lessee or the Guarantor under the Operative Documents, such Lessor Party shall deliver a notice accompanied by a certificate as contemplated by Section 4.3( c) below, regarding such loss or expenses. The Lessee shall, within thirty (30) days of receipt of such notice, pay directly to the Agent for the benefit of such Lessor Party as Supplemental Rent, an amount, reasonably determined to be equal to the excess, if any, of (A) the amount such Lessor Party would have received if its investment had been made or continued based on the interest rate borne by the relevant instrument over (B) the amount realized by such party from re-employing the funds. (c) A certificate (describing in reasonable detail the calculation of the yield maintenance or other amount, as applicable, to be paid under this Section 4.3) submitted by the applicable Lessor Party to the Lessee (with a copy to the Agent) shall, absent demonstrable error, be final and conclusive. 12 Section 4.4 Increased Costs. etc. If after the date hereof any change in applicable law or regulation or in the interpretation or administration thereof by any Governmental Authority charged with the interpretation or administration thereof (whether or not having the force of law) (i) shall subject any Lessor Party to, or increase the net amount of, any tax, levy, impost, duty, charge, fee, deduction or withholding with respect to any Note, the Tranche B Loan, any Liquidity Loan or the Equity Investment (or any portion thereof), or the funding of (or agreement to provide funding for) such Notes, Tranche B Loan, Liquidity Loans or the Equity Investment, or shall change the basis of taxation of payments to the Lessor Parties or any other fees or amounts payable under the Operative Documents or in connection with the Overall Transaction (excluding (x) with respect to the New Partners and, except to the extent any of the Lessor's rights under this Section 4.4 shall inure to the benefit of the Note Purchaser (and its successors and assigns) pursuant to Section 13.4(i) of this Participation Agreement, the Lessor, any Taxes or other items specifically excluded from the definition of Impositions, and (y) with respect to any Lessor Party other than the New Partners and, except to the extent any of the Lessor's rights under this Section 4.4 shall inure to the benefit of the Note Purchaser (and its successors and assigns) pursuant to Section 13.4(i) of this Participation Agreement, the Lessor, any Taxes (A) attributable to changes in the rate of general corporate, franchise, net income or other income tax imposed on such Lessor Party by the jurisdiction in which such Lessor Party either maintains its applicable lending office or is otherwise subject to tax other than as a result of the transactions contemplated by the Operative Documents or in connection with the Overall Transaction or (B) that would not have been imposed but for the failure of such Lessor Party to comply with any certification, information, documentation or other reporting requirement; provided that the exclusions described in clauses (x) and (y) above shall not include Structural Impositions or Prior Impositions), (ii) shall impose, modify or deem applicable any reserve, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, such Lessor Party that would affect the amount of capital required or reasonably expected to be maintained by such Lessor Party or any Person directly or indirectly controlling such parties, and such Lessor Party reasonably and in good faith determines that the rate of return on its or such controlling Person's capital as a consequence of its obligations under or in respect of the Operative Documents or in connection with the Overall Transaction is reduced to a level below that which such party would have achieved but for the occurrence of any such circumstance by an amount deemed by such party to be material, or (iii) shall impose on such Lessor Party any other condition (other than a condition involving administrative matters such as additional reporting requirements to any such Governmental Authority) affecting this Participation Agreement, any other Operative Document, the funding (or agreement to provide funding hereunder) or the Overall Transaction, and the result of any of the foregoing shall be to increase the cost to such Lessor Party of, or to reduce the amount of any sum received or receivable by such Lessor Party in respect of, making, continuing or maintaining (or its obligation to make, continue or maintain) its investments in the respective instruments .( or providing funding therefor) by an amount reasonably determined in good faith by such Lessor Party to be material, then the Lessee shall pay to the Agent for the benefit of the Lessor Party, as Supplemental Rent, such additional amount or amounts, as will compensate such Lessor Party on an After Tax Basis for such increase or reduction upon demand by such party. Each such Lessor Party shall within thirty (30) days of such Lessor Party's discovery of such event, notify the Lessee in writing of the occurrence of any such event, such notice to state, in reasonable detail, the reasons therefor and the calculation of the additional amount required fully to compensate such party for such 13 increased costs or reduced amount. Such additional amount shall be payable by the Lessee to the Agent for the benefit of such claiming party within fifteen (15) Business Days of its receipt of such notice and such notice shall, in the absence of manifest error, be conclusive and binding on the Lessee. Notwithstanding any other provision of this Participation Agreement, any amount of Taxes that would, but for this sentence, give rise to both Supplemental Rent payable to the Lessor or the New Partners pursuant to this Section 4.4 and an indemnity payment obligation in favor of the Lessor or the New Partners pursuant to Section 13.4 shall be governed solely by the provisions of Section 13.4; provided, however, that this sentence is intended to apply Section 13.4 to Taxes subject to an actual indemnity payment obligation pursuant to both Section 4.4 and Section 13.4, but not to diminish any claim for indemnification (or Supplemental Rent) pursuant to this Section 4.4 that would not give rise to an actual indemnity payment obligation pursuant to Section 13.4. Section 4.5 Change of Circumstances. (a) If, on or before the first day of any Rent Period, the Lessor, any Tranche B Bank or any Liquidity Bank shall advise the Agent that the one (1) month LIBOR rate cannot be adequately and reasonably determined due to the unavailability of funds in or other circumstances generally affecting the London interbank market, the Agent shall immediately give notice of such condition to the other Transaction Parties. After the giving of any such notice (and until the Agent shall otherwise notify the Lessee that the circumstances giving rise to such condition no longer exist), the rates to be paid by the Lessee pursuant to Section 4.2(a)(ii) and.4.2(b) herein (as applicable) as of the first day of the next Basic Rent Payment Date shall be the Alternate Rate. (b) If, after the date of this Participation Agreement, as the result of the adoption of any Requirement of Law, any change in any Requirement of Law or the application or requirements thereof (whether such change occurs in accordance with the terms of such Requirement of Law as enacted, as a result of amendment or otherwise), any change in the interpretation or administration of any Requirement of Law by any Governmental Authority, or any request or directive (whether or not having the force of law) of any Governmental Authority (each a "Change of Law"), it shall become unlawful or impossible for the Lessor, any Tranche B Bank or any Liquidity Bank to fund or maintain its portion of the Outstanding Lease Balance at the one (1) month LIBOR rate, such Person shall immediately notify the Agent and the Agent shall immediately notify the other Transaction Parties of such Change of Law. After the giving of any such notice (and until the Agent shall otherwise notify the Lessee and the Lessor that such Change of Law is no longer in effect), the one (1) month LIBOR rate shall be unavailable and the rates to be paid by the Lessee pursuant to Section 4.2(a)(ii) and.4.2(b) herein (as applicable) as of the next Basic Rent Payment Date shall be the Alternate Rate. Section 4.6 Taxes. All payments of Basic Rent, Supplemental Rent, principal of, and interest or yield on, the Notes, the Tranche B Loan, the Liquidity Loans and the Equity Investment and all other amounts payable hereunder and under the Master Lease shall be made free and clear of and without deduction for any present or future income, excise, stamp, transfer or franchise taxes and other taxes, fees, duties, withholdings or other charges of any nature whatsoever (including interest and penalties) now or hereafter imposed by any Governmental Authority or taxing authority thereof ("Taxes"), but excluding (x) with respect to the New 14 Partners and, except to the extent any of the Lessor's rights under this Section 4.6 shall inure to the benefit of the Note Purchaser (and its successors and assigns) pursuant to Section 13.4(i) of this Participation Agreement, the Lessor, any Taxes or other items, in each case, specifically excluded from the definition of Impositions, and (y) with respect to any Lessor Party other than those described in clause (x) preceding in the circumstances therein, franchise taxes and other taxes imposed on or measured by the net income of, as the case may be, of such Lessor Party (or its applicable lending office) by its jurisdiction of incorporation or the jurisdiction in which it maintains its applicable lending office, provided that the exclusions described in clauses (x) and (y) above shall not include Structural Impositions or Prior Impositions (in each case, such non- excluded Taxes being called "Other Taxes"). In the event that any withholding or deduction from any payment to be made by the Lessee hereunder is required in respect of any Taxes pursuant to any applicable law, rule or regulation, then the Lessee will: (a) pay as Supplemental Rent directly to the relevant Governmental Authority or taxing authority the full amount required to be so withheld or deducted; (b) forward to the Agent for the benefit of the relevant Lessor Party official receipts or other documentation reasonably satisfactory to such Lessor Party evidencing such payment to such authority; and (c) with respect to Other Taxes, pay to the Agent for the benefit of the relevant Lessor Party such additional amount or amounts as is necessary to ensure that the net amount actually received by such Lessor Party will equal the full amount such Lessor Party would have received had no such withholding or deduction been required. Moreover, if any Other Taxes are directly asserted against any Lessor Party with respect to any payment received by such Lessor Party, such Lessor Party may pay such Other Taxes and the Lessee will pay to the Agent for the benefit of such Lessor Party, as Supplemental Rent, within fifteen (15) Business Days after receipt of a written demand therefor (accompanied by a written statement describing in reasonable detail the amount so payable) from such Lessor Party such additional amounts (including any interest, reasonable expenses and any penalties incurred in connection therewith) as are necessary in order that the net after-tax amount received by such Person after the payment of such Other Taxes (including any Taxes on such additional amount) shall equal the amount such Person would have received had such Other Taxes not been asserted plus interest on such additional amounts at the Alternate Rate calculated from the date of payment of such Other Taxes by such Lessor Party to the date of payment of such additional amounts by the Lessee. If the Lessee fails to pay any Other Taxes when due to the appropriate taxing authority or fails to remit to the Agent for the benefit of the relevant Lessor Party the required receipts or other required documentary evidence, then the Lessee shall indemnify such Lessor Party for any incremental Taxes, interest, penalties and reasonable expenses that may become payable by such Lessor Party as a result of any such failure. Notwithstanding any other provision of this Participation Agreement, any amount of Taxes that would, but for this sentence, give rise to both Supplemental Rent payable to the Lessor or the New Partners pursuant to this Section 4.6 and an indemnity payment obligation in 15 favor of the Lessor or the New Partners pursuant to Section 13.4 shall be governed solely by the provisions of Section 13.4; provided, however, that this sentence is intended to apply Section 13.4 to Taxes subject to an actual indemnity payment obligation pursuant to both Section 4.6 and Section 13.4, but not to diminish any claim for indemnification (or Supplemental Rent) pursuant to this Section 4.6 that would not give rise to an actual indemnity payment obligation pursuant to Section 13.4. Section 4.7 Replacement of Affected Parties. (a) If any Tranche B Bank or Liquidity Bank (an "Affected Party") makes demand upon the Lessee for amounts pursuant to Section 4.3. 4.4 or 4.6 hereof, then the Lessee may (x) request such Affected Party to, and such Affected Party shall upon such request, use reasonable efforts consistent with legal and regulatory restrictions to designate another lending office acceptable to such Affected Party in its sole discretion for its investment (with the object of avoiding the consequences of such events) or (y) give notice (a "Replacement Notice") in writing to such Tranche B Bank, Liquidity Bank, the Note Purchaser, the Conduit Agent and the Agent of its intention to replace such Affected Party with an Eligible Assignee designated in such Replacement Notice, if such replacement would result in the elimination or reduction of charges similar to those being claimed by the Affected Party. Any replacement of a Tranche B Bank or a Liquidity Bank pursuant to the foregoing provisions must be acceptable to the Note Purchaser and the Conduit Agent in their sole discretion (including, without limitation, for Rating Agency concerns). (b) With respect to a Replacement Notice involving a Liquidity Bank, the Note Purchaser and the Conduit Agent shall, in the exercise of their sole discretion and within thirty (30) days of their receipt of a Replacement Notice with respect to one of the Liquidity Banks, notify the Lessee and the Affected Party whether the designated Eligible Assignee is satisfactory to the Note Purchaser and the Conduit Agent; and if either shall fail to give such notice, the Eligible Assignee shall be deemed rejected. With respect to a Replacement Notice involving a Tranche B Bank, the Agent shall, in the exercise of its sole discretion and within thirty (30) days of its receipt of a Replacement Notice with respect to one of the Tranche B Banks, notify the Lessee and the Affected Party whether the designated Eligible Assignee is satisfactory to the Agent; and if the Agent shall fail to give such notice, the Eligible Assignee shall be deemed rejected. (c) Upon approval of the designated Eligible Assignee as aforesaid, the Affected Party shall assign its rights and obligations under the Operative Documents to such Eligible Assignee and, as a condition of such assignment, the Affected Party shall receive payment in full of all outstanding Liquidity Loans and all other amounts due it under the Operative Documents. (d) In the event the Note Purchaser and the Conduit Agent or the Agent (as applicable) do not approve the replacement of the Affected Party with the designated Eligible Assignee, the Lessee shall have the option to designate another Eligible Assignee pursuant to Section 4.7(a) and Section 4.7(b) above. 16 Section 4.8 Fees. (a) The Lessee shall pay to the Agent for the benefit of the Tranche B Banks, the Liquidity Banks and the New Partners, a one-time up front fee equal to thirty-five one-hundredths of one percent (.35%) of the Aggregate Tranche B Commitment, the allocated portion of the "Commitments" (as defined in the Liquidity Agreement) and the Aggregate Equity Investment Commitment (as applicable) provided by each Tranche B Bank (including KeyBank), Liquidity Bank (including KeyBank) and New Partner (the "Upfront Fees"). The Lessee shall pay the Up front Fees in advance on the Initial Funding Date as a Transaction Expense. (b) The Lessee shall pay to the Agent, for the ratable benefit of the Liquidity Banks to be paid pro rata based upon each Liquidity Bank's Percentage, commitment fees (the "Commitment Fees") equal to one-half of one percent (.50%) of the Liquidity Banks' average daily unused allocated portion of the "Commitment" (as defined in the Liquidity Agreement). The Lessee shall pay the Commitment Fees in arrears on each Basic Rent Payment Date in each March, June, September and December (commencing on September 12,2001) and on the Maturity Date (or if the Overall Transactions are terminated on a date prior to such date, on such prior date); provided, however, the payment of Commitment Fees due on September 12,2001 shall be prorated to reflect the number of days from the Documentation Date to September 12, 2001. The Commitment Fees shall constitute Supplemental Rent for the purposes of the Operative Documents. (c) The Lessee shall pay to the Agent, for the ratable benefit of the Liquidity Banks to be paid pro rata based upon each Liquidity Bank's Percentage, renewal fees (the "Renewal Fees") equal to one-quarter of one percent (.25%) of the allocated portion of the "Commitments" (as defined in the Liquidity Agreement) renewed by each Liquidity Bank (including KeyBank). The Lessee shall pay the Renewal Fees in advance on each anniversary of the Initial Funding Date. The Renewal Fees shall constitute Supplemental Rent for the purposes of the Operative Documents. No additional fees shall be payable to the Liquidity Banks pursuant to the Liquidity Documentation. (d) The Lessee shall pay to the Agent for the benefit of the Structuring Agent a one-time structuring fee (the "Structuring Fee") as set forth in the Proposal. The Lessee shall pay the Structuring Fee in advance on the Initial Funding Date as a Transaction Expense. (e) The Lessee shall pay to the Agent for its own account an annual administrative fee (the "Administrative Fee") equal to the greater of (i) $20,000 or (ii) $3,000 per Tranche B Bank and Liquidity Bank. The Lessee shall pay the Administrative Fees in advance on each anniversary of the Initial Funding Date. The Administrative Fees shall constitute Supplemental Rent for the purposes of the Operative Documents. Section 4.9 Calculation of Interest and Fees. All calculations of the Note Interest Amount, the Tranche B Interest Amount, the Yield Amount, any other forms of interest or fees under this Participation Agreement and the other Operative Documents for any period, unless otherwise specified herein or therein, shall (a) include the first day of such period and exclude the last day of such period and (b) be calculated on the basis of a year of 360 days for actual days elapsed, except that during any period any of the foregoing amounts is calculated based upon the 17 Alternate Rate, such amount shall be calculated on the basis of a year of 365 or 366 days, as appropriate, for actual days elapsed. Section 4.10 Method of Payment. Each payment of Basic Rent or Supplemental Rent payable by the Lessee pursuant hereto and pursuant to the Master Lease or any other Operative Document shall be made by wire transfer prior to 2:00 p.m., New York time on the date due, to the relevant account specified on Schedule I hereof in immediately available funds consisting of Dollars. Payments received after 2:00 p.m., New York time, on the date due shall, solely for the purpose of Section 18 of the Master Lease, be deemed to have been received on such day; provided, however, that for the purpose of the second sentence of Section 7(g) of the Master Lease, such payments shall be deemed to have been received on the next succeeding Business Day and subject to interest at the Overdue Rate as provided in such Section 7(g) of the Master Lease. Section 4.11 Non-Business Day Payments. If any Basic Rent Payment Date falls on a day that is not a Business Day, the amount of Basic Rent otherwise due on such Basic Rent Payment Date shall instead be due on the next succeeding Business Day and Basic Rent shall be recalculated as if such next succeeding Business Day were such Basic Rent Payment Date. Section 4.12 Assignment of Basic Rent and Other Payments. The Lessor hereby irrevocably directs that each payment of Basic Rent, Supplemental Rent, interest (if any) on the Lessee Loans, Outstanding Lease Balance, Purchase Option Price, and Maximum Recourse Amount payable by the Lessee under the Master Lease or any other Operative Document shall be made for its account to or as directed by the Agent pursuant to the payment instructions set forth in Schedule I hereof and applied in accordance with the relevant provisions of Article XI hereof. To the extent that the Lessee shall have timely made such payments in full in immediately available funds to the Agent or as directed by the Agent, the Lessee's obligation with respect to such payment under the Operative Documents shall be deemed satisfied in the amount of such payment and none of the Lessee Parties shall be responsible for any undue delay or failure on the part of the Agent in remitting the appropriate amounts to the other Lessor Parties or any other Person entitled to such payment. ARTICLE V CERTAIN INTENTIONS OF THE PARTIES Section 5.1 Nature of Transaction. (a) The parties hereto intend that, with respect to the Property and the Master Lease, (i) for financial accounting purposes with respect to the Lessee, (x) the Master Lease will be treated as an "operating lease" pursuant to Statement of Financial Accounting Standards (SFAS) No. 13, as amended, (y) the Lessor will be treated as the owner and the lessor of the Property to which it holds title subject to the Master Lease and the Lessee will be treated as the lessee of the Property, (ii) for federal and all state and local income tax purposes and bankruptcy purposes, (A) the Master Lease will be treated as a financing arrangement, (B) the Note Purchaser with respect to the Notes, the Tranche B Banks with respect to the Tranche B Loans, the Liquidity Banks with respect to the Liquidity Loans, and the New Partners with respect to the 18 Equity Investment will be deemed to be lenders making loans to the Lessee in an aggregate amount equal to the Outstanding Lease Balance, which loans are secured, inter alia, by the Property subject to the Master Lease, and (C) the Lessee under the Master Lease will be treated as the owner of the Property and will be entitled to all tax benefits ordinarily available to an owner of property like such Property for such tax purposes, and (iii) all risks relating to environmental matters shall be borne by the Lessee in accordance with the provisions of this Participation Agreement and the Environmental Indemnity Agreement. (b) The parties hereto intend that, for federal, state, local and foreign tax and regulatory purposes, the Notes, the Tranche B Loan, any Liquidity Loans and the Equity Investment will be Indebtedness of the Lessee secured, inter alia, by the Property and the rights to payment of Rent under the Master Lease, and agree to treat the Notes, the Tranche B Loan, any Liquidity Loans and the Equity Investment accordingly for all such purposes. (c) Notwithstanding anything else to the contrary set forth herein, each Transaction Party acknowledges and agrees that none of the other Transaction Parties has made any representations or warranties concerning the tax, accounting or (except as otherwise expressly contained in this Participation Agreement or other Operative Documents) legal characteristics of the Operative Documents and that each Transaction Party, respectively, has obtained and relied upon such tax, accounting and legal advice concerning the Operative Documents as it deems appropriate. (d) Specifically, without limiting the generality of the foregoing, the parties hereto intend and agree that in the event of any insolvency or receivership proceedings or a petition under the United States bankruptcy laws or any other applicable insolvency laws or statutes of the United States of America or any state or commonwealth thereof affecting the Lessee or any other Transaction Party or any collection actions, the transactions evidenced by the Operative Documents are loans made to the Lessee by the New Partners through the Lessor (using their own funds as well as funds provided by the Note Purchaser, the Tranche B Banks and/or the Liquidity Banks as unrelated third party lenders). (e) In furtherance of the intent of the parties as set forth in this Section 5.1, the Lessee hereby absolutely, unconditionally and irrevocably (i) agrees to pay in full when due (after giving effect to any applicable grace period), whether at stated maturity, by required prepayment, declaration, acceleration, demand or otherwise, all amounts owing to the Lessor Parties (including all such amounts which would become due but for the operation of the automatic stay under Section 362(a) of the United States Bankruptcy Code, 11 U.S.C. ss.362(a), and the operation of Sections 502(b) and 506(b) of the United States Bankruptcy Code, 11 U.S.C. ss.502(b) and ss.506(b>>, and (ii) indemnifies and holds harmless the Lessor Parties for any and all costs and expenses (including reasonable attorneys' fees and expenses) incurred by such Person in enforcing any rights under this Section 5.1. Section 5.2 Amounts Due Hereunder and Under the Master Lease. Anything else herein or elsewhere to the contrary notwithstanding, it is the intention of the Transaction Parties that: (i) the amount and timing of installments of Basic Rent due and payable from time to time from the Lessee hereunder and under the Master Lease shall be equal to the aggregate payments due and payable in respect of the amounts outstanding under the Notes, the Tranche B Loan, the 19 Liquidity Loans and the outstanding portion of the Equity Investment on each Basic Rent Payment Date then due and payable; (ii) if the Lessee elects to purchase all of the Property under the Master Lease or becomes obligated to purchase all of the Property pursuant thereto, the Outstanding Lease Balance, all accrued and unpaid Basic Rent, Supplemental Rent, interest (if any) on the Lessee Loans, and all other obligations of the Lessee owing to the Lessor Parties or any other Person under the Operative Documents shall be paid in full by the Lessee; and (iii) if the Lessee properly elects the Remarketing Option under the Master Lease, the Lessee shall only be required to pay to the Lessor all accrued and unpaid Basic Rent, Supplemental Rent, interest (if any) on the Lessee Loans, the Gross Sales Proceeds of the sale of the Property, the corresponding Maximum Recourse Amount and any amounts due pursuant to Articles XI and XIII hereof and Section 12.1 of the Master Lease (subject to Section 12.1(n) of the Master Lease) (which aggregate amount may be less than the Outstanding Lease Balance); and (iv) upon an Event of Default resulting in the obligations of the Lessee becoming due and payable, the amounts then due and payable by the Lessee under the Master Lease shall include all amounts necessary to pay in full the Outstanding Lease Balance, plus all accrued and unpaid Rent (including, without duplication, Supplemental Rent) plus all other amounts then due from Lessee to the Lessor Parties, or any other Person under the Operative Documents. Amounts payable to the Lessor pursuant to Section 5.2(ii) or (iii) hereof shall be remitted to the Agent upon receipt by the Lessee or any other Person and shall be applied upon receipt thereof in accordance with the provisions of Article XI hereof. Section 5.3 Allocation of Payment Obligations: Payment to Agent. (a) The Note Purchaser and the Lessor shall submit to the Agent no later than 5 :00 p.m., New York time, on the fourth (4th) Business Day prior to each Basic Rent Payment Date, a summary of the Basic Rent payments due in respect of the amounts outstanding under the Notes and the outstanding portion of the Equity Investment, together with reasonable detail supporting the calculations made. In addition, the Agent shall calculate the amounts outstanding under the Tranche B Loan and any Liquidity Loans. The Agent shall prepare and distribute to the Note Purchaser, the Tranche B Banks, the Liquidity Banks, the Lessor, the Lessee and the Guarantor, no later than three (3) Business Days prior to each Basic Rent Payment Date, an invoice with respect to the Basic Rent payable as of such date, which invoice shall set forth, inter alia, the aggregate amount of Basic Rent payable by the Lessee as of the upcoming Basic Rent Payment Date together with a detailed description of the allocation of Basic Rent to each outstanding type of instrument, with such amounts further allocated to reflect the amounts payable by the Lessee and the interest rates payable on such instrument. Such invoice shall further specify the relevant payment instructions. Notwithstanding the foregoing, any delay or failure on the part of the Agent to deliver the invoice shall neither extinguish nor diminish Lessee's obligations to pay the Basic Rent due and payable on the applicable Basic Rent Payment Date. (b) Except as otherwise expressly set forth in this Participation Agreement or any other Operative Documents, all payments to be made by the Lessee or any other Lessee Party shall be paid to the Agent for the benefit of, and disbursement to, the Lessor Party for whose account such payment has been made, and payment to the Agent shall, as between such Lessee Party and such Lessor Party, constitute payment to such Lessor Party. 20 ARTICLE VI CONDITIONS PRECEDENT TO FUNDING DATES Section 6.1 Conditions Precedent to the Initial Funding Date. The obligation of the New Partners to acquire the Partnership Interests, the Lessor to issue the Notes specified in Section 3.1, the Tranche B Banks to advance the Tranche B Loan specified in Section 3.3, the New Partners to fund the Equity Investment specified in Section 3.4, the Note Purchaser (or the Liquidity Banks if the Note Purchaser does not) to purchase such Notes and fund amounts thereunder or Percentage Interests and the obligation of the Lessor to amend the lease of the Property to the Lessee pursuant to the Master Lease are subject to the satisfaction (or waiver by the appropriate Lessor Parties) of each of the following conditions precedent (such satisfaction or waiver to be evidenced by the purchase of the Partnership Interests, the purchase of the Notes and the funding of the advances thereunder, the funding of the Tranche B Loan and the funding of the Equity Investment on the Initial Funding Date unless otherwise documented in writing by the appropriate parties): (a) Funding Notice. The Agent, for the benefit of the Lessor Parties, shall have received a fully executed counterpart of the Funding Notice substantially in the form of Exhibit B attached hereto with respect to the issuance of the Notes and the funding of the advances thereunder, the funding of the Tranche B Loan and the funding of the Equity Investment to finance the Acquisition and Refinancing Costs. The delivery of such Funding Notice and the acceptance by the Lessee of the application of the proceeds of the initial funds made available pursuant to the issuance of the Notes by the Note Purchaser, the funding of the Tranche B Loan and the funding of the Equity Investment to purchase the Partnership Interests and refinance the outstanding Indebtedness under the Existing Credit Agreement shall constitute a representation and warranty by the Lessee that on such Funding Date (both immediately before and after giving effect to the application of the proceeds under the Notes, the Tranche B Loan and the Equity Investment), the statements made in Section 7.1 and 7.2 are true and correct in all material respects. (b) Operative Documents to be Delivered on the Initial Funding Date. (i) Participation Agreement. Each of the parties hereto shall have duly executed and delivered this Participation Agreement. (ii) Partnership Interests Purchase Agreement. The New Partners and the Existing Partners shall have duly executed and delivered the Partnership Interests Purchase Agreement in the form of Exhibit C-l attached hereto, to be dated as of the Initial Funding Date, pursuant to which the New Partners shall acquire the Partnership Interests in the Lessor from the Existing Partners. (iii) Master Termination Agreements. The Lessor, DKB (as agent for the Existing Lenders), the Lessee, the Guarantor, Merrill Leasing, Merrill Lynch, Merrill and the Existing Lenders shall have duly executed and delivered the Master Termination Agreement (Debt) in the form of Exhibit C-2 attached hereto, and the Lessor, the Existing Partners, DKB (in 21 various capacities) and The Dai-Ichi Kangyo Bank, Limited, San Francisco Agency shall have duly executed and delivered the Master Termination Agreement (Equity) in the form of Exhibit C-3, each to be dated the Initial Funding Date, pursuant to which the parties thereto shall, inter alia, (A) acknowledge that all amounts outstanding under the various documents, instruments and agreements referenced therein as "Documents" have been paid in full by the Lessor, and (B) effective immediately upon such repayment, terminate such "Documents" upon the terms and subject to the conditions set forth therein. (iv) Amendment No.2 to Master Lease. The Lessee and the Lessor shall have duly executed and delivered Amendment No.2 in the form of Exhibit D attached hereto, such Amendment No.2 to be dated as of the Initial Funding Date. (v) Guaranty. The Guarantor shall have duly authorized, executed and delivered the Guaranty in the form of Exhibit E attached hereto, with respect to the guaranty by the Guarantor of obligations of the Lessee under the Operative Documents, such Guaranty to be dated as of the Initial Funding Date. (vi) Environmental Indemnity Agreement. The Lessee shall have duly authorized, executed and delivered the Environmental Indemnity Agreement in the form of Exhibit F attached hereto, such Environmental Indemnity Agreement to be dated as of the Initial Funding Date. (vii) Liquidity Documentation. Each of the parties to the Liquidity Documentation shall have duly authorized, executed and delivered such agreements, each to be dated as of the Initial Funding Date, and the conditions precedent set forth therein shall have been satisfied or waived as provided for therein. (c) Precautionary Deed of Trust. The Precautionary Deed of Trust substantially in the form of Exhibit G attached hereto shall have been executed and delivered by the Lessee, such document to be dated as of the Initial Funding Date. (d) Deed of Trust. The Lessor shall have executed and delivered the Deed of Trust to the Agent substantially in the form of Exhibit H attached hereto, such instrument to be dated as of the Initial Funding Date. (e) Opinion of Counsel to Lessee and Guarantor. The Agent on behalf of the Lessor Parties shall have received an opinion of Perkins Coie LLP, counsel to the Lessee and the Guarantor, to be dated as of the Initial Funding Date, as to the matters set forth in Exhibit I. which opinion shall be acceptable in form and substance to the Lessor Parties. By its execution hereof, each of the Lessee and the Guarantor expressly instruct such counsel to execute and deliver such opinion to the Persons designated in the preceding sentence and, if requested by the Note Purchaser or the Liquidity Banks, the Rating Agencies. (f) Initial Appraisal. The Agent on behalf of the Lessor Parties shall have received the Initial Appraisal of the Property dated as of a date that is satisfactory to the Lessor Parties and in form and substance satisfactory to the Lessor Parties in their sole discretion. 22 (g) Environmental Audit. The Agent on behalf of the Lessor Parties shall have received the results of an Environmental Audit with respect to the Property which is dated no earlier than thirty (30) days prior to the Initial Funding Date, which Environmental Audit shall be satisfactory in form and substance to the Lessor Parties in their sole discretion. (h) Conveyance Instruments. On or prior to the Initial Funding Date, the Agent on behalf of the Lessor Parties shall have received evidence satisfactory to them that appropriate Conveyance Instruments have been executed and delivered and, if deemed necessary or desirable by any such Person or its counsel, recorded in such jurisdictions as such Person may request, in order to perfect the interests of the Agent in the Master Lease and the Property. (i) The Lessee's Responsible Officer's Certificate. The Agent on behalf of the Lessor Parties shall have received a Responsible Officer's Certificate of the Lessee, substantially in the form of Exhibit J attached hereto, dated as of the Initial Funding Date, stating that to such Responsible Officer's knowledge (i) each and every representation and warranty of the Lessee contained in each Operative Document to which it is a party is true and correct in all material respects on and as of the Initial Funding Date, except to the extent such representation or warranty relates solely to an earlier date, in which case such representation or warranty shall have been true and correct on and as of such earlier date, (ii) no Default or Event of Default has occurred and is continuing, (iii) each Operative Document to which the Lessee is a party is in full force and effect with respect to it, and (iv) the Lessee has duly performed and complied with all conditions contained herein or in any other Operative Document required to be performed or complied with by it on or prior to such Initial Funding Date. (j) Guarantor's Responsible Officer's Certificate. The Agent on behalf of the Lessor Parties shall have received a Responsible Officer's Certificate of the Guarantor in substantially the form of Exhibit K attached hereto, dated as of the Initial Funding Date stating that to such Responsible Officer's knowledge (i) each and every representation and warranty of the Guarantor contained in each Operative Document to which it is a party is true and correct in all material respects on and as of the Initial Funding Date, except to the extent such representation or warranty relates solely to an earlier date, in which case such representation or warranty shall have been true and correct on and as of such earlier date, (ii) no Default or Event of Default has occurred and is continuing, (iii) each Operative Document to which the Guarantor is a party is in full force and effect with respect to it, and (iv) the Guarantor has duly performed and complied with all conditions contained herein or in any other Operative Document required to be performed or complied with by it on or prior to such Initial Funding Date. (k) UCC Financing: Statements. On or prior to the Initial Funding Date, the Lessee shall have delivered to the Agent on behalf of the Lessor Parties all UCC Financing Statements relating to the Property and other security interests granted under the Operative Documents, as the Lessor Parties may reasonably request in order to protect the interests of the Lessor Parties under the Operative Documents to the extent the Master Lease, Precautionary Deed of Trust, Deed of Trust, Conveyance Instruments or other Operative Documents constitute security agreements. (l) Recordation of Conveyance Instruments and Financing Statements. The Agent on behalf of the Lessor Parties shall have received evidence reasonably satisfactory to 23 each of them that (i) the Precautionary Deed of Trust, (ii) the Deed of Trust, and (iii) the UCC Financing Statements have been or are being recorded in a manner sufficient to properly perfect each of their respective interests therein. (m) Property Survey. On or prior to the Initial Funding Date, the Lessee shall have delivered to Agent on behalf of the Lessor Parties copies of the ALTA/1999 (Urban) Survey with respect to the Property (the "ALTA Property Survey"), which survey shall be reasonably satisfactory to the Lessor Parties. (n) Title Policies. On or prior to the Initial Funding Date, the Lessee shall have delivered to the Agent on behalf of the Lessor Parties a commitment from the Title Company to deliver (x) at the Lessor's sole discretion, either an ALTA extended owner's title insurance policy or endorsements to any existing owner's title insurance policy covering the Property in favor of the Lessor and (y) at the Lessor's sole discretion, either an ALTA extended lender's title insurance policy or endorsements to any existing lender's title insurance policy covering the Property in favor of the Lessor and the Agent. The owner's policy described in clause (x} shall (i) be subject only to Permitted Exceptions, (ii) be in an amount not less than the Aggregate Commitment Amount, (iii) be reasonably satisfactory to the Lessor Parties and (iv) contain comprehensive, mechanics liens, zoning, recharacterization endorsements, pending disbursements endorsements and such other endorsements reasonably requested by the Lessor Parties. The lender's policy described in clause (y} shall (i) be subject only to Permitted Exceptions, (ii) be in an amount not less than the Aggregate Commitment Amount, (iii) be reasonably satisfactory to the Lessor Parties and (iv) contain revolving credit, variable rate, comprehensive, fraudulent conveyances, doing business, mechanics liens, zoning, pending disbursement endorsements and such other endorsements reasonably requested by the Lessor Parties. (o) Evidence of Property Insurance. The Agent on behalf of the Lessor Parties shall have received evidence that the insurance maintained by the Lessee with respect to the Property as of the Initial Funding Date satisfies the requirements set forth in Section 10 of the Master Lease, setting forth the respective coverage, limits of liability, carrier, policy number and period of coverage. (p) Governmental Approvals. All necessary Governmental Actions required by any Requirement of Law for the purpose of (i) authorizing the New Partners and the Lessor to enter into the transactions contemplated by the Operative Documents as of the Initial Funding Date, or (ii) authorizing the Lessee or the Guarantor to execute and deliver the Operative Documents to which it is a party and perform its obligations thereunder, shall have been obtained or made and be in full force and effect. (q) Requirements of Law. The transactions contemplated by the Operative Documents do not and will not violate any Requirement of Law and do not and will not subject the Transaction Parties to any adverse regulatory prohibitions or constraints. (r) No Event of Default. There shall not have occurred and be continuing any Default or Event of Default, and no Default or Event of Default will have occurred after giving effect to the issuance of the Notes and the funding of the advances thereunder, the purchase 24 thereof by the Note Purchaser or the Liquidity Banks as of the Initial Funding Date, the funding of the Tranche B Loan as of the Initial Funding Date or the funding of the Equity Investment as of the Initial Funding Date. (s) Administration Agreement. The Administration Agreement shall have been executed and delivered by all parties thereto substantially in the form of Exhibit L attached hereto. (t) Representation and Warranties. On the Initial Funding Date, the representations and warranties of the Lessee, the Guarantor and the Lessor Parties contained herein and in each of the other Operative Documents shall be true and correct in all material respects as though made on and as of such date, except to the extent such representations or warranties relate solely to an earlier date, in which case such representations and warranties shall have been true and correct in all material respects on and as of such earlier date. (u) Litigation. On the Initial Funding Date, there shall not be any actions, suits or proceedings pending or, to the knowledge of the Lessee or the Guarantor, threatened with respect to the Lessee, the Guarantor or the Property (i) that are reasonably likely to reduce the Fair Market Value of the Property or the ability of the Lessee or the Guarantor to fulfill their obligations under the Operative Documents or have a material adverse effect on the title to, or the use or operation of all or any portion of the Property or (ii) that question the validity of the Operative Documents or the rights or remedies of the Lessor Parties with respect to the Lessee, the Guarantor or the Property under the Operative Documents. (v) Available Commitments: Maximum Amount of Notes and Equity Investment. After giving effect to the purchase of the Notes and the funding of the advances thereunder, the funding of the Tranche B Loan and the funding of the Equity Investment requested to be issued and made pursuant to the Funding Notice delivered as of the Initial Funding Date, and the application of the proceeds thereof (including, without limitation, to the acquisition by the New Partners of the Partnership Interests), the Outstanding Lease Balance shall not exceed the Aggregate Commitment Amount. (w) Taxes. All taxes, fees and other charges in connection with the execution, delivery, recording, filing and registration of the Operative Documents to be delivered as of the Initial Funding Date shall have been paid or provisions for such payment shall have been made by the Lessee to the reasonable satisfaction of the Lessor Parties. (x) No Material Adverse Effect, After giving effect to the purchase of the Notes and the funding of the advances thereunder, the funding of the Tranche B Loan and the funding of any portion of the Equity Investment, there shall be no change with respect the Property or the financial condition of the Lessee or the Guarantor that would have a Material Adverse Effect. (y) Fees. The Agent on behalf of each Tranche B Bank, Liquidity Bank and the Structuring Agent shall have received from the Lessee fees in the amounts required pursuant to Section 4.8 hereof. (z) Opinion of Counsel to the Lessor and the New Partners. The Agent on behalf of the Lessor Parties shall have received an opinion from each of (i) Orrick, Herrington & 25 Sutcliffe LLP and (ii) Thompson, Hine & Flory, LLP, as counsel to the New Partners and the Lessor, each to be dated as of the Initial Funding Date, which opinions shall be acceptable in form and substance to the other Lessor Parties. By its execution hereof, each of the New Partners and the Lessor expressly instructs such counsel to execute and deliver such opinions to the Persons designated in the preceding sentence and, if requested by the Note Purchaser or the Liquidity Banks, the Rating Agencies. (aa) The Lessor's Responsible Officer's Certificate. The Agent on behalf of the other Lessor Parties shall have received a Responsible Officer's Certificate of the general partner of the Lessor, dated as of the Initial Funding Date, stating that to such Responsible Officer's knowledge (i) each and every representation and warranty of the Lessor contained in each Operative Document to which it is a party is true and correct in all material respects on and as of the Initial Funding Date, except to the extent such representation or warranty relates solely to an earlier date, in which case such representation or warranty shall have been true and correct on and as of such earlier date, (ii) each Operative Document to which the Lessor is a party is in full force and effect with respect to it, and (iii) the Lessor has duly performed and complied with all conditions contained herein or in any other Operative Document required to be performed or complied with by it on or prior to such Initial Funding Date. (bb) The New Partners' Responsible Officer's Certificates. The Agent on behalf of the other Lessor Parties shall have received a Responsible Officer's Certificate of each New Partner, dated as of the Initial Funding Date, stating that to such Responsible Officer's knowledge (i) each and every representation and warranty of such New Partner contained in each Operative Document to which it is a party is true and correct in all material respects on and as of the Initial Funding Date, except to the extent such representation or warranty relates solely to an earlier date, in which case such representation or warranty shall have been true and correct on and as of such earlier date, (ii) each Operative Document to which such New Partner is a party is in full force and effect with respect to it, and (iii) such New Partner has duly performed and complied with all conditions contained herein or in any other Operative Document required to be performed or complied with by it on or prior to such Initial Funding Date. (cc) Other Documents. The Lessee and the Guarantor shall have delivered or caused to be delivered such other documents as the Lessor Parties may reasonably request. Section 6.2 Conditions Precedent to all Accretion Funding Dates. The obligation of the Lessor to fund the advances under the Notes with respect to the funding of the Accreted Amounts are subject to the satisfaction (or waiver by the appropriate Lessor Parties) of each of the following conditions precedent (such satisfaction or waiver to be evidenced by the funding of the advances under the Notes on such Funding Date unless otherwise documented in writing by the appropriate parties): (a) Representations and Warranties. The representations and warranties of the Guarantor and the Lessee set forth in the Operative Documents (including the representations and warranties set forth in Sections 7.1 and 7.2) shall be true and correct in all material respects on and as of such Funding Date except to the extent such representations or warranties relate solely to an earlier date, in which case such representations and warranties shall have been true and correct in all material respects on and as of such earlier date. The acceptence by the Lessor 26 of the proceeds of such funding shall constitute a representation and warranty on such Funding Date (both immediately before and after giving effect to the funding of such advances under the Notes and the application of the proceeds thereof), the statements made in Section 7.2 hereof are true and correct in all material respects. (b) No Event of Default. No Event of Default has occurred and is continuing or will result from such funding. (c) Operative Documents. All of the Operative Documents are in full force and effect. Section 6.3 Closing. All documents, instruments and agreements required to be delivered on the Initial Funding Date shall be delivered to the offices of Orrick, Herrington & Sutcliffe LLP, 400 Sansome Street, San Francisco, California 94111, or at such other location as may be determined by the Transaction Parties. ARTICLE VII REPRESENTATIONS Section 7.1 Representations and Warranties of the Lessee and the Guarantor. Each of the Guarantor and the Lessee hereby represents and warrants, as of the Initial Funding Date, to the Lessor Parties as follows: (a) Corporate Authority. (i) Incorporation: Good Standing. Each of the Guarantor and the Lessee (A) is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation or organization, (B) has all requisite corporate power and authority and legal right to own and operate its property, as to the Lessee, to lease the property it operates as lessee, and to conduct its business as now conducted and as presently contemplated, and (C) is in good standing as a foreign corporation and is duly authorized to do business in each jurisdiction where such qualification is necessary except where a failure to be so qualified would not have a Material Adverse Effect. Except as provided in Subsection (c )(iv) hereof, the Lessee and the Guarantor each has full power and authority and holds all requisite governmental licenses, permits and other approvals to enter into and perform its Obligations under the Operative Documents to which it is a party and, as to the Lessee, to own and hold under lease its rights in the Property and to conduct its business substantially as currently conducted by it. (ii) Authorization. The execution, delivery and perfom1ance of this Participation Agreement and the other Operative Documents to which it is a party and the transactions contemplated hereby and thereby (A) are within its corporate authority and legal right, (B) have been duly authorized by all necessary corporate proceedings, (C) do not conflict with or result in any breach or contravention of any provision of law, statute, rule or regulation to which it is subject or any judgment, order, writ, injunction, license or pem1it applicable to it which could have a Material Adverse Effect, (D) do not conflict with any provision of its corporate charter or bylaws of, or any agreement or other instrument binding upon it, (E) do not require any consent, approval or authorization of any Governmental Authority or any other 27 Person not a party hereto and (F) do not result in, or require the creation or imposition of, any Lien on any of its properties other than as contemplated by the Operative Documents. (iii) Enforceability. The execution and delivery of this Participation Agreement and the other Operative Documents to which it is a party will result in valid and legally binding obligations of it enforceable against it in accordance with the respective terms and provisions hereof and thereof, except as enforceability is limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting generally the enforcement of creditors' rights and except to the extent that availability of the remedy of specific performance or injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought. The Guarantor further specifically represents that the Guaranty shall be enforceable against it in accordance with its terms, notwithstanding the occurrence of a bankruptcy or insolvency proceeding with respect to the Lessee. (iv) Subsidiaries. The Guarantor and each of its Subsidiaries have only those Subsidiaries listed on Item 7.1 (a) of Schedule II hereto (as supplemented from time to time). The Lessee is a wholly-owned Subsidiary of the Guarantor. (v) Jurisdiction of Organization. Chief Executive Office. Etc The jurisdiction of incorporation, chief executive office and principal place of business of the Lessee is specified below its name on Schedule I hereto. (b) Litigation. etc. Except as disclosed on Item 7.1 (b) of Schedule II hereto, there is no litigation, at law or in equity, or any proceeding before any federal, state or municipal board or other governmental or administrative agency or any arbitration pending or to the knowledge of the Guarantor or the Lessee threatened which is likely to involve any risk of any judgment or liability not covered by insurance which may result in a Material Adverse Effect or which may otherwise result in a Material Adverse Effect, or which seeks to enjoin the consummation of, or which questions the validity of, any of the transactions contemplated by this Participation Agreement or any of the other Operative Documents, and no judgment, decree or order of any court, board or other governmental or administrative agency or arbitrator has been issued against or binds the Guarantor, the Lessee or any of their respective Subsidiaries which has, or could have, a Material Adverse Effect. (c) Burdensome Obligations: Compliance with Other Instruments. Laws: No Defaults: Permits. (i) Except as disclosed on Item 7.1 (c) of Schedule II hereto, neither the Guarantor nor any of its Subsidiaries, is subject to any charter, corporate or other legal restriction, or any judgment, decree, order, rule or regulation that has or, to the Guarantor's knowledge, is expected in the future to have a Material Adverse Effect. Except as disclosed on Item 7.1 (c) of Schedule II hereto, neither the Guarantor nor any of its Subsidiaries, is a party to any contract or agreement that has or, to the best of the Guarantor's knowledge, in the judgment of the Guarantor's officers, could have, a Material Adverse Effect. (ii) Neither the Guarantor nor the Lessee, is in violation of any provision of its charter documents, bylaws, or any agreement or instrument to which it is subject 28 or by which it or any of its properties are bound or any law, decree, order, judgment, statute, license, rule or regulation (including, without limitation, all Environmental Laws) in a manner that is reasonably likely to result in the imposition of substantial penalties that may result in a Material Adverse Effect or that may otherwise have a Material Adverse Effect. (iii) No Default or Event of Default has occurred and is continuing. (iv) Except as set forth on Item 7.1(c) of Schedule II hereto, the Guarantor and the Lessee have all necessary Permits from or by, have made all necessary filings with, and have given all necessary notices to, each Governmental Authority having jurisdiction over it, to the extent required to own and operate its properties, to lease the properties it operates under lease and to conduct its business as now conducted or presently proposed to be conducted by it, except for (x) Permits which can be obtained by the taking of ministerial action to secure the grant or transfer thereof and where the failure to have such Permits would not have a Material Adverse Effect and (y) where failure to have such Permits will not have a Material Adverse Effect. (v) No authorization or approval or other action by, and no notice to of filing with, any Governmental Authority or regulatory body or other Person (other than in connection with the repair, maintenance or renovation of the Property in accordance with applicable local law) is required for the due execution, delivery or performance by the Lessee or the Guarantor of any Operative Document to which it is a party, except as contemplated by the Operative Documents. (vi) The delivery and performance by each Lessee Party of its obligation under the Operative Documents to which such Lessee Party is a party do not contravene or result in a breach of, or constitute a default under any bond, indenture, deed of trust, mortgage, agreement or any other instrument to which the deed of trust, mortgage, agreement or any other instrument to which such Lessee Party is subject or by which the Lessee Party is bound. (d) Government Regulation. Neither the Guarantor nor the Lessee is subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act or the Investment Company Act of 1940, in each case as amended and in effect from time to time, or is subject to any Requirement of Law which regulates the incurring by the Guarantor or the Lessee of Indebtedness for borrowed money, including, without limitation, any Requirement of Law relating to common or contract carriers or to the sale of electricity, gas, steam, water or other public utility services. (e) Margin Regulations. Neither the Guarantor nor any of its respective Subsidiaries is engaged in the business of extending credit for the purpose of purchasing or carrying "margin stock" or "margin securities" within the meaning of Regulation T, U or X issued by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") and does not own any margin stock or margin securities. Neither the proceeds of the funds advanced under the Notes nor the Tranche B Loan will not be used, directly or indirectly, for the purpose of purchasing or carrying any margin security, for the purpose of reducing or retiring any Indebtedness which was originally incurred to purchase or carry any margin security or for 29 any other purpose which might cause the funds advanced under the Notes or the Tranche B Loan to be considered an advance of "purpose credit" within the meaning of Regulation U or X of the Federal Reserve Board. The Guarantor will not take nor permit any of its Subsidiaries or any agent acting on its or their behalf to take, any action which might cause this Participation Agreement or any other Operative Document or any document or instrument delivered pursuant to this Participation Agreement to violate any regulation of the Federal Reserve Board. (f) Certain Tax Matters. (i) The Guarantor and its Subsidiaries have (a) made or filed all material federal, state, local and foreign income and all other material Tax returns, reports and declarations required by any jurisdiction to which any of them is subject or properly filed for and received extensions with respect thereto which are still in full force and effect and which have been fully complied with in all material respects, (b) paid all Taxes and other governmental assessments and charges shown or determined to be due on such returns, reports and declarations, except those being contested in good faith by appropriate proceedings and for which adequate reserves, to the extent required by GAAP, have been established and (c) to the extent required by GAAP, set aside on their books provisions reasonably adequate for the payment of all estimated taxes for periods subsequent to the periods to which such returns, reports or declarations apply. There are no unpaid Taxes in any material amount claimed to be due by the taxing authority of any jurisdiction, and the officers of the Guarantor know of no basis for any such claim other than Taxes that the Guarantor and its Subsidiaries are contesting in good faith through appropriate proceedings and for which appropriate reserves, to the extent required by GAAP, have been established. (ii) Except as set forth in Schedule 7.1 (f) of Schedule II hereto, no material sales, use, excise, transfer or other Tax, fee or imposition shall result from the sale, transfer or purchase of the Partnership Interests,. except such material Taxes, fees or impositions that have been paid in full or are insured as to payment in full by the Title Company. (g) Liens. Except as set forth on Item 7.1 (g) of Schedule II hereto or as permitted by Section 8.2(b ), there are no Liens on or rights of third parties in, nor has there occurred any event which would give any third party a claim to such a right in, any of the properties or assets of the Guarantor or the Lessee. The Permitted Exceptions do not and will not materially and adversely affect (1) the ability of the Lessee or the Guarantor to pay their respective obligations under the Operative Documents in a timely manner or (2) the use of the Property for the use currently being made thereof, the operation of the Property as currently being operated or the value of the Property. Upon execution by the Lessee and recording thereof of the Precautionary Deed of Trust, and upon execution and filing of the Precautionary Financing Statements, the Agent will have a valid first lien on the Lessee's interest in the Property and a valid security interest in the personal property thereon subject to no Liens, charges or encumbrances other than the Permitted Exceptions. (h) Financial Matters. There has been delivered to each of the Lessor Parties a complete and correct copy of the consolidated balance sheet of the Guarantor as at the end of the Fiscal Year ended March 31, 2001 and the related consolidated statements of income, common shareholders' equity and cash flows of the Guarantor for such Fiscal Year, prepared in each case 30 in accordance with Section 8.1 (d)(iii). together with the accountant' s report with respect thereto as required by such Section. Such financial statements have been prepared in accordance with GAAP consistently applied and present fairly the consolidated financial condition of the Guarantor as at March 31. 2001. and the results of operations of the Guarantor for the Fiscal Year ended March 31. 2001. (i) Changes. etc. Except as set forth on Item 7.1 (i) of Schedule II hereto, or as disclosed in or reflected on the consolidated balance sheet of the Guarantor as at March 31, 2001 referred to in Section 7.1 (h )(i) no event has occurred and is continuing which has had or could have a Material Adverse Effect. (j) Employee Benefit Plans. (i) In General. Each Employee Benefit Plan has been maintained and operated in compliance in all material respects with the provisions of ERISA and, to the extent applicable, the Revenue Code, including but not limited to the provisions thereunder respecting prohibited transactions. The Guarantor has heretofore delivered to the Lessor Parties the most recently completed annual report, Form 5500, with all required attachments, with respect to each Guaranteed Pension Plan. (ii) Terminability of Welfare Plans. Under each Employee Benefit Plan which is an employee welfare benefit plan within the meaning of ss.3(1) or ss.3(2)(B) of ERISA, no benefits are due unless the event giving rise to the benefit entitlement occurs prior to plan termination (except as required by Title 1, Part 6 of ERISA). The Guarantor or an ERISA Affiliate, as appropriate, may terminate each such plan at any time (or at any time subsequent to the expiration of any applicable bargaining agreement) in the discretion of the Guarantor or such ERISA Affiliate without liability to any Person. (iii) Guaranteed Pension Plans. Each contribution required to be made to a Guaranteed Pension Plan, without regard to any waiver or extension, whether required to be made to avoid the incurrence of an accumulated funding deficiency, the notice of lien provisions of ss.302(f) of ERISA, or otherwise, has been timely made. No waiver of an accumulated funding deficiency or extension of amortization periods has been received with respect to any Guaranteed Pension Plan. No liability to the PBGC (other than required insurance premiums, all of which have been paid) has been incurred by the Guarantor or any ERISA Affiliate with respect to any Guaranteed Pension Plan and there has not been any ERISA Reportable Event, or any other event or condition which presents a material risk of termination of any Guaranteed Pension Plan by the PBGC, other than those ERISA Reportable Events or other events or conditions which have been disclosed in writing to the Lessor Parties and which have not been deemed by any of the foregoing to pose a material risk of termination of any Guaranteed Pension Plan by the PBGC. Based on the latest valuation of each Guaranteed Pension Plan (which in each case occurred within twelve months of the date of this representation), and on the actuarial methods and assumptions employed for that valuation, the aggregate benefit liabilities of all such Guaranteed Pension Plans within the meaning of ss.4001 of ERISA did not exceed the aggregate value of the assets of all such Guaranteed Pension Plans by more than $500,000, disregarding for this purpose the benefit liabilities and assets of any Guaranteed Pension Plan with assets in excess of benefit liabilities. 31 (iv) Multiemployer Plans. Neither the Guarantor nor any ERISA Affiliate has incurred any material liability (including secondary liability) to any Multiemployer Plan as a result of a complete or partial withdrawal from such Multiemployer Plan under ss.4201 of ERISA or as a result of a sale of assets described in ss.4204 of ERISA. Neither the Guarantor nor any ERISA Affiliate has been notified that any Multiemployer Plan is in reorganization or insolvent under and within the meaning of ss.4241 or ss.4245 of ERISA or that any Multiemployer Plan intends to terminate or has been terminated under ss.4041A of ERISA. (v) No Prohibited Transactions. Compliance by the parties with the terms of the Operative Documents will not involve any non-exempt prohibited transactions under Section 406(a) of ERISA or Section 4975 of the Internal Revenue Code of 1986, as amended. (k) Insurance. All policies of insurance of any kind or nature owned by or issued to the Guarantor or any of its Subsidiaries, the lapse of which, individually or collectively, would have a Material Adverse Effect, are in full force and effect and are of a nature and provide such coverage as is sufficient and as is customarily carried by companies of the size and character of the Guarantor and the Subsidiaries. In addition, all insurance coverage meeting the requirements of Section 10 of the Master Lease is in full force and effect with respect to the Property. (1) Labor Matters. Except as set forth on Item 7.1 (1) of Schedule II hereto, there are no strikes, grievances, unfair labor practices, written complaints, or other labor disputes pending or threatened against the Guarantor or its Subsidiaries except for those strikes, grievances, unfair labor practices, written complaints or other labor disputes which could not have a Material Adverse Effect. All payments due from any of the Guarantor or its Subsidiaries pursuant to the provisions of any collective bargaining agreement have been paid or accrued as a liability on the books of the Guarantor or such Subsidiaries unless, in the case of any Subsidiary other than the Lessee, the failure to make such payment could not reasonably be expected to have a Material Adverse Effect. (m) Environmental Protection. Except as disclosed on Item 7.1(m) of Schedule II hereto (which items, individually or in the aggregate, do not constitute a Material Adverse Environmental Condition): (i) the operations of the Guarantor and each of its Material Subsidiaries comply in all material respects with all Environmental Laws, (ii) the Guarantor and each of its Material Subsidiaries have obtained all material environmental, health and safety Permits necessary for its operation, and all such Permits are in good standing, with all applicable applications or renewals being timely filed, and the Guarantor and each of its Material Subsidiaries are in material compliance with all terms and conditions of such Permits, (iii) none of the operations of the Guarantor or any of its Material Subsidiaries is subject to any material proceeding by or before any Governmental Authority alleging the violation of, or any liability under any, Environmental Laws, (iv) neither the Guarantor nor any of its Material Subsidiaries (including all of their present facilities and operations, as well as its past facilities and operations), is subject to any material outstanding written order or agreement with any Governmental Authority or Person respecting (A) any Remedial Action, or (B) any Environmental Claims, (v) to the best of the Guarantor's knowledge, none of the operations of the Guarantor or any of its Material Subsidiaries is the subject of any material federal or state investigation under Environmental Laws including any investigation evaluating whether any Remedial Action is needed to respond to a Release of any Hazardous Substance, (vi) none of the 32 operations of the Guarantor or any of its Material Subsidiaries is subject to any other Environmental Law, which could result in a Material Adverse Environmental Condition upon such operations, taken as a whole and (vii) neither the Guarantor nor any of its Material Subsidiaries has received notice that any Hazardous Substance which anyone of them has Released, generated, transported or disposed of has been found at any site at which any third party (including any Governmental Authority) has conducted or is conducting or is required to conduct any Remedial Action. (n) Copyrights. Patents and Trademarks. The Guarantor and its Subsidiaries own or possess all patents, trademarks, service marks, copyrights and licenses, and all rights with respect to the foregoing, necessary for the conduct of its business as now conducted. To the best of the Guarantor's and the Lessee's knowledge, such ownership or possession do not materially conflict with the rights of others, except for conflicts, which if become the subject of any action or proceedings brought by any third party, including any Governmental Authority, would not have a Material Adverse Effect. (o) Title. The Guarantor and the Lessee have title to its assets reflected in the balance sheet for the Fiscal Year ended March 31, 2001 referred to in Section 7.1 (h )(i) (except as set forth on Item 7.1 (0) of Schedule II hereto and except for assets disposed of since such date in the ordinary course of business), and none of the properties and assets of the Guarantor or the Lessee is subject to any Liens, except Liens permitted by this Participation Agreement. The Guarantor and the Lessee enjoy peaceful and undisturbed possession of the Property. Neither the Guarantor nor the Lessee nor, to the Guarantor's and the Lessee's knowledge, any other party to any lease of real property on which facilities operated by the Guarantor or the Lessor is situated is in default of its obligations thereunder or has delivered or received any notice of default under any such lease, nor has any event occurred which, with the giving of notice, the passage of time or both, would constitute a default under any such lease, except for any default which would not have a Material Adverse Effect. (p) Full Disclosure: Pro Forma Effect of Overall Transaction. Neither this Participation Agreement (including the schedules and exhibits hereto), nor any of the other Operative Documents, nor any written statement prepared or furnished by or on behalf of the Guarantor or the Lessee to a Lessor Party in connection with the negotiation, preparation, execution or performance of this Participation Agreement and the other Operative Documents contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained herein or therein, in light of the circumstances under which they were made, not misleading. There is no fact known to the Guarantor or the Lessee which the Guarantor or the Lessee has not disclosed to the Lessor Parties which had or would have a Material Adverse Effect or which would, immediately after giving effect to the Overall Transaction, cause any of the representations and warranties of the Guarantor and the Lessee set forth in this Section 7.1 to be untrue in any material respect or which would cause any of the statements made herein to be misleading in any material respect. (q) Seniority. None of the Notes, the Tranche B Loan or the Equity Investment is subordinate or junior in right of payment, in any manner, to any other Indebtedness of the Guarantor or any Indebtedness of the Lessee (except as anticipated under Article XI of this Participation Agreement and other provisions of the Operative Documents). 33 (r) Compliance of Property with Requirements of Law. The contemplated use of the Property by the Lessee and its respective agents, assignees, employees, lessees, licensees and tenants complies in all material respects with all (i) Requirements of Law (including, all zoning and land use laws and Environmental Laws) and (ii) Insurance Requirements. (s) Plans and Specifications, Utilities, etc. All water, sewer, electric, gas, telephone and drainage facilities for the Property, all other utilities required to adequately service the Property for its intended use and means of access between the Property and public highways for pedestrians and motor vehicles are available pursuant to adequate permits (including any that may be required under applicable Environmental Laws). All utilities serving the Property are located in, and vehicular access to the Property is provided by, either public rights-of-way abutting the Property or Appurtenant Rights. The Property has adequate rights of access to public ways. (t) No Adverse Proceedings. There is no action, suit or proceeding (including any proceeding in condemnation or eminent domain under any Environmental Law or any proceeding proposing special or other assessments for public improvements or affecting the Property) pending or, to the best knowledge of the Lessee, threatened, with respect to the Lessee, its Affiliates or the Property or any part thereof which adversely affects the title to the Property, or adversely affects the use, operation or value of, the Property. (u) Master Lease. Upon the execution and delivery of the Master Lease, (i) the Lessee will have reaffirmed its unconditional acceptance of the Property covered thereby and (ii) no right of offset will exist with respect to any Rent or other sums payable under the Master Lease covering the Property. (v) Conveyance Instruments. The Conveyance Instruments, when filed and recorded in the jurisdictions specified in the opinion delivered pursuant to Sections 6.1 (f), will create, inter alia, in favor of the Agent, enforceable Liens of record and perfected first priority security interests in the Property, subject to Permitted Exceptions. (w) Private Offering. Neither the Lessee nor the Guarantor has offered any interest in this Participation Agreement, the Notes, the Tranche B Loan, the Equity Investment, the Master Lease, the Rent or any similar security for sale to, or solicited offers to buy any thereof from, or otherwise directly or indirectly approached or negotiated with respect thereto with, any prospective purchaser other than the Note Purchaser, the Tranche B Banks, the New Partners, the Lessor and the Liquidity Banks, each of which was offered such interest by the Lessee and the Guarantor in a manner that will not require registration of such interests under the Securities Acts or the qualification of any of the Operative Documents under the Trust Indenture Act of 1939, and each of which the Lessee had reasonable grounds to believe, and as to the Note Purchaser, the New Partners, the Tranche B Banks, the Lessor and the Liquidity Banks, after reasonable inquiry does believe, has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of such an investment; and, assuming the truthfulness of the representations by the other Lessor Parties herein, the issuance, sale and delivery of the Notes, the funding of the advances thereunder, the funding of the Tranche B Loan and the funding of the Equity Investment and the interests in this Participation Agreement represented thereby under the circumstances contemplated by this Participation Agreement do 34 not require the registration of such Notes, Tranche B Loan, Equity Investment or interests under the Securities Act or the qualification of any of the Operative Documents (or of any indenture in respect of any thereof) under the Trust Indenture Act of 1939, as amended. Section 7.2 Representations and Warranties of the Guarantor and the Lessee as of each Funding Date after the Initial Funding Date. Each of the Guarantor and the Lessee represents and warrants to each of the Lessor Parties as of each Funding Date after the Initial Funding Date as follows: (a) Representations and Warranties. The representations and warranties of the Guarantor and the Lessee set forth in the Operative Documents (including the representations and warranties set forth in Section 7.1) are true and correct in all material respects on and as of the Funding Date except to the extent such representations or warranties relate solely to an earlier date, in which case such representations and warranties shall have been true and correct in all material respects on and as of such earlier date. (b) Liens. Neither the Guarantor nor the Lessee has permitted any Liens to be placed against the Property other than Permitted Liens. (c) Absence of Default, Etc. No Default or Event of Default has occurred and is continuing. No Default or Event of Default will occur as a result of, or after giving effect to, the funding of the advances under the Notes requested by the Funding Notice on such date. Section 7.3 Representations and Warranties of the Note Purchaser. The Note Purchaser represents and warrants to each of the Transaction Parties as follows: (a) ERISA. It is not and will not be purchasing the Notes or funding the advances thereunder with the assets of an "employee benefit plan" (as defined in Section 3(3) of ERISA) which is subject to Title I of ERISA, or "plan" (as defined in Section 4975(e)(1) of the Revenue Code), nor will any such assets be used in connection with any other arrangement related to the transactions contemplated hereby, including the Note Purchase Agreement, the Liquidity Agreement or the sale of Commercial Paper. (b) Corporate Existence. It is a corporation duly incorporated, validly existing and in good standing under the laws of the state of its incorporation. (c) Corporate and Governmental Authorization: No Contravention. The execution, delivery and performance by it of this Participation Agreement and each other Operative Document to which it is or will be a party (i) are within its corporate powers, (ii) have been duly authorized by all necessary corporate action, (iii) require no action by or in respect of, or filing with, any governmental body, agency or official, and (iv) do not contravene, or constitute a default under, its certificate of incorporation or by-laws. (d) No Lessor Liens. The Property is free and clear of all Lessor Liens created by' it (whether voluntary or involuntary). (e) Validity. This Participation Agreement constitutes the legal, valid and binding obligation of the Note Purchaser, enforceable against it in accordance with its terms, and 35 each Operative Document executed by it pursuant hereto will, on the due execution and delivery thereof, be its legal, valid and binding obligation, enforceable in accordance with its terms, subject, in each case, as to enforceability, bankruptcy, insolvency, reorganization and other similar laws affecting enforcement of creditor rights generally (insofar as any such law relates to the bankruptcy, insolvency, reorganization or similar event with respect to it) and, as to the availability of specific performance or other injunctive relief, subject to the discretionary power of a court to deny such relief and to general equitable principles. (f) Private Offering. The Note Purchaser has not offered (or solicited offers for), and will not offer (or solicit offers for), any interest in this Participation Agreement, the Notes, the Tranche B Loan, the Equity Investment, the Master Lease or the Rent, as applicable, in a manner which would require the registration of such interest, Notes, Tranche B Loan or Equity Investment under the Securities Act or the qualification of any of the Operative Documents (or of any indenture in respect of any thereof) under the Trust Indenture Act of 1939, as amended. Section 7.4 Representations and Warranties of the New Partners. Effective as of the date of execution hereof and as of the Initial Funding Date, each New Partner represents and warrants to each of the other parties hereto as follows: (a) ERISA. It is not and will not be funding the Equity Investment with the assets of an "employee benefit plan" (as defined in Section 3(3) of ERISA) which is subject to Title I of ERISA, or "plan" (as defined in Section 4975(e)(1) of the Revenue Code), nor will any such assets be used in connection with any other arrangement related to the transactions contemplated hereby. (b) Corporate and Governmental Authorization: No Contravention. The execution, delivery and performance by it of this Participation Agreement and each other Operative Document to which it is or will be a party (i) are within its corporate or limited liability company powers, as applicable, (ii) have been duly authorized by all necessary corporate or limited liability company action, as applicable, (iii) require no action by or in respect of, or filing with, any governmental body, agency or official, and (iv) do not contravene, or constitute a default under, its organizational documents. (c) Validity. This Participation Agreement constitutes the legal, valid and binding obligation of each New Partner, enforceable against it in accordance with its terms, and each Operative Document executed by it pursuant hereto will, on the due execution and delivery thereof, be its legal, valid and binding obligation, enforceable in accordance with its terms, subject, in each case, as to enforceability, bankruptcy, insolvency, reorganization and other similar laws affecting enforcement of creditor rights generally (insofar as any such law relates to the bankruptcy, insolvency, reorganization or similar event with respect to it) and, as to the availability of specific performance or other injunctive relief, subject to the discretionary power of a court to deny such relief and to general equitable principles. (d) Litigation. There is no litigation, at law or in equity, or any proceeding before any federal, state or municipal board or other governmental or administrative agency or any arbitration pending or, to the knowledge of each New Partner, threatened which is likely to involve any risk of any material judgment or liability not covered by insurance or which may 36 otherwise result in a material adverse effect on such New Partner's ability to perform its obligations under the Operative Documents, or which seeks to enjoin the consummation of, or which questions the validity of, any of the transactions contemplated by this Participation Agreement or any of the other Operative Documents, and no judgment, decree or order of any court, board or other governmental or administrative agency or arbitrator has been issued against or binds such New Partner which has, or could have, a material adverse effect on such New Partner's ability to perform its obligations under the Operative Documents. (e) Private Offering. No New Partner has offered (or solicited offers for), nor will it offer (or solicit offers for), any interest in the Partnership Interests, this Participation Agreement, the Notes, the Tranche B Loan, the Equity Investment, the Master Lease or the Rent, as applicable, in a manner which would require the registration of such interest, Notes, Tranche B Loan or Equity Investment under the Securities Act or the qualification of any of the Operative Documents (or of any indenture in respect of any thereof) under the Trust Indenture Act of 1939, as amended. Furthermore, assuming the truthfulness of the representations by the other Lessor Parties herein, the issuance, sale and delivery of the Notes, the funding of the advances thereunder, the funding of the Tranche B Loan and the funding of the Equity Investment and the interests in this Participation Agreement represented thereby under the circumstances contemplated by this Participation Agreement do not require the registration of such Notes, Tranche B Loan, Equity Investment or interests under the Securities Act or the qualification of any of the Operative Documents (or of any indenture in respect of any thereof) under the Trust Indenture Act of 1939, as amended. Section 7.5 Representations and Warranties of the Lessor. Effective as of the date of execution hereof and as of the Initial Funding Date, the Lessor represents and warrants to each of the other parties hereto as follows: (a) Jurisdiction of Organization. Chief Executive Office. Etc Its jurisdiction of organization, chief executive office and principal place of business, and the place where the documents, accounts and records relating to the Overall Transaction are kept, are located at the location specified below its name on Schedule I hereto. (b) Corporate Existence. It is a corporation duly incorporated, validly existing and in good standing under the laws of the state of its incorporation. (c) Corporate and Governmental Authorization: No Contravention. The execution, delivery and performance by it of this Participation Agreement and each other Operative Document to which it is or will be a party (i) are within its corporate powers, (ii) have been duly authorized by all necessary corporate action, (iii) require no action by or in respect of, or filing with, any governmental body, agency or official, and (iv) do not contravene, or constitute a default under, its certificate of incorporation or by-laws. (d) No Lessor Liens. The Property is free and clear of all Lessor Liens created by it (whether voluntary or involuntary). (e) Validity. This Participation Agreement constitutes the legal, valid and binding obligation of the Lessor, enforceable against it in accordance with its terms, and each 37 Operative Document executed by it pursuant hereto will, on the due execution and delivery thereof, be its legal, valid and binding obligation, enforceable in accordance with its terms, subject, in each case, as to enforceability, bankruptcy, insolvency, reorganization and other similar laws affecting enforcement of creditor rights generally (insofar as any such law relates to the bankruptcy, insolvency, reorganization or similar event with respect to it) and, as to the availability of specific performance or other injunctive relief, subject to the discretionary power of a court to deny such relief and to general equitable principles. (f) Litigation. There is no litigation, at law or in equity, or any proceeding before any federal, state or municipal board or other governmental or administrative agency or any arbitration pending or, to the knowledge of the Lessor, threatened which is likely to involve any risk of any material judgment or liability not covered by insurance or which may otherwise result in a material adverse effect on the Lessor's ability to perform its obligations under the Operative Documents, or which seeks to enjoin the consummation of, or which questions the validity of, any of the transactions contemplated by this Participation Agreement or any of the other Operative Documents, and no judgment, decree or order of any court, board or other governmental or administrative agency or arbitrator has been issued against or binds the Lessor which has, or could have, a material adverse effect on the Lessor's ability to perform its obligations under the Operative Documents. (g) Private Offering. The Lessor has not offered (or solicited offers for), and will not offer (or solicit offers for), any interest in this Participation Agreement, the Notes, the Tranche B Loan, the Equity Investment, the Master Lease or the Rent, as applicable, in a manner which would require the registration of such interest, Notes, Tranche B Loan or Equity Investment under the Securities Act or the qualification of any of the Operative Documents (or of any indenture in respect of any thereof) under the Trust Indenture Act of 1939, as amended. (h) Certain Tax Matters. Each of the Lessor and its Affiliates has (a) made or filed all material federal, state, local and foreign income and all other material Tax returns, reports and declarations required by any jurisdiction to which it is subject or properly filed for and received extensions with respect thereto which are still in full force and effect and which have been fully complied with in all material respects, (b) paid all Taxes and other governmental assessments and charges shown or determined to be due on such returns, reports and declarations, except those being contested in good faith by appropriate proceedings and for which adequate reserves, to the extent required by GAAP, have been established and (c) to the extent required by GAAP, set aside on their books provisions reasonably adequate for the payment of all estimated taxes for periods subsequent to the periods to which such returns, reports or declarations apply. There are no unpaid Taxes in any material amount claimed to be due by the taxing authority of any jurisdiction, and the officers of the Lessor know of no basis for any such claim other than Taxes that the Lessor and/or its Affiliates are contesting in good faith through appropriate proceedings and for which appropriate reserves, to the extent required by GAAP, have been established. Notwithstanding the foregoing, the Lessor shall not be deemed to have breached any of the representations contained herein made as to its Affiliates unless such breach would have a material adverse effect on the Property or the Lessor Parties' security interest, Liens or other rights in the Property and the Collateral. 38 Section 7.6 Representations and Warranties of each Tranche B Bank and each Liquidity Bank. Effective as of the date of execution hereof and as of the Initial Funding Date, each of Tranche B Bank and each Liquidity Bank represents and warrants to each of the other parties hereto as follows: (a) Existence. It is validly existing and is duly licensed and qualified to operate as a banking corporation (or as an agency or branch, if it is an agency or a branch of a foreign bank) and is in good standing under the laws of the United States or the State of New York or such other State where it is qualified to operate in the United States. (b) Authorization: Validity. The execution, delivery and performance by it of this Participation Agreement and each other Operative Document to which it is or will be a party have been duly authorized. This Participation Agreement constitutes its legal, valid and binding obligation, enforceable against it in accordance with its terms, and each Operative Document executed by it pursuant hereto will, on the due execution and delivery thereof, be its legal, valid and binding obligation, enforceable in accordance with its terms, subject, in each case, as to enforceability, bankruptcy, insolvency, reorganization and other similar laws affecting enforcement of creditor rights generally (insofar as any such law relates to the bankruptcy, insolvency, reorganization or similar event with respect to it) and, as to the availability of specific performance or other injunctive relief, subject to the discretionary power of a court to deny such relief and to general equitable principles. (c) Private Offering. It has not offered (or solicited offers for), and will not offer (or solicit offers for), any interest held by it in this Participation Agreement, the Notes, the Tranche B Loan, the Equity Investment, the Master Lease or the Rent, as applicable, in a manner which would require the registration of such interest, Notes, Tranche B Loan or Equity Investment under the Securities Act or the qualification of any of the Operative Documents (or of any indenture in respect of any thereof) under the Trust Indenture Act of 1939, as amended. ARTICLE VIII COVENANTS Section 8.1 Affirmative Covenants of Guarantor and Lessee. Each of the Guarantor and the Lessee hereby agrees for the benefit of the Lessor Parties that, until all Commitments have terminated and all Obligations have been paid and performed in full, it will, and, to the extent required, will cause each of its Subsidiaries to, perform the obligations set forth in this Section 8.1. (a) Conduct of Business. (i) Corporate Existence: Maintenance of Properties. The Guarantor will do or cause to be done all things necessary to preserve and keep in full force and effect its corporate existence, material rights, and those of its Subsidiaries except to the extent that the Guarantor's failure to do so will not have a Material Adverse Effect; Provided, however, that the corporate existence and material rights of the Lessee shall always be preserved and kept in full force and effect. The Guarantor (a) will cause all of its material properties and those of its 39 Subsidiaries used or useful in the conduct of its business or the business of its Subsidiaries to be maintained and kept in good condition, repair and working order and supplied with all reasonably necessary equipment, and (b) will cause to be made all reasonably necessary repairs, renewals, replacements, betterments and improvements thereof, all as in the judgment of the Guarantor may be necessary so that the business carried on in connection therewith may be properly and advantageously conducted at all times; Provided, however, that nothing in this Section 8.1 (a) shall prevent the Guarantor from discontinuing the operation and maintenance of any of its properties or those of its Subsidiaries if such discontinuance is, in the reasonable discretion of the Guarantor, desirable in the conduct of its or their business and would not have a Material Adverse Effect; Provided, further, that the Property shall always be maintained and operated in accordance with the Master Lease. (ii) Compliance with Laws, Contracts, Licenses, and Permits. The Guarantor will, and will cause each of its Subsidiaries to, comply with (A) the applicable laws and regulations wherever its business is conducted, including all Environmental Laws which may be in effect from time to time, (B) the provisions of its charter documents and by-laws, (C) all agreements and instruments by which it or any of its properties or business may be bound and (D) all applicable decrees, orders, and judgments; if in each such case failure to comply would have a Material Adverse Effect. If at any time any authorization, consent, approval, permit or license from any office, agency or instrumentality of any government shall become necessary or required in order that the Guarantor may fulfill any of the Obligations, the Guarantor will promptly take or cause to be taken all reasonable steps within the power of the Guarantor to obtain such authorization, consent, approval, permit or license and furnish the Lessor Parties with evidence thereof. (b) Insurance. The Guarantor and the Lessee shall keep their respective assets which are of an insurable character insured by financially sound and reputable insurers (or make adequate and prudent provisions for self insurance) against loss or damage (i) to the extent and in the manner customary for companies in similar businesses similarly situated and (ii) to the extent such coverage is available on commercially reasonable terms. Without limiting the generality of the foregoing, the Lessee shall maintain insurance on and with respect to the Property in accordance with the relevant provisions of the Master Lease. (c) Records and Accounts. The Guarantor and the Lessee will each (i) keep true and accurate records and books of account in which full, true and correct entries will be made in accordance with GAAP, and (ii) maintain adequate accounts and reserves for all taxes (including income taxes), depreciation, depletion, obsolescence and amortization of its properties and the properties of its Subsidiaries, contingencies, and other reserves. (d) Reports. The Guarantor. shall deliver to the Lessor Parties: (i) Promptly (but in no event later than five (5) Business Days after obtaining knowledge thereof) upon any principal officer of the Guarantor or the Lessee obtaining knowledge of any Default or Event of Default, a certificate of a Responsible Officer of the Guarantor specifying the nature and period of existence thereof and what action has been taken, is being taken or is proposed to be taken with respect thereto. 40 (ii) As soon as available, and in any event within sixty (60) days after the last day of each of the first three Fiscal Quarters of each Fiscal Year, commencing with the Fiscal Quarter ending immediately after the Initial Funding Date the consolidated and consolidating balance sheets of the Guarantor as at the end of such quarter and the consolidated and consolidating statements of income, retained earnings and cash flows of the Guarantor for such quarter and for the portion of the current Fiscal Year then ended, all in reasonable detail and accompanied by a certificate from the Chief Financial Officer or the Senior Vice President - Finance of the Guarantor stating that such statements have been properly prepared in accordance with the books and records of the Guarantor and fairly present the financial condition and operations of the Guarantor subject only to normal year-end audit adjustments. (iii) As soon as available, and in any event within one hundred and five (105) days after the end of each Fiscal Year, the consolidated and consolidating balance sheets of the Guarantor as at the end of such year and the consolidated and consolidating statements of income, retained earnings and cash flows of the Guarantor for such Fiscal Year, setting forth in each case in comparative form the consolidated figures for the Guarantor for the previous Fiscal Year (all in reasonable detail), which consolidated statements of the Guarantor shall be audited by KPMG, or other independent public accountants of recognized national standing selected by the Guarantor, and accompanied by a letter of such accountants that such financial statements have been prepared in accordance with GAAP . (iv) Together with the financial statements delivered pursuant to clause (ii) and clause (iii), a certificate of the Chief Financial Officer or the Senior Vice President- Finance of the Guarantor setting forth a computation showing compliance by the Guarantor with the financial tests set forth in Section 8.3 hereof, certifying as to the Lessee's compliance with the maintenance requirements for the Property set forth in the Master Lease, and stating that such officer has caused the provisions of this Participation Agreement to be reviewed and has no knowledge of any Default or Event of Default, or, if such signing officer has such knowledge, specifying such Default or Event of Default and the nature thereof, and what action the Guarantor has taken, is taking, or proposes to take with respect thereto (the "Compliance Certificate"). (v) Promptly upon its receipt thereof, copies of all audit reports (including so-called "management letters") submitted by independent public accountants in connection with each annual, interim or special audit of the financial statements of the Guarantor or any of its Subsidiaries made by such accountants. (vi) Promptly and in any event within thirty (30) days after the Guarantor, any of its Subsidiaries or any ERISA Affiliate knows or has reason to know that any ERISA Reportable Event has occurred. (vii) Upon request of any Lessor Party, a copy of the most recent actuarial statement required to be submitted under ss. 103(d) of ERISA and Annual Report, Form 5500, with all required attachments, in respect of each Guaranteed Pension Plan and promptly upon receipt or dispatch, any notice, report, demand or letter sent or received in respect of a Guaranteed Pension Plan under ss.ss.302, 4041, 4042, 4043, 4063, 4065, 4066 and 4068 of ERISA, or in respect of a Multiemployer Plan, under ss.ss.4041A, 4202, 4219, 4242, or 4245 of ERISA. 41 (viii) Promptly and in any event within thirty (30) days after notice or knowledge thereof, notice that the Guarantor or any of its Subsidiaries has become subject to the tax on prohibited transactions imposed by Section 4975 of the Revenue Code in an amount which has, individually or in the aggregate, a reasonable likelihood of resulting in a Material Adverse Effect, together with a copy of Form 530. (ix) As soon as available, copies of all notices, proxy statements, reports and financial statements which the Guarantor or any of its Subsidiaries shall send or make available to its shareholders and all registration statements and reports which the Guarantor or any of its Subsidiaries shall file with the Securities and Exchange Commission. (x) With reasonable promptness. such other information respecting the business. properties. assets. operations or condition. financial or otherwise. of the Guarantor or any of its Subsidiaries as from time to time any of the Lessor Parties may reasonably request. (e) Right to Inspect Premises and Records. The Guarantor and the Lessee will agree to all reasonable requests by the Lessor Parties (i) to make extracts from the books of account and financial records of the Guarantor or the Lessee solely for its own use in connection with the Obligations of the Lessee and the Guarantor under the Operative Documents, (ii) to provide the Lessor Parties or its authorized representatives, during normal business hours or such other time as agreed upon by the parties, at the offices of the Guarantor, all books and records for inspections or consultation in connection with the Guarantor's and Lessee's compliance and performance of the obligations under the Operative Documents, and (iii) to authorize the Lessor Parties or its authorized representatives (collectively, the "Inspecting Parties") right of access and entry on the Property for inspection of any or all components of the Property; Provided, however, at any time no Default or Event of Default shall have occurred and be continuing, a Lessor Party shall give the Guarantor and the Lessee written notice no later than five (5) Business Days prior to the day of inspection. In connection with any such inspections of the Property, the Inspecting Parties may conduct, to the extent relevant, environn1ental testing and sampling. All such inspections shall be at the expense and risk of the Inspecting Parties, except that if an Event of Default or Default has occurred and is continuing, the Lessee shall reimburse the Inspecting Parties for the reasonable costs of such inspections and such inspections shall be at the Lessee's risk, excluding the gross negligence or willful misconduct of an Inspecting Party. The Lessee shall furnish to the Inspecting Parties statements that are, to the best of the Lessee's knowledge after reasonable inquiry, accurate in all material respects, regarding the condition and state of repair of the Property at such times as may be reasonably requested; Provided, however, the Lessor Parties shall not require such statements more than once a year so long as no Default or Event of Default shall have occurred and be continuing. No inspection shall unreasonably interfere with the Lessee's operations or the operations of any other occupant of the Property. None of the Inspecting Parties shall have any duty to make any such inspection or inquiry and none of the Inspecting Parties shall incur any liability or obligation by reason of not making any such inspection or inquiry. None of the Inspecting Parties shall incur any liability or obligation by reason of making any such inspection or inquiry unless and to the extent, so long as no Default or Event of Default has occurred and is continuing at the time of inspection, such Inspecting Party causes damage to the Property or any property of the Lessee or any other Person during the course of such inspection. 42 (f) Payment of Liabilities. The Guarantor shall pay and discharge, and shall cause each of its Subsidiaries to pay and discharge, at or before their maturity or in accordance with customary trade terms, all of their respective Indebtedness due and payable, except where such Indebtedness is contested in good faith and by appropriate proceedings diligently conducted and reserves or other appropriate provisions, if any, as shall be required by GAAP, shall have been made therefore, and except to the extent otherwise provided by any subordination provisions applicable to such Indebtedness, unless, in the case of the Guarantor or any such Subsidiary other than the Lessee, failure to pay or discharge such Indebtedness could not reasonably be expected to have a Material Adverse Effect. (g) Payment of Charges and Indebtedness. The Guarantor shall, and shall cause each of its Subsidiaries to, timely file or cause to be filed all tax returns, and shall timely pay and discharge all taxes and other governmental charges and assessments, due and payable, and shall pay all claims for labor, materials or supplies which if unpaid might by law become a Lien or charge upon any property of the Guarantor or any of its Subsidiaries; provided, however, that any such taxes and other governmental charges and assessments or claims, the nonpayment of which would not be reasonably likely to have a Material Adverse Effect, need not be paid if the validity or amount thereof shall currently be contested in good faith by appropriate proceedings and if the Guarantor or such Subsidiary shall, in accordance with GAAP, have set aside on its books adequate reserves with respect thereto; and provided further, however, that the Guarantor shall, and shall cause each Subsidiary to, pay all such taxes, governmental charges, assessments or claims forthwith upon the commencement of proceedings to foreclose any Lien which may have attached as security therefore. The obligations of the Guarantor under this Section 8.1(g) with respect to the filing of tax returns and the payment of taxes, governmental charges, assessments and claims shall survive the payment, prepayment or redemption of the Notes, the Tranche B Loan and the Equity Investment and the termination of this Participation Agreement and the other Operative Documents. (h) Material Change in Business. The primary business of the Guarantor, the Lessee and the Guarantor's Subsidiaries shall continue to be developing and publishing products for interactive electronic media. (i) Compliance with Securities Laws. Except for non-compliance which, individually or collectively, does not have a Material Adverse Effect, (i) any and all purchases or redemptions by the Guarantor and/or any of its Subsidiaries of any securities issued by the Guarantor or any of its Subsidiaries or any other Person shall be effected in compliance with all applicable Requirements of Law, including, but not limited to, the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, and (ii) any and all offers to sell and sales of securities or of obligations of the Guarantor or any of its Subsidiaries evidenced by notes, bonds, debentures or similar instruments, shall be effected in compliance with all applicable Requirements of Law, including, but not limited to, the Trust Indenture Act of 1939, as amended. (j) Application of Proceeds. The proceeds of the Notes, the proceeds of the Tranche B Loan and the funding of the Equity Investment shall only be used as contemplated by the Operative Documents. 43 (k) Environmental Protection. (i) The Guarantor shall, and shall cause each of its Material Subsidiaries to, (i) comply in all material respects with the requirements of all Environmental Laws applicable to it, except where such non-compliance could not reasonably be expected to result in a material impairment in the value of, or a material liability with respect to the affected premises, (ii) notify the Lessor Parties promptly in the event of any Release, Environmental Claim or other Adverse Environmental Condition from, upon or affecting any premises owned or occupied by the Guarantor or any Material Subsidiary which Release, Environmental Claim or Adverse Environmental Condition could result in a Material Adverse Effect or a material impairment of the value of, or a material liability with respect to, such premises and (iii) promptly forward to the Lessor Parties copies of all orders, notices, permits, applications or other communications and reports in connection with any such Release, Environmental Claim or other Adverse Environmental Condition or any other matter relating to the Environmental Laws as they may affect such premises which could result in a Material Adverse Effect or result in a material impairment of the value of, or material liability with respect to, such premises. The covenants provided for herein shall survive the payment or redemption of the Notes and the Equity Investment and the termination of this Participation Agreement and the other Operative Documents. (ii) The Guarantor shall fully and promptly pay, perform, discharge, defend, indemnify and hold harmless the Lessor Parties, their respective Subsidiaries and Affiliates, and the respective managers, members, directors, officers, employees and agents of any of the foregoing as to any environmental matter as provided in Article XIII hereof. (iii) Without limiting the foregoing, the Guarantor and the Lessee will comply at all times with the environmental provisions of the Participation Agreement and the Environmental Indemnity Agreement and shall take all actions necessary or required to preserve all indemnities and other remedies available under the Participation Agreement and the Environmental Indemnity Agreement. (1) Ownership of the Lessee. The Guarantor shall at all times maintain direct or indirect ownership of 100% of the issued and outstanding Stock of the Lessee (including all rights to subscribe for, purchase (including by conversion of any other security) or otherwise acquire any such Stock), free and clear of all Liens. (m) Notice of Change in Name, Identity or Address. Each of the Guarantor and the Lessee shall provide the Lessor Parties thirty (30) days prior written notice of any change in its name, its jurisdiction of organization or the address of its chief executive office, principal place of business or the office where it keeps its records concerning its accounts and the Property leased by the Lessee under the Master Lease. (n) Further Assurances. The Guarantor and the Lessee shall take or cause to be taken from time to time all action reasonably necessary to assure that the intent of the parties pursuant to the Operative Documents is given effect as contemplated by Section 5.1 hereof, and that the Lessor and the Agent, for the benefit of the other Lessor Parties, as each such Lessor Party's respective interests may appear, holds a first priority perfected Lien on the Property and 44 the Master Lease, securing the amounts due thereon or under the Operative Documents. The Guarantor and the Lessee shall execute and deliver, or cause to be executed and delivered, to the Lessor Parties from time to time, promptly upon request therefore, any and all other and further instruments (including correction instruments and supplemental mortgages and security agreements, as appropriate) that may be reasonably requested by the Lessor Parties to cure any deficiency in the execution and delivery of this Participation Agreement or any other Operative Document to which it is a party. (o) No Disposition of the Property. The Lessee shall not sell, contract to sell, assign, lease, transfer, conveyor otherwise dispose of, or permit to be sold, assigned, leased, transferred, conveyed or otherwise disposed of, the Property or any part thereof except as expressly permitted by the Operative Documents. (p) Defense of Title. The Lessee will, at all times, at its own cost and expense, warrant and defend the title of the Lessor to the Property except with respect to Lessor Liens. Section 8.2 Negative Covenants. The Guarantor hereby covenants and agrees, subject to Section 15.5 hereof, for the benefit of the Lessor Parties from and after the Documentation Date and until all Commitments have terminated and all Obligations have been paid and performed in full: (a) Limitations on Indebtedness. Neither the Guarantor nor any of its Subsidiaries, including the Lessee, shall create, incur, assume or permit to exist any Indebtedness except for Indebtedness which, in aggregate, on a pro forma basis, would not result in a violation by the Guarantor of the financial covenants set forth in Section 8.3 ("Permitted Indebtedness"). (b) Limitation on Liens, Etc. Neither Guarantor nor any of its Subsidiaries shall create, incur, assume or permit to exist any Lien on or with respect to any of its assets or property of any character, whether now owned or hereafter acquired, except for Permitted Liens. (c) Asset Dispositions. Neither the Guarantor nor any of its Subsidiaries shall sell, lease, transfer or otherwise dispose of any of its assets or property, whether now owned or hereafter acquired, except for the following: (i) Sales of inventory and products by the Guarantor and its Subsidiaries in the ordinary course of their businesses; (ii) Sales of surplus, damaged, worn or obsolete equipment or inventory for not less than fair market value; (iii) Sales or other dispositions of Investments permitted by clauses (i) and (iii) of Section 8.2(e) below for not less than fair market value; (iv) Sales or assignments of defaulted receivables to a collection agency in the ordinary course of business; (v) Licenses by the Guarantor or its Subsidiaries of its patents, copyrights, trademarks, trade names and service marks in the ordinary course of its business 45 provided that, in each case, the terms of the transaction are terms which then would prevail in the market for similar transactions between unaffiliated parties dealing at arm's length; (vi) Sales or other dispositions of assets and property by the Guarantor to any of the Guarantor's Subsidiaries or by any of the Guarantor's Subsidiaries to the Guarantor or any of its other Subsidiaries, provided that, on the date of any such sale or disposition, the Guarantor and such Subsidiary each reasonably believes that such sale or disposition is made on terms which are no less favorable to the Guarantor then would prevail in the market for similar transactions between unaffiliated parties dealing at arm's length; and (vii) Other sales, leases, transfers and disposals of assets and property for not less than fair market value, provided that the net proceeds from any such sale, lease, transfer or disposal shall not exceed ten percent (10%) of the consolidated total assets of the Guarantor and its Subsidiaries immediately prior to such sale, lease, transfer or disposal. provided, however, that the foregoing exceptions shall not be construed to permit any sales, leases, transfers or disposals of any of the Property, except as expressly permitted by the Master Lease or any of the other Operative Documents. (d) Mergers, Acquisitions, Etc. Neither the Guarantor nor any of its Subsidiaries shall consolidate with or merge into any other Person or permit any other Person to merge into it, establish any new Subsidiary, acquire any Person as a new Subsidiary or acquire all or substantially all of the assets of any other Person, except for the following: (i) Any Subsidiary of the Guarantor (other than the Lessee) may merge or consolidate with any other Subsidiary of Guarantor; (ii) Any Subsidiary of the Guarantor (other than the Lessee) may merge or consolidate with the Guarantor, provided that the Guarantor is the surviving corporation; and (iii) The Guarantor may merge or consolidate with any other corporation, establish a new Subsidiary, acquire any Person as a new Subsidiary or acquire all or substantially all of the assets of any other Person, provided that (A) in the case of any merger or consolidation, either (1) the Guarantor is the surviving corporation or (2) the surviving corporation (y) is a Solvent United States corporation with a financial condition equal to or better than the financial condition of the Guarantor immediately prior to such merger or consolidation and (z) assumes all of the obligations of the Guarantor in a manner reasonably acceptable to the Consenting Parties; (B) no Default or Event of Default has occurred and is continuing at the time of such merger, consolidation, establishment or acquisition or will occur after giving effect to such merger, consolidation or acquisition; and (C) based upon a pro forma Compliance Certificate provided to the Agent on behalf of the Lessor Parties immediately prior to the consummation of any such merger, consolidation or acquisition, the Guarantor shall continue to be in compliance with each of the financial covenants set forth in Section 8.3 hereof immediately after giving effect to such merger, consolidation or acquisition. (e) Investments. Neither the Guarantor nor any of its Subsidiaries shall make any Investment except for the following: 46 (i) Investments by the Guarantor and its Subsidiaries in Cash Equivalents; (ii) Any transaction permitted by Section 8.2(a); (iii) Money market mutual funds registered with the Securities and Exchange Commission, meeting the requirements of Rule 2a- 7 promulgated under the Investment Company Act of 1940; (iv) Investments listed in Item 8.2(e) of Schedule II hereto existing on the date of this Participation Agreement; (v) Investments in Guarantor's Affiliates and Subsidiaries; and (vi) Other Investments, provided that the Guarantor shall continue to be in compliance with each of the financial covenants set forth in Section 8.3 hereof immediately after giving effect to each such Investment, and provided further that before making any such Investment in an amount greater than $25,000,000, the Guarantor shall provide the Agent on behalf of the Lessor Parties a pro forma Compliance Certificate to the effect that such Investment will not otherwise violate this clause (vi). (f) Dividends, Redemptions, Etc. Neither the Guarantor nor any of its Subsidiaries shall (i) pay any dividends or make any distributions on its Stock; (ii) purchase, redeem, retire, defease or otherwise acquire for value any of its Stock; (iii) return any capital to any holder of its Stock as such; (iv) make any distribution of assets, Stock, obligations or securities to any holder of its Stock as such; or (v) set apart any sum for any such purpose (each act described in clauses (i), (ii), (iii), (iv) and (v) being a "Distribution"); except under the following conditions: (A) No Event of Default shall have occurred and be continuing; (B) The Guarantor shall continue to be in compliance with each of the financial covenants set forth in Section 8.3 hereof immediately after giving effect to each such Distribution; and (C) If the Distribution (in cash or value) is in an amount greater than $25,000,000, the Guarantor shall have provided to the Agent on behalf of the Lessor Parties a pro forma Compliance Certificate to the effect that the Guarantor shall continue to be in compliance with each of its financial covenants set forth in Section 8.3 hereof immediately after giving effect to such Distribution. Notwithstanding the foregoing, a conversion of the Guarantor's Class B Common Stock into the Guarantor's Class A Common Stock shall not be deemed a Distribution for the purpose of this Section 8.2(f). (g) Employee Benefit Plans. Neither the Guarantor nor any ERISA Affiliate will: 47 (i) engage in any "prohibited transaction" within the meaning of ss.406 of ERISA or ss.4975 of the Revenue Code which could result in a material liability for the Guarantor or any of its Subsidiaries; or (ii) permit any Guaranteed Pension Plan to incur an "accumulated funding deficiency", as such term is defined in ss.302 of ERISA, in excess of $1,000,000, whether or not such deficiency is or may be waived; or (iii) fail to contribute to any Guaranteed Pension Plan to an extent which, or terminate any Guaranteed Pension Plan in a manner which, could result in the imposition of a lien or encumbrance on the assets of the Guarantor or any of its Subsidiaries pursuant to ss.302(f) or ss.4068 of ERISA; or (iv) permit or take any action which would result in the aggregate benefit liabilities (with the meaning of ss.4001 of ERISA) of all Guaranteed Pension Plans exceeding the value of the aggregate assets of such plans by more than $1,000,000, disregarding for this purpose the benefit liabilities and assets of any such plan with assets in excess of benefit liabilities. (h) Prohibited Uses of Proceeds. The Guarantor and the Lessee shall not directly or indirectly, use the proceeds of any financial accommodations provided hereunder in any manner which would result in a violation of Regulation T, U or X of the Board of Governors of the Federal Reserve System as now and from time to time hereafter in effect. (i) Transactions with Affiliates. The Guarantor shall not and shall not permit any of its Subsidiaries to, enter into any transaction with any Affiliate on terms that are less favorable to the Guarantor or such Subsidiary, as the case may be, than terms which might be obtained at the time from Persons that are not Affiliates if a Default or Event of Default shall be continuing hereunder immediately prior to such transaction or would occur under Section 18 of the Master Lease on a pro forma basis after giving effect to such transaction. (j) Additional Activities Prohibited. The Lessee shall not engage in any business or activity, whether or not engaged in for gain or other pecuniary advantage, other than leasing the Property from the Lessor pursuant to the Master Lease and leasing from SELCO that certain real property subject to the December 2000 Lease. Section 8.3 Financial Covenants. The Guarantor hereby covenants and agrees, subject to Section 15.5 hereof, for the benefit of the Lessor Parties from and after the Documentation Date and until all Commitments have terminated and all Obligations have been paid and performed in full: (a) Consolidated Net Worth. The Guarantor shall not permit the Consolidated Net Worth of the Guarantor at any time (such day on which the Consolidated Net Worth of the Guarantor is measured shall be referred to herein as a "determination date") which commences after the Documentation Date to be less than the sum on such determination date of the following: 48 (i) Ninety percent (90%) of the Consolidated Net Worth of the Guarantor as of September 30, 2000; plus (ii) Seventy-five percent (75%) of the sum of the positive net income of the Guarantor for each quarter after September 30,2000; plus (iii) Seventy-five percent (75%) of net equity proceeds (excluding equity issued through the ESOP or employee stock purchase plans) and equity issued pursuant to the conversion of debt for each quarter after September 30, 2000. (b) Fixed Charge Coverage Ratio. The Guarantor shall not permit the ratio of its Consolidated EBITDAR to Consolidated Fixed Charges as of the end any measurement period to be less than 3.00:1.00. For purpose of this paragraph, "measurement period" shall mean, with respect to any four fiscal quarter period, the period of four fiscal quarters ending on the last day of such fiscal quarter. (c) Total Consolidated Debt to Total Consolidated Capital. The Guarantor shall not, at any time, permit its Total Consolidated Debt to exceed sixty percent (60%) of its Total Consolidated Capital. (d) Quick Ratio. The Guarantor shall not, at any time, permit the ratio of the sum its cash and Cash Equivalents and accounts receivables (net reserves) to Total Consolidated Debt to be less than 1.00: 1.00 for those fiscal quarters ending on June 30 and September 30 and 1.75:1.00 for those fiscal quarters ending on December 31 and March 31. ARTICLE IX COVENANTS OF THE LESSOR, THE NEW PARTNERS, THE NOTE PURCHASER, THE TRANCH B BANKS AND THE LIQUIDITY BANKS Section 9.1 General Covenants of the New Partners. the Lessor and the Note Purchaser. Each of the New Partners, the Lessor and the Note Purchaser hereby covenants and agrees, individually and not jointly, that so long as this Participation Agreement and the other Operative Documents are in effect: (a) it will not create, incur, assume or suffer to exist any Lessor Lien attributable to such Person upon the Master Lease or the Property (other than as contemplated by any of the Operative Documents); and (b) it will remove, at its sole expense, any Lessor Lien created or incurred by it and attributable to it upon the Master Lease or the Property (other than such Liens as are contemplated by any of the Operative Documents). 49 Section 9.2 Specific Covenants of the Lessor. The Lessor hereby covenants and agrees, for the benefit of the Lessee, that so long as this Participation Agreement and the other Operative Documents are in effect: (a) the representations and warranties of the Lessor contained in the Note Purchase Agreement shall be true and correct in all material respects on and as of the date of each Note Purchase, as though made on and as of such date, except to the extent such representations or warranties relate solely to an earlier date, in which case such representations and warranties shall have been true and correct on and as of such earlier date; (b) it will comply with each of its covenants set forth in the Note Purchase Agreement (including, without limitation, (i) to timely present all requests and information necessary to cause the Note Purchaser to purchase the Notes and fund the advances to be made thereunder as and when required under the Note Purchase Agreement and (ii) to not cause an Acceleration Event or an Unmatured Acceleration Event to occur and be continuing) except to the extent such failure to comply is a result of a breach by the Guarantor or the Lessee of its obligations under this Participation Agreement or any of the other Operative Documents; (c) when it receives funds from the Note Purchaser or the Tranche B Banks, it will transmit such funds to the Lessee or as the Lessee may direct without deduction or offset as and when required under this Participation Agreement and the other Operative Documents; (d) when it receives funds from the Lessee, it will transmit such funds to the Note Purchaser, the Tranche B Banks and the Liquidity Banks (as applicable) without deduction or offset as and when required under this Participation Agreement, the Note Purchase Agreement and the other Operative Documents; (e) it will keep complete and accurate books and records of the transactions involving the Lessor arising under this Participation Agreement, the Note Purchase Agreement and the other Operative Documents; and (f) so long as no Default or Event of Default shall have occurred and be continuing, it will not assign its Equity Investment or its interest in the Operative Documents without the prior written consent of the Lessee (which consent shall not be unreasonably withheld). Section 9.3 Specific Covenants of the New Partners. Each New Partner hereby covenants and agrees, for the benefit of the Lessee, that so long as this Participation Agreement and the other Operative Documents are in effect: (a) they, jointly and severally, will cause the Lessor to comply with each of its covenants set forth in this Participation Agreement and the other Operative Documents (including, without limitation, (i) to timely present all requests and information necessary to cause the Note Purchaser to purchase the Notes and fund the advances to be made thereunder as and when required under the Note Purchase Agreement and (ii) to not cause an Acceleration Event or an Unmatured Acceleration Event to occur and be continuing) except to the extent such failure to comply is a result of a breach by the Guarantor or the Lessee of its obligations under this Participation Agreement or any of the other Operative Documents; 50 (b) when the Lessor receives funds from the Note Purchaser or the Tranche B Banks, they, jointly and severally, will cause the Lessor to transmit such funds to the Lessee or as the Lessee may direct without deduction or offset as and when required under this Participation Agreement and the other Operative Documents; (c) when the Lessor receives funds from the Lessee, they, jointly and severally, will cause the Lessor to transmit such funds to the Note Purchaser, the Tranche B Banks and the Liquidity Banks (as applicable) without deduction or offset as and when required under the Note Purchase Agreement and the other Operative Documents; (d) they, jointly and severally, will cause the Lessee to keep complete and accurate books and records of the transactions involving the Lessor arising under this Participation Agreement, the Note Purchase Agreement and the other Operative Documents; (e) the New Partners will not assign their respective Equity Investment or their respective interests in the Operative Documents without the prior written consent of the Lessee and the Note Purchaser (which consents shall not be unreasonably withheld); (f) they, jointly and severally, will provide the Lessee with copies of (i) each return, report and declaration filed by the Lessor or Selco Redwood, LLC with respect to Structural Impositions or Prior Impositions which may be the subject of an indemnity hereunder, (ii) any communication with a Governmental Authority with respect to Structural Impositions or Prior Impositions of the Lessor or Selco Redwood, LLC which may be the subject of an indemnity hereunder and (iii) any return, report, declaration or communication with a Governmental Authority with respect to the Lessor or Selco Redwood, LLC which relates to any Imposition which is a property tax or similar tax; and (g) they, jointly and severally, agree to execute and file Internal Revenue Service Form 8832 (and any corresponding state form) with respect to Selco Redwood, LLC (and thereby elect to treat Selco Redwood, LLC as a corporation for income and franchise tax purposes) within five (5) days after the date such form or forms have been provided to the New Partners by the Lessee. Section 9.4 Specific Covenant of the Note Purchaser. The Note Purchaser hereby covenants and agrees, for the benefit of the Lessee, that so long as this Participation Agreement and the other Operative Documents are in effect and no Event of Default or Default shall have occurred and be continuing, it shall purchase the Notes and make advances under the Notes in accordance with the terms and conditions of this Participation Agreement and the Note Purchase Agreement. Section 9.5 Other Covenants of the Lessor Parties. To the extent not otherwise provided above, each of the Lessor Parties severally hereby covenants and agrees, for the benefit of the Lessee, that so long as this Participation Agreement and the other Operative Documents are in effect and no Event of Default or Default shall have occurred and be continuing, it will comply with each of its covenants set forth in the Operative Documents to which such Person is a party, except to the extent such failure to comply directly or indirectly arises out of, or relates to (or is 51 alleged to have arisen out of or be related to) a breach by the Guarantor or the Lessee of its obligations under this Participation Agreement or any of the other Operative Documents. Section 9.6 Notices Under the Note Purchase Agreement and the Liquidity Documentation. Each of the Lessor and the Note Purchaser hereby agrees that it shall promptly (but in any event no later than ten (10) Business Days after delivery thereof), deliver to the Guarantor a copy of each notice sent by it under the Note Purchase Agreement and the Liquidity Documentation to any other party thereto. ARTICLE X PAYMENT OF CERTAIN EXPENSES; OPTIONAL APPRAISALS The Lessee agrees, for the benefit of the Lessor, that: Section 10.1 Transaction Expenses. The Lessee shall pay, or cause to be paid, from time to time all Transaction Expenses. Transaction Expenses may, subject to the conditions hereof, be paid with the proceeds of the Notes, the Tranche B Loan and/or the funding of any portion of the Equity Investment. Section 10.2 Stamp Taxes. The Lessee shall pay or cause to be paid any and all stamp, transfer and other similar taxes, fees and excises, if any, including any interest and penalties, which are payable in connection with the transactions contemplated by this Participation Agreement and the other Operative Documents. Section 10.3 Note Purchase Agreement and Related Obligations. The Lessee shall pay, before the delinquency date thereof, all costs, expenses and other amounts (other than amounts that, pursuant to the Operative Documents, are specifically required to be paid by any Lessor Party or that arise out of or in connection with a default by the Lessor under the Operative Documents that does not directly or indirectly arise out of or relate to a breach by the Guarantor or the Lessee of its obligations under any of the Operative Documents) required to be paid by the Lessor under this Participation Agreement, the Note Purchase Agreement, any Note, the Asset Purchase Agreement or the Liquidity Agreement. Section 10.4 Optional Appraisals. If the Lessee elects the Remarketing Option pursuant to Section 12.1 of the Master Lease, then any Lessor Party may, at the sole option of each party, respectively, but at the expense and cost of the Lessee, require reports of one or more independent appraisers selected by the requesting parties, which reports shall state, in a manner reasonably satisfactory to the requesting parties, the following: (a) the appraiser's determination of the Fair Market Value of the Property as of (i) the day on which the Remarketing Option was elected and (ii) the Financing Termination Date; and (b) such other matters as the Lessor Parties may reasonably request. 52 Upon any party's delivery of written notice to the Guarantor that any of the referenced parties is requiring delivery of appraisals pursuant to this Section 10.4, the Guarantor shall cause such reports to be delivered to the requesting party no later than thirty (30) days after such notice. ARTICLE XI APPLICATION OF PAYMENTS Section 11.1 Consenting Parties: Voting Rights of Lessor Parties in Connection with Direction of the Agent. (a) In accordance with Article XIV hereof and subject to Section 15.5 hereof, all actions taken by the Agent prior to the occurrence and continuance of an Event of Default, and all amendments, modifications, consents or approvals with respect to any Operative Documents, shall be taken solely at the direction of the Consenting Parties. The Lessee and the Guarantor shall be entitled to rely on all such actions by the Agent and amendments, modifications, consents and approvals entered into or provided by the Agent as authorized by the Consenting Parties without inquiry or investigation. (b) The "Consenting Parties" shall mean, with respect to amendments, modifications, consents or approvals with respect to any Operative Document, (i) at any time the Outstanding Lease Balance is greater than $0, the (x) Note Purchaser and (y) the other Lessor Parties whose aggregate percentage of the Outstanding Lease Balance equals or exceeds sixty-six and two-thirds percent (66-2/3%); and (ii) at any time the Outstanding Lease Balance is $0, (x) the Note Purchaser and (y) the other Lessor Parties whose portion of the Aggregate Commitment Amount equals or exceeds sixty-six and two-thirds percent (66-2/3%); provided, however, that "Consenting Parties" shall not include the Note Purchaser at any time during which all of the Notes have been funded and/or purchased by the Liquidity Banks pursuant to the Liquidity Documentation. For purposes of calculating each Lessor Party's percentage of the Outstanding Lease Balance or portion of the Aggregate Commitment Amount, so long as the Liquidity Banks have an obligation to fund the Aggregate Note Purchase Commitment pursuant to the Liquidity Agreement or have purchased the Notes from the Note Purchaser pursuant to the Asset Purchase Agreement, each Liquidity Bank shall be deemed to hold a percentage or portion (as applicable) calculated based upon its Percentage as provided pursuant to the Asset Purchase Agreement. (Thus, for example, if the Outstanding Lease Balance is $100,000,000, consisting of $3,500,000 (principal amount) of Equity Investment, $20,000,000 (principal amount) of the Tranche B Loan made by one Tranche B Bank and $76,500,000 (principal amount) of outstanding Notes, and each of four Liquidity Banks' Percentage under the Asset Purchase Agreement is exactly 25%, then the Lessor's percentage of the Outstanding Lease Balance would be 3.500%, the Tranche B Bank's percentage of the Outstanding Lease Balance would be 20.000% and each Liquidity Bank's percentage of the Outstanding Lease Balance would be 19.125%). Section 11.2 Application of Payments made by the Lessee and Guarantor Pursuant to the Operative Documents prior to the Occurrence and Continuance of any Event of Default. Prior to the occurrence and continuance of any Event of Default, moneys received by the Lessor (or by the Agent on behalf of the Lessor), including, without limitation, funds deposited in the 53 Prepayment Account, shall be paid to the Person or Persons entitled thereto after being applied as follows: (a) Basic Rent shall be applied pro rata to satisfy the obligations of the Lessor with respect to the Note Interest Amount, the Tranche B Interest Amount, the Yield Amount and any other costs related to the Notes, the Tranche B Loan and the Equity Investment. (b) Interest (if any) on the Lessee Loans; (c) Payments made pursuant to Sections 4.3, 4.4, 4.6, 4.8, 11.4, 11.5 and Article XIII hereof shall be applied as specified therein. (d) All other payments made by or on behalf of the Lessee Parties pursuant to this Participation Agreement and the other Operative Documents, unless otherwise specified, shall be applied first, to repay, in full, the Notes and the Tranche B Loan (together with any other amounts payable to the Note Purchaser, the Tranche B Banks or the Liquidity Banks, as applicable) pursuant to the Operative Documents), ratably in accordance with their respective interests, second, if any amounts remain, to redeem, in full, the Equity Investment (together with any other amounts payable to the Lessor pursuant to the Operative Documents), and third, if any amounts remain, to the Lessee and any other Person as the Lessee's and/or such Person's interest may appear. Section 11.3 Application of Funds Upon the Occurrence and Continuance of any Event of Default. Upon the occurrence and continuance of any Event of Default, moneys received by the Lessor (or by the Agent on behalf of the Lessor) shall be paid to the Person or Persons entitled thereto after being applied as follows: (a) Basic Rent shall be applied pro rata to satisfy the obligations of the Lessor with respect to the Note Interest Amount, the Tranche B Interest Amount, the Yield Amount and any other costs related to the Notes, the Tranche B Loan and the Equity Investment. (b) Payments made pursuant to Sections 4.3, 4.4, 4.6, 4.8, 11.4, 11.5 and Article XIII hereof shall be applied as specified therein. (c) All other payments made by or on behalf of the Lessee Parties or received as remarketing, casualty, sale, foreclosure or other payments or proceeds pursuant to this Participation Agreement and the other Operative Documents, shall be applied first, to repay, in full, the Notes and the Tranche B Loan (together with any other amounts payable to the Note Purchaser, the Tranche B Banks or the Liquidity Banks, as applicable pursuant to the Operative Documents), ratably in accordance with their respective interests, second, if any amounts remain, to redeem, in full, the Equity Investment (together with any other amounts payable to the Lessor pursuant to the Operative Documents), third, if any amounts remain, to repay, in full, outstanding interest (if any) on the Lessee Loans,; and fourth, if any amounts remain, to any other Person as such Person's interest may appear. Section 11.4 Application of Funds Upon Exercise of the Remarketing Option. If the Lessee shall have exercised the Remarketing Option, moneys received by the Lessor (or by the Agent on behalf of the Lessor) shall be paid to the Person or Persons entitled thereto after being 54 applied as follows: first, to repay, in full, the Notes (together with any other amounts payable to the Note Purchaser or the Liquidity Banks, as applicable, pursuant to the Operative Documents), ratably in accordance with their respective interests, second, if any amounts remain, to repay, in full, the Tranche B Loan (together with any other amounts payable to the Tranche B Banks pursuant to the Operative Documents), ratably in accordance with their respective interests, third, if any amounts remain, to redeem, in full, the Equity Investment (together with any other amounts payable to the Lessor pursuant to the Operative Documents), and fourth, if any amounts remain, to the Lessee or any other Person as the Lessee's and/or such Person's interest may appear. Section 11.5 Casualty or Condemnation Proceeds. Except to the extent such amounts are returned to the Lessee pursuant to Section 16 of the Master Lease or Section 16.2(h) hereof, without regard to whether a Default, Event of Default, Acceleration Event or Unmatured Acceleration Event shall have occurred and be continuing, Casualty Proceeds or Condemnation Proceeds with respect to the Property shall be paid to the Person or Persons entitled thereto after being applied as follows: first, to the ratable repayment in full of the Notes and the Tranche B Loan (together with any other amounts payable to the Note Purchaser, the Tranche B Banks or the Liquidity Banks, as applicable) pursuant to the Operative Documents, ratably in accordance with their respective interests and second, if any amounts remain, to the redemption of the Equity Investment (together with any other amounts payable to the Lessor pursuant to the Operative Documents). Section 11.6 Construction of Local Laws. It is acknowledged and agreed that the foreclosure on the Property may give rise to the application of local laws which require, inter alia, that the proceeds of such foreclosure(s) be applied in a manner which is not consistent with the application of proceeds specified in this Article XI. To the extent such inconsistent applications are made in accordance with applicable law, the parties hereto agree to reallocate the remaining proceeds in a manner which gives effect to the allocations specified in this Article XI. ARTICLE XII ASSIGNMENTS AND TRANSFERS BY LESSOR, TRANCHE B BANKS, LIQUIDITY BANKS AND NOTE PURCHASER Section 12.1 Acknowledgment of Grant of Security Interest to the Agent; Assignments. (a) The Lessor, the New Partners, the Guarantor and the Lessee hereby acknowledge that the right of the Lessor to receive Rent and certain other rights under the Master Lease are being pledged to the Agent to secure payment of the Secured Obligations. In addition, in accordance with the terms and conditions of the Liquidity Documentation, the Notes may be transferred to the Liquidity Banks or otherwise transferred from time to time. Such transfers shall be governed by the relevant provisions of the Note Purchase Agreement, and this Participation Agreement, as the context requires. (b) Each Tranche B Bank may, at any time, sell and assign to any Eligible Assignee all or any portion of its rights and obligations under this Participation Agreement and 55 the other Operative Documents pursuant to an assignment agreement in the form and substance satisfactory to the Agent; provided, however, that: (i) Without the written consent of the Lessor, the Agent and, if no Default or Event of Default has occurred and is continuing, the Lessee (which consent of the Lessor, the Agent and the Lessee shall not be unreasonably withheld), no Tranche B Bank may make any assignment to any Person which is not, immediately prior to such assignment, a Tranche B Bank hereunder or an Affiliate thereof; or (ii) Without the written consent of the Lessor, the Agent and, if no Default or Event of Default has occurred and is continuing, the Lessee (which consent of the Lessor, the Agent and the Lessee shall not be unreasonably withheld), no Tranche B Bank may make any assignment to any Person if, after giving effect to such assignment, the portion of the Aggregate Tranche B Commitment of such Tranche B Bank or such assignee would be less than Five Million Dollars ($5,000,000) (except that a Tranche B Bank may make an assignment which reduces its portion of the Aggregate Tranche B Commitment to zero without the written consent of the Lessor, the Agent or the Lessee). Upon its receipt of a fully executed assignment agreement, together with payment to the Agent by the assignor Tranche B Bank of a registration and processing fee of $3,000, the Agent shall (A) promptly accept such assignment agreement and (B) on the assignment effective date determined pursuant thereto record the information contained therein in its books and records and give notice of such acceptance and recordation to the Lessee and the other Lessor Parties. Upon such execution, delivery, acceptance and recording of each assignment agreement, from and after the effective date determined pursuant to such assignment agreement, (y) each assignee thereunder shall be a Tranche B Bank hereunder with a portion of the Aggregate Tranche B Commitment as set forth in such assignment agreement and shall have the rights, duties and obligations of such a Tranche B Bank under this Participation Agreement and the other Operative Documents, and (z) the assignor Tranche B Bank thereunder shall be a Tranche B Bank with a portion of the Aggregate Tranche B Commitment as set forth in such assignment agreement, or, if such Tranche B Bank's portion of the Aggregate Tranche B Commitment has been reduced to 0%, the assignor shall cease to be a Tranche B Bank; provided, however, that any such assignor Tranche B Bank which ceases to be a Tranche B Bank shall continue to be entitled to the benefits of any provision of this Participation Agreement and the other Operative Documents which by its terms survives the termination of this Participation Agreement. (c) Each Liquidity Bank may, at any time, sell and assign to any Eligible Assignee all or any portion of its rights and obligations under this Participation Agreement and the other Operative Documents in accordance with the Liquidity Documentation. Section 12.2 Assignments by Note Purchaser, etc. Provided the same does not require registration of the Notes under the Securities Act of 1933, as amended, the Note Purchaser may, without restriction or formality of any kind: (x) transfer all or part of its rights, obligations and interest in, to and under the Notes and the Operative Documents to any Lessor Party or to any bankruptcy-remote commercial paper conduit sponsored by The Bank of Tokyo-Mitsubishi, Ltd. and grant a security interest therein to the Collateral Agent for its commercial paper program; and (y) the Conduit Agent may similarly transfer any interest it so receives. 56 Section 12.3 Participations and Sub-Participations. Each Lessor Party may at any time sell to one or more Persons ("Subparticipants") subparticipation interests in the rights and interests of such Lessor Party under this Agreement and the other Operative Documents. In the event of any such sale by a Lessor Party of subparticipation interests, such Lessor Party's obligations under this Participation Agreement and the other Operative Documents shall remain unchanged, such Lessor Party shall remain solely responsible for the performance thereof and the Lessee and the other Lessor Parties shall continue to deal solely and directly with such Lessor Party in connection with such Lessor Party's rights and obligations under this Participation Agreement. Any agreement pursuant to which any such sale is effected may require the selling Lessor Party to obtain the consent of the Subparticipant in order for such Lessor Party to agree in writing to any amendment, waiver or consent of a type specified in Section 15.5(a) of this Participation Agreement but may not otherwise require the selling Lessor Party to obtain the consent of such Subparticipant to any other amendment, waiver or consent hereunder. The Lessee agrees that any Lessor Party which has transferred any subparticipation interest shall, notwithstanding any such transfer, be entitled to the full benefits accorded such Lessor Party in this Participation Agreement and the other Operative Documents as if such Lessor Party had not made such transfer. Section 12.4 Disclosure of Information. Each Lessor Party may, in connection with any assignment, sale of a participation, proposed assignment or proposed sale of a participation by it pursuant to this Article XII, disclose to the applicable transferee or proposed transferee any information relating to the Lessee, the Guarantor or the Property in its possession. Section 12.5 Limitation on Assignment. Except as otherwise provided above or as contemplated in the Asset Purchase Agreement, no Lessor Party shall assign or transfer its rights, obligations or interest in, to and under the Operative Documents without the written consent of the Agent and, if no Default or Event of Default has occurred and is continuing, the Guarantor (which consent of the Agent and the Guarantor shall not be unreasonably withheld). ARTICLE XIII INDEMNIFICATION Section 13.1 General Indemnification. The Lessee and the Guarantor jointly and severally agree, whether or not any of the transactions contemplated hereby shall be consummated, to assume liability for, and to indemnify, protect, defend, save and keep harmless each Indemnitee, on an After Tax Basis, from and against, any and all Claims that may be imposed on, incurred by or asserted against such Indemnitee (whether because of action or omission by such Indemnitee or otherwise), whether or not such Indemnitee shall also be indemnified as to any such Claim by any other Person and whether or not such Claim arises or accrues prior to the Documentation Date or after the Financing Termination Date or the Maturity Date (as applicable), in any way relating to or arising out of: (a) any of the Operative Documents or any of the transactions contemplated hereby or pursuant to the Overall Transaction, and any amendment, modification or waiver in respect thereof including, without limitation, any Claim directly or indirectly arising out of or relating to, or alleged to directly or indirectly arise out of or relate to, any fact, circumstance or 57 condition in existence at any time prior to the execution and delivery of this Participation Agreement (whether or not such fact, circumstance or condition was known or knowable by the Lessee, the Guarantor or any other Person and notwithstanding any due diligence or other investigation by any Indemnitee), (b) the Property or any part thereof or interest therein; (c) the purchase, design, construction, preparation, installation, inspection, delivery, non-delivery, acceptance, rejection, ownership, management, possession, operation, rental, lease, sublease, repossession, maintenance, repair, alteration, modification, addition or substitution, storage, transfer of title, redelivery, use, financing, refinancing, disposition, operation, condition, sale (including any sale pursuant to the Master Lease), return or other disposition of all or any part or any interest in the Property or the imposition of any Lien (or incurring of any liability to refund or pay over any amount as a result of any Lien) thereon, including (1) Claims or penalties arising from any violation of law or in tort (strict liability or otherwise), (2) latent or other defects, whether or not discoverable, (3) any Claim based upon a violation or alleged violation of the terms of any restriction, easement, condition or covenant or other matter affecting title to the Property, including, but not limited to, the terms set forth in the Redwood Shores Documents, (4) the making of any Modifications in violation of any standards imposed by any insurance policies required to be maintained by the Lessee pursuant to the Master Lease which policies are in effect at any time with respect to the Property or any part thereof, (5) any Claim for patent, trademark or copyright infringement, and (6) Claims arising from any public improvements with respect to the Property resulting in any change or special assessments being levied against the Property or any plans to widen, modify or realign any street or highway adjacent to the Property, or any Claim for utility "tap-in" fees; (d) the breach by the Lessee or the Guarantor of any covenant, representation or warranty made by it or deemed made by it in any Operative Document or any certificate required to be delivered by any Operative Document or in connection with the Overall Transaction; (e) the retaining or employment of any broker, finder or financial advisor by the Lessee to act on its behalf in connection with this Participation Agreement; (f) the existence of any Lien on or with respect to the Property, any improvements, title thereto, any interest therein or any Basic Rent or Supplemental Rent, including any Liens which arise out of the possession, use, occupancy, construction, repair or rebuilding of the Property or by reason of labor or materials furnished or claimed to have been furnished to the Lessee, or any of its contractors or agents or by reason of the financing of any personally or equipment purchased or leased by the Lessee or Modifications constructed by the Lessee, except Lessor Liens and Liens created under the Operative Documents in favor of one or more of the Lessor Parties; . (g) the transactions contemplated by this Participation Agreement, any other Operative Document or in connection with the Overall Transaction, in respect of the application of Parts 4 and 5 of Subtitle B of Title I of ERISA and any prohibited transaction described in Section 4975(c) of the Revenue Code; 58 (h) any indemnification claim made against any Liquidity Bank under the Liquidity Documentation; (i) the sale of the Partnership Interests by the Existing Partners to the New Partners, the offer by the New Partners to the Existing Partners to acquire the Partnership Interests and the acquisition by the New Partners of the Partnership Interests or the provision of financing therefore pursuant to this Participation Agreement or the other Operative Documents or any fact, circumstance or condition directly or indirectly related hereto or thereto (or alleged to directly or indirectly relate hereto or thereto) (whether or not such fact, circumstance or condition was known or knowable by the Lessee, the Guarantor or any other Person and notwithstanding any due diligence or other investigation by any Indemnitee), including, without limitation, (i) invalid title to the transferred Partnership Interests or the Property, (ii) Liens against the Partnership Interests or the Property (other than Permitted Exceptions), (iii) adverse claims affecting the Partnership Interests or the Property, (iv) pre-existing actions, suits or claims against the Partnership Interests or the Property (whether known or unknown), (v) taxes or tax deficiencies against the Lessor, the Partnership Interests or the Property (whether pre-existing or arising in connection with the transfer of the Partnership Interests to the New Partners), (vi) violations of any rules or regulations promulgated by any Governmental Authority (including federal or state securities laws) arising as a result of ownership of the Property or the transfer of the Partnership Interests to the New Partners, and (vii) adverse claims arising under any federal or state bankruptcy or insolvency laws related to the transfer of the Partnership Interests to the New Partners; or (j) to the extent not otherwise provided pursuant to clauses (a) through (i) above, any Claim directly or indirectly arising out of or relating to the Pre-existing Transaction; provided, however, neither the Lessee nor the Guarantor shall be required to indemnify any Indemnitee under this Section 13.1 for any of the following: (1) any Claim to the extent resulting from the willful misconduct or gross negligence of such Indemnitee (it being understood that the Lessee and the Guarantor shall be required to indemnify an Indemnitee even if the ordinary (but not gross) negligence of such Indemnitee caused or contributed to such Claim), (2) any Claim resulting from Lessor Liens to the extent such Indemnitee is in breach of any obligation under the Operative Documents to discharge such Liens, (3) any Claim to the extent solely attributable to acts or events attributable to such Indemnitee and occurring after the return of the Property or the Financing Termination Date or the Maturity Date (as applicable) so long as no Default or Event of Default shall have occurred and be continuing as of the date of such return, the Financing Termination Date or the Maturity Date (as applicable), (4) any Claim arising from a breach by such Indemnitee of any agreement entered into in connection with the assignment or participation of any interest of such Indemnitee under this Participation Agreement or the other Operative Documents, (5) Taxes (other than, without duplication of any indemnity under Section 13.4, Structural Impositions, Prior Impositions and Taxes necessary for any claim under this Section 13.1 to be indemnified on an After-Tax Basis) or (6) any Claim arising solely from the failure of such Indemnitee to comply with laws applicable to banks or their affiliates generally or the failure of such Indemnitee to file any notice, report, filing or other document required by any Governmental Authority regulating banks or their affiliates in connection with such Indemnitee's execution of, and participation in the transactions contemplated by, the Operative Documents or in connection with the Overall Transaction. It is expressly understood and agreed that the 59 indemnity provided for herein shall survive the expiration or termination of, and shall be separate and independent from any remedy under, the Master Lease or any other Operative Document. Without limiting the express rights of any Indemnitee under this Section 13.1, this Section 13.1 shall be construed as an indemnity only and not a guaranty of residual value of the Property or as a guaranty of the repayment of the Notes or the redemption of the Equity Investment. Section 13.2 Environmental Indemnity. Without limitation of the other provisions of this Article XIII or the Environmental Indemnity Agreement, the Lessee and the Guarantor hereby agree, jointly and severally, to indemnify, hold harmless and defend each Indemnitee from and against any and all claims (including third party claims for personal injury or real or personal property damage or diminution of value), losses (including, to the extent the Outstanding Lease Balance and all other Obligations have not been fully paid, any loss of value of any Property related thereto), damages, liabilities, fines, penalties, charges, administrative and judicial proceedings (including any informal proceedings) and all orders, judgments, remedial action, requirements, enforcement actions of any kind, and all reasonable and documented costs and expenses incurred in connection therewith (including reasonable and documented attorneys' and/or paralegals' fees, experts' fees and expenses), including all costs incurred in connection with any investigation or monitoring of site conditions or any Remedial Action, arising in whole or in part, out of: (a) the presence on or under the Property of any Hazardous Substances, or any Releases or threat of Release or discharges of any Hazardous Substances on, under, from or onto the Property; (b) any Hazardous Activity or activity, including construction, carried on at the Property, and whether by the Lessee or any predecessor in title or any employees, agents, contractors or subcontractors of the Lessee or any predecessor in title, or any other Persons (including such Indemnitee), in connection with the handling, treatment, removal, storage, decontamination, clean-up, transport or disposal of any Hazardous Substances that at any time are Released on, at, from or under or are located or present on or under the Property, (c) loss of or damage to any property or the environment (including Remediation Costs, investigation costs, clean-up costs, response costs, remediation and removal costs, cost of corrective action, costs of financial assurance, fines and penalties and natural resource damages and diminution of value), or death or injury to any Person, and all expenses associated with the protection of wildlife, aquatic species, vegetation, flora and fauna, and any mitigative action required by or under Environmental Laws, in each case arising from activities on or conditions with respect to the Property; (d) any Governmental Claim, Adverse Environmental Condition or any other claim concerning lack of compliance with Environmental Laws, or any act or omission causing an environmental condition that requires remediation or would allow any Governmental Authority or Person to record a Lien on the land records, in each case arising from activities on or conditions with respect to the Property; or (e) any residual contamination on or under the Property, or affecting any natural resources, and any contamination of any property or natural resources arising in connection with 60 the generation, use, handling, storage, transport or disposal of any such Hazardous Substances from the Property; and irrespective of whether any of such activities were or will be undertaken in accordance with applicable laws, regulations, codes and ordinances; provided, however, neither the Lessee nor the Guarantor shall be required to indemnify any Indemnitee under this Section 13.2 for (1) any Claim to the extent resulting from the willful misconduct or gross negligence of such Indemnitee (it being understood that the Lessee and the Guarantor shall be required to indemnify an Indemnitee even if the ordinary (but not gross) negligence of such Indemnitee caused or contributed to such Claim) or (2) any Claim to the extent solely attributable to acts or events attributable to such Indemnitee first occurring after the return of all of the Property on the Financing Termination Date or the Maturity Date (as applicable) so long as no Default or Event of Default shall have occurred and be continuing as of the date of such return, the Financing Termination Date or the Maturity Date (as applicable). It is expressly understood and agreed that the indemnity provided for herein shall survive the expiration or termination of, and shall be separate and independent from, any remedy under the Master Lease or any other Operative Document. Section 13.3 Proceedings in Respect of Claims. With respect to any amount that Lessee or the Guarantor is requested by an Indemnitee to pay by reason of Section 13.1 or 13.2, such Indemnitee shall, if so requested by Lessee or the Guarantor, as applicable, and prior to any payment, submit such additional information to the Lessee or the Guarantor as such Person may reasonably request and which is in the possession of or available to such Indemnitee to substantiate properly the requested payment. In case any action, suit or proceeding shall be brought against any Indemnitee or any Indemnitee receives written notice of any threatened action, suit or proceeding, such Indemnitee shall with reasonable promptness notify the Guarantor of the commencement thereof, and the Guarantor shall be entitled, at its expense, to participate in, and, to the extent that the Guarantor desires to, assume and control the defense thereof (with counsel reasonably satisfactory to such Indemnitee) provided, however, that the Guarantor shall have acknowledged in writing its obligation to fully indemnify such Indemnitee in respect of such action, suit or proceeding, and the Guarantor shall keep such Indemnitee fully apprised of the status of such action, suit or proceeding and shall provide such Indemnitee with all information with respect to such action, suit or proceeding as such Indemnitee shall reasonably request; and provided, further, that the Guarantor shall not be entitled to assume and control the defense of any such action, suit or proceeding if and to the extent that (A) in the reasonable opinion of such Indemnitee, (x) such action, suit or proceeding involves any risk of imposition of criminal liability or will involve any material risk of the sale, forfeiture or loss of the Property or any part thereof not stayed during the pendency of the contest or (y) the control of such action, suit or proceeding by the Guarantor would involve an actual or potential conflict of interest, (B) such proceeding involves Claims not fully indemnified by the Lessee and the Guarantor which the Guarantor and the Indemnitee have been unable to sever from the indemnified claim(s), or (C) an Event of Default has occurred and is continuing and the Indemnitee notifies the Guarantor that it does not want the Guarantor to assume and control such defense. The Indemnitee will undertake all reasonable efforts to join in the Guarantor's efforts to sever any such action referred to in clause (B) above. The Indemnitee may participate in a reasonable manner at its own expense (provided that in the case of clauses (A), (B) or (C) above, the Guarantor shall pay the reasonable expenses of such Indemnitee) and 61 with its own counsel in any proceeding conducted by the Guarantor in accordance with the foregoing. The Guarantor shall not enter into any settlement or other compromise with respect to any Claim which is entitled to be indemnified under Section 13.1 or 13.2 without the prior written consent of the Indemnitee, which consent shall not be unreasonably withheld in the case of a money settlement not involving an admission of liability of such Indemnitee. Each Indemnitee shall, at the expense of the Guarantor, with reasonable promptness supply the Guarantor with such information and documents reasonably requested by the Guarantor as are necessary or advisable for the Guarantor to participate in and, to the extent permitted hereunder, control any action, suit or proceeding to the extent permitted by Section 13.1 or 13.2. Unless an Event of Default shall have occurred and be continuing, no Indemnitee shall enter into any settlement or other compromise with respect to any Claim which is entitled to be indemnified under Section 13.1 or 13.2 without the prior written consent of the Guarantor, which consent shall not be unreasonably withheld, unless such Indemnitee waives its right to be indemnified under Section 13.1 or 13.2 with respect to such Claim. Upon payment in full, or provision for payment in full reasonably satisfactory to the Indemnitee, of any Claim by the Lessee or the Guarantor pursuant to Section 13.1 or.13.2 to or on behalf of an Indemnitee, the Guarantor, without any further action, shall be subrogated to any and all claims that such Indemnitee may have relating thereto (other than claims in respect of insurance policies maintained by such Indemnitee at its own expense), and such Indemnitee shall execute such instruments of assignment and conveyance, evidence of claims and payment and such other documents, instruments and agreements as may be necessary to preserve any such claims and otherwise cooperate with the Guarantor and give such further assurances as are necessary or advisable to enable the Guarantor vigorously to pursue such claims. Any amount payable to an Indemnitee pursuant to Section 13.1 or 13.2 shall be paid to such Indemnitee promptly upon receipt of a written demand therefore from such Indemnitee, accompanied by a written statement describing in reasonable detail the basis for such indemnity and the computation of the amount so payable. Section 13.4 General Tax Indemnity. (a) Indemnification. The Lessee and the Guarantor, jointly and severally, shall pay and assume liability for, and do hereby agree to indemnify, protect and defend the Property, the Partnership Interests and all Tax Indemnitees, and hold them harmless against, all Impositions on an After Tax Basis. (b) Contests. If any claim shall be made against any Tax Indemnitee or if any proceeding shall be commenced against any Tax Indemnitee (including a written notice of such proceeding) for any Imposition as to which the Lessee or the Guarantor may have an indemnity obligation pursuant to this Section 13.4, or if any Tax Indemnitee shall determine that any Imposition to which the Lessee or the Guarantor may have an indemnity obligation pursuant to this Section 13.4 may be payable, such Tax Indemnitee shall promptly (and in any event, within fifteen (15) Business Days) notify the Guarantor in writing (provided that failure to so notify the Guarantor within fifteen (15) Business Days shall not alter such Tax Indemnitee's rights under this Section 13.4 except to the extent such failure precludes or materially adversely affects the 62 ability to conduct a contest of any indemnified Taxes) and shall not take any action with respect to such claim, proceeding or Imposition without the written consent of the Guarantor (such consent not to be unreasonably withheld or unreasonably delayed) for thirty (30) days after the receipt of such notice by the Guarantor; provided, however, that in the case of any such claim or proceeding, if such Tax Indemnitee shall be required by law or regulation to take action prior to the end of such thirty (30) day period, such Tax Indemnitee shall in such notice to the Guarantor, so inform the Guarantor, and such Tax Indemnitee shall not take any action with respect to such claim, proceeding or Imposition without the consent of the Guarantor (such consent not to be unreasonably withheld or unreasonably delayed) for ten (10) days after the receipt of such notice by the Guarantor unless such Tax Indemnitee shall be required by law or regulation to take action prior to the end of such ten (10) day period. The Guarantor shall be entitled for a period of thirty (30) days from receipt of such notice from such Tax Indemnitee (or such shorter period as such Tax Indemnitee has notified the Guarantor is required by law or regulation for such Tax Indemnitee to commence such contest), to request in writing that such Tax Indemnitee contest the imposition of such Tax, at the Guarantor's expense. If (x) such contest can be pursued in the name of the Guarantor or the Lessee and independently from any other proceeding involving a Tax liability of such Tax Indemnitee for which the Lessee and the Guarantor have not agreed to indemnify such Tax Indemnitee, (y) such contest must be pursued in the name of such Tax Indemnitee, but can be pursued independently from any other proceeding involving a Tax liability of such Tax Indemnitee for which the Lessee and the Guarantor have not agreed to indemnify such Tax Indemnitee or (z) such Tax Indemnitee so requests, then the Guarantor or such Lessee shall be permitted to control the contest of such claim, provided that in the case of a contest described in clause (y) if such Tax Indemnitee determines reasonably and in good faith that such contest by the Guarantor or the Lessee could have a material adverse impact on the business or operations of such Tax Indemnitee and provides a written explanation to the Guarantor of such determination, such Tax Indemnitee may elect to control or reassert control of the contest, and provided that the taking control by the Guarantor or the Lessee of any contest shall not alter the applicable Tax Indemnitee's rights to indemnification hereunder, and provided, further, that in determining the application of clauses (x) and (y) of the preceding sentence, each Tax Indemnitee shall take any and all reasonable steps to segregate claims for any Taxes for which the Lessee and the Guarantor indemnify hereunder from Taxes for which the Lessee and the Guarantor are not obligated to indemnify hereunder, so that the Guarantor can control the contest of the former. In all other claims requested to be contested by the Guarantor, such Tax Indemnitee shall control the contest of such claim, acting through counsel selected by such Tax Indemnitee and reasonably acceptable to the Guarantor. In no event shall the Guarantor be permitted to contest (or such Tax Indemnitee be required to contest) any claim, (A) if such Tax Indemnitee provides the Guarantor with a legal opinion of counsel reasonably acceptable to the Guarantor that such action, suit or proceeding involves a risk of imposition of criminal liability or will involve a material risk of the sale, forfeiture or loss of, or the creation of any Lien (other than a Permitted Lien) on the Property or any part thereof unless the Guarantor shall have posted and maintained a bond or other security reasonably satisfactory to the relevant Tax Indemnitee in respect to such risk, (B) if an Event of Default has occurred and is continuing unless the Guarantor shall have posted and maintained a bond or other security reasonably satisfactory to the relevant Tax Indemnitee in respect of the Taxes subject to such claim and any and all expenses for which the Guarantor or the Lessee is responsible hereunder reasonably foreseeable 63 in connection with the contest of such claim, (C) unless the Guarantor shall have agreed to pay and shall pay, to such Tax Indemnitee on written demand all reasonable, documented out-of- pocket costs, losses and expenses that such Tax Indemnitee may incur in connection with contesting such Imposition including all reasonable legal, accounting and investigatory fees and disbursements and (if applicable) reasonable, allocable internal overhead costs determined in accordance with normal bank operating procedures, or (D) if such contest shall involve the payment of the Tax prior to the contest, unless the Guarantor shall provide to such Tax Indemnitee an interest-free advance in an amount equal to the Imposition that such Tax Indemnitee is required to pay (with no additional net after-tax costs to such Tax Indemnitee). In addition, for contests controlled by such Tax Indemnitee and claims contested in the name of such Tax Indemnitee in a public forum, no contest shall be required: (A) unless the amount of the potential indemnity (taking into account all similar or logically related claims that have been or could be raised in any audit involving any or all such Tax Indemnitees with respect to any period for which the Guarantor or the Lessee may be liable to pay an indemnity under this Section 13.4(b)) exceeds (1) with respect to the Lessor or the New Partners, $25,000 and (2) with respect to any Tax Indemnitee other than the Lessor or the New Partners, $75,000 and (B) unless, if requested by such Tax Indemnitee, the Guarantor shall have provided to such Tax Indemnitee an opinion of counsel selected by the Guarantor (which may be in-house counsel) (except, in the case of income taxes indemnified hereunder, in which case such opinion shall be an opinion of independent tax counsel selected by the Guarantor and reasonably acceptable to such Tax Indemnitee) that a reasonable basis exists to contest such claim. In no event shall a Tax Indemnitee be required to appeal an adverse judicial determination to the United States Supreme Court. The party conducting the contest shall consult in good faith with the other party and its counsel with respect to the contest of such claim for Taxes (or claim for refund) but the decisions regarding what actions to be taken shall be made by the controlling party in its sole judgment; provided, however, that if such Tax Indemnitee is the controlling party and the Guarantor recommends the acceptance of a settlement offer made by the relevant Governmental Authority and such Tax Indemnitee rejects such settlement offer, then the amount for which a Lessee and the Guarantor will be required to indemnify such Tax Indemnitee with respect to the Taxes subject to such offer shall not exceed the amount which it would have owed if such settlement offer had been accepted provided that any Tax Indemnitee shall be entitled to reject any indemnity payment it would otherwise be entitled to hereunder if such Tax Indemnitee reasonably determines that accepting such offer would have an unindemnified impact on such Tax Indemnitee and provided further that no Tax Indemnitee may reject any such indemnity payment if the Guarantor agrees to pay to such Tax Indemnitee the amount of such unindemnified impact, as reasonably determined by such Tax Indemnitee. In addition, the controlling party shall keep the noncontrolling party reasonably informed as to the progress of the contest, and shall provide the noncontrolling party with a copy of (or appropriate excerpts from) any reports or claims issued by the relevant auditing agents or taxing authority to the controlling party thereof, in connection with such claim or the contest thereof, provided, however, that such obligation shall not obligate any Tax Indemnitee to disclose its tax returns or information or documentation unrelated to such claim or contest. Each Tax Indemnitee shall, at the expense of the Lessee and the Guarantor, supply the Lessee or the Guarantor with such information and documents reasonably requested by the 64 Lessee or the Guarantor as are necessary or advisable for such Person to participate in any action, suit or proceeding to the extent permitted by this Section 13.4(b); provided, however, that such Tax Indemnitee shall not be required to provide to such Lessee or the Guarantor copies of its tax returns or any other information, documentation, or materials that it deems to be confidential or proprietary. Notwithstanding anything in this Section 13.4(b) to the contrary, no Tax Indemnitee shall enter into any settlement or other compromise or fail to appeal an adverse ruling with respect to any claim which is entitled to be indemnified under this Section 13.4 (and with respect to which contest is required under this Section 13 .4(b) without the prior written consent of the Guarantor, unless such Tax Indemnitee waives its right to be indemnified under this Section 13.4 with respect to such claim. Notwithstanding anything contained herein to the contrary, a Tax Indemnitee shall not be required to contest (and neither the Lessee nor the Guarantor shall be permitted to contest in any judicial forum if such contest could, in a Tax Indemnitee's reasonable judgment, be materially adverse to it) a claim with respect to the imposition of any Tax if such Tax Indemnitee shall have waived its right to indemnification under this Section 13.4 with respect to such claim (and any claim with respect to such year or any other taxable year the contest of which is precluded or materially adversely affected as a result of such waiver). (c) Reimbursement. If(x) a Tax Indemnitee or any Affiliate thereof actually realizes a refund or reduction of any Taxes in respect of which the Lessee or the Guarantor has paid an indemnity pursuant to this Section 13.4 or (y) by reason of the incurrence or imposition of any Tax (or the circumstances or event giving rise thereto) for which a Tax Indemnitee was indemnified hereunder or any payment made to or for the account of such Tax Indemnitee by the Lessee or the Guarantor pursuant to this Section 13.4 or any payment made by a Tax Indemnitee to the Lessee or the Guarantor by reason of this Section 13.4(c), such Tax Indemnitee at any time actually realizes a reduction in any Taxes for which neither the Lessee nor the Guarantor are required to indemnify such Tax Indemnitee pursuant to this Section 13.4, which reduction in Taxes was not taken into account in computing such payment by the Lessee and the Guarantor to or for the account of such Tax Indemnitee or by such Tax Indemnitee to the Lessee and the Guarantor, any such refund or reduction to be determined without regard to Income Tax Savings, then such Tax Indemnitee shall promptly pay to the Guarantor (xx) the amount of the net tax savings refund, together with the amount of any interest received by such Tax Indemnitee on account of such refund or (yy) an amount equal to such reduction in Taxes, as the case may be, in either case together with an amount equal to any reduced Taxes payable by such Tax Indemnitee as a result of such payment; provided that no such payment shall be made so long as a Default or Event of Default shall have occurred and be continuing, but shall be paid promptly after cure of such Default or Event of Default. Notwithstanding the foregoing, no Tax Indemnitee shall be required to make any payment to the Guarantor or the Lessee pursuant to this Section 13.4(c) to the extent such payment would exceed, in the aggregate at any time, the amount of all prior payments made by or on behalf of the Lessee and the Guarantor to such Tax Indemnitee and/or its Affiliates pursuant to this Section 13.4 that gave rise to such refund or reduction in Taxes. Each Tax Indemnitee agrees to take such actions as the Guarantor may reasonably request (provided, in the reasonable good faith judgment of such Tax Indemnitee, such actions would not result in an adverse effect on such Tax Indemnitee for which such Tax Indemnitee is not entitled to indemnification from such Lessee and the Guarantor) and to otherwise act in good faith to claim such refunds and other available Tax benefits, and take such 65 other actions as may be reasonable to minimize any payment due from the Lessee and the Guarantor pursuant to this Section 13.4 and to maximize the amount of any Tax savings available to the Lessee and the Guarantor. The disallowance or reduction of any refund or other Tax savings with respect to which a Tax Indemnitee has made a payment to the Lessee under this Section 13.4(c) shall be treated as a Tax for which the Lessee is obligated to indemnify such Tax Indemnitee hereunder without regard to the exclusions set forth in the definition of "Impositions" except the exclusions set forth in clauses (iv), (v), (vii), (ix) and (xii) of such definition. (d) Payments. Any Imposition indemnifiable under this Section 13.4 shall be paid directly when due to the applicable taxing authority if direct payment is practicable and permitted. If direct payment to the applicable taxing authority is not permitted or is otherwise not made, any amount payable to a Tax Indemnitee pursuant to Section 13.4 shall be paid within thirty (30) days after receipt of a written demand therefor from such Tax Indemnitee accompanied by a written statement describing in reasonable detail the amount so payable, but not before two (2) Business Days prior to the date that the relevant Taxes are due. Any payments made pursuant to this Section 13.4 shall be made directly to such Tax Indemnitee entitled thereto or the Guarantor, as the case may be, in immediately available funds at such bank or to such account as specified by the payee in written directions to the payor, or, if no such direction shall have been given, by check of the payor payable to the order of the payee by certified mail, postage prepaid at its address as set forth in Schedule I hereto. Upon the request of any Tax Indemnitee with respect to a Tax that the Guarantor or the Lessee is required to pay, the Guarantor or the Lessee, as the case may be, shall furnish to such Tax Indemnitee the original or a certified copy of a receipt for such Person's payment of such Tax or such other evidence of payment as is reasonably acceptable to such Tax Indemnitee. (e) Reports. In the case of any report, return or statement required to be filed with respect to any Taxes that are subject to indemnification under this Section 13.4 and of which the Guarantor or the Lessee has knowledge, the Guarantor or the Lessee, as the case may be, shall promptly notify such Tax Indemnitee of such requirement and, at the expense of the Guarantor and the Lessee (i) if the Guarantor or the Lessee, as the case may be, is permitted (unless otherwise requested by such Tax Indemnitee) by Applicable Law, timely file such report, return or statement in its own name or (ii) if such report, return or statement is required to be in the name of or filed by such Tax Indemnitee or such Tax Indemnitee otherwise requests such report, return or such statement for filing by such Tax Indemnitee in such manner as shall be satisfactory to such Tax Indemnitee and send the same to such Tax Indemnitee for filing no later than fifteen (15) days prior to the due date therefor. In any case in which such Tax Indemnitee will file any such report, return or statement, the Guarantor or the Lessee shall, upon written request of such Tax Indemnitee, provide such Tax Indemnitee with such information as is reasonably necessary to allow such Tax Indemnitee to file such report, return or statement. (f) Verification. At the request of the Guarantor of the Lessee, the amount of any indemnity payment by the Lessee or the Guarantor or any payment by a Tax Indemnitee to the Lessee or the Guarantor pursuant to this Section 13.4 shall be verified and certified by an independent public accounting firm mutually acceptable to the Lessee or the Guarantor and such Tax Indemnitee. The costs of such verification shall be borne by the Lessee or the Guarantor unless such verification shall result in an adjustment in favor of the Lessee or the Guarantor in an amount greater than the lesser of (i) $10,000, and (ii) ten percent (10%) of the payment as 66 computed by such Tax Indemnitee, in which case such fee shall be paid by such Tax Indemnitee. In no event shall the Guarantor or the Lessee have the right to review such Tax Indemnitee's tax returns or receive any other confidential information from such Tax Indemnitee in connection with such verification. Any information provided to such accountants by any Person shall be and remain the exclusive property of such Person and shall be deemed by the parties to be (and the accountants will confirm in writing that they will treat such information as) the private, proprietary and confidential property of such Person, and no Person other than such Person and the accountants shall be entitled thereto and all such materials shall be returned to such Person. Such accounting firm shall be requested to make its determination within thirty (30) days of the Guarantor's or the Lessee's request for verifications and the computations of the accounting firm shall be final, binding and conclusive upon the Guarantor, the Lessee and such Tax Indemnitee absent manifest error. The parties agree that the sole responsibility of the independent public accounting firm shall be to verify the amount of a payment pursuant to the Operative Documents or in connection with the Overall Transaction and that matters of interpretation of the Operative Documents or the Overall Transaction are not within the scope of the independent accounting firm's responsibilities. (g) Tax Ownership. Each Tax Indemnitee represents and warrants that except as actually required by law it will (i) not claim ownership of (or any tax benefits, including depreciation, with respect to) the Property for any income tax purposes, it being understood that the Lessee is and will remain the owner of the Property leased under the Master Lease for such income tax purposes and (ii) treat all Notes and all portions of the Equity Investment as Indebtedness of the Lessee for federal income tax purposes; provided that this sentence shall not preclude the Lessor from claiming ownership of, and any tax benefits with respect to, the Property for periods beginning after (x) the Property has been returned to the Lessor pursuant to the Lessee's exercise of the Remarketing Option or (y) the Lessor has exercised remedies under Section 19 of the Master Lease and foreclosed or otherwise sold the Property pursuant to such exercise. If, notwithstanding the income tax intentions of the parties as set forth herein, any Tax Indemnitee actually receives any income tax deductions, reductions in income tax or other income tax benefits (collectively, "Income Tax Savings") as a result of any claim for, or recharacterization requiring such party to take, any tax benefits attributable to ownership of the Property for income tax purposes, such Tax Indemnitee shall pay to the Guarantor, together with an amount equal to any reduced Taxes payable by such Tax Indemnitee as a result of such payment, the amount of such Income Tax Savings actually realized by such Tax Indemnitee (less the amount of any anticipated increase in income tax which is payable as a result of such claim or recharacterization), provided that the Guarantor and the Lessee shall agree to reimburse such Tax Indemnitee for any subsequent increase in such Tax Indemnitee's income taxes resulting from such claim or recharacterization not taken into account in the payment made to the Guarantor, up to the net amount paid to the Guarantor by each Tax Indemnitee and provided further, that no Default or Event of Default shall have occurred and be continuing. The parties agree that this Section 13.4(g) is intended to require a Tax Indemnitee to make a payment to the Guarantor if and only if such Tax Indemnitee shall have actually received any net unanticipated Income Tax Savings with respect to the Property that would not have been received if such Tax Indemnitee had advanced funds to the Lessee under an arrangement properly characterized for federal income tax purposes as a loan secured by thy Property in an amount equal to such Tax Indemnitee's portion of the Outstanding Lease Balance. Nothing in this Section 13.4(g) shall be construed to require any Tax Indemnitee to take any affirmative action to realize any Income Tax 67 Savings if in its sole discretion, exercised in good faith, such action may have a material adverse effect on such Tax Indemnitee (including as a result of such position being or being viewed as materially inconsistent with any other tax position claimed by such Tax Indemnitee for the relevant period or periods). (h) Structural Impositions and Prior Impositions. Notwithstanding anything contained in any Operative Document to the contrary, the Lessee and the Guarantor shall have no right, and the Lessor Parties (other than the New Partners to the extent, and only to the extent, expressly set forth herein) shall have no obligation, relating to Structural Impositions or Prior Impositions imposed upon or with respect to any Indemnitee (other than the New Partners to the extent, and only to the extent, expressly set forth herein) pursuant to any provision of this Section 13.4 (including without limitation any provision relating to contests, reimbursement or the filing of reports) or otherwise; provided however, for purposes of this sentence, Structural Impositions and Prior Impositions imposed with respect to the Lessor shall be treated as imposed with respect to the New Partners to the extent that the Lessor's rights inure to the benefit of the New Partners pursuant to Section 13.4(i). For the avoidance of doubt, nothing contained in this Section 13.4(h) shall be construed to diminish any right to indemnity or otherwise of any Lessor Party, or to relieve either the Lessee or the Guarantor of any indemnification or other obligation. (i) Lessor as Indemnitee. Notwithstanding anything contained in any Operative Document to the contrary, to the extent that the Lessor shall be an Indemnitee having rights arising under or otherwise relating to Structural Impositions or Prior Impositions pursuant to Section 4.4 or 4.6 or this Section 13.4, such rights shall inure to the benefit of the Note Purchaser (and its successors and assigns) or, with the Note Purchaser's consent (not to be unreasonably withheld), the New Partners. The Lessee and the Guarantor shall perform all obligations otherwise inuring to the benefit of the Lessor arising under or relating to such provisions for the benefit of, or (if so directed) as directed by, the Note Purchaser (and its successors and assigns) or the New Partners, as applicable, and the Lessor shall otherwise take such actions (and omit to take such actions) as shall be in the best interests of (or as directed by) the Note Purchaser (and its successors and assigns) or the New Partners, as applicable, in connection with their enjoyment of such rights. Section 13.5 Indemnity Payments in Addition to Master Lease Obligations. Each of the Lessee and the Guarantor acknowledges and agrees that the obligations of the Lessee and the Guarantor to make indemnity payments under this Article XIII are separate from, in addition to, and do not reduce (i) the Lessee's obligations under the Master Lease and (ii) without duplication, the indemnities provided in Article IV hereof. Each of the Lessee and the Guarantor further acknowledges and agrees that the rights to indemnity contained in this Article XIII are in addition to, and not in limitation of, any rights (including, without limitation, rights to indemnity) contained in any Operative Document or otherwise available at law or in equity. 68 ARTICLE XIV AGENT; PLEDGED PROPERTY Section 14.1 Appointment and Duties of the Agent. (a) The Lessor Parties (excluding the Agent) hereby designate and appoint KeyBank to act as the Agent under the Operative Documents, and such parties hereby authorize the Agent to take such actions on their behalf under the provisions of the Operative Documents and to exercise such powers and perform such duties as are expressly delegated to the Agent by the terms of the Operative Documents, together with such other powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary elsewhere in the Operative Documents, the Agent shall not have any duties or responsibilities, except those expressly set forth herein or in the other Operative Documents, or any fiduciary relationship with the other Lessor Parties and no implied covenants, functions or responsibilities shall be read into the Operative Documents, or otherwise exist against the Agent. (b) The Agent shall not exercise any rights or remedies under any of the Operative Documents or give any consent or approve as satisfactory to it any matters requiring such approval under any of the Operative Documents or enter into any agreement amending, modifying, supplementing or waiving any provision of any Operative Document unless it shall have been directed to do so in writing by the requisite percentages required under the Operative Documents or, in the absence of an express provision, by the Consenting Parties. The Lessor and the Guarantor shall be entitled to assume, and rely on such assumption, that the Agent will be in compliance with the preceding sentence at all times during which this Participation Agreement and the other Operative Documents are in effect. (c) The Agent will prepare continuation statements for the Financing Statements and the Precautionary Financing Statements. The costs of such continuation statements shall be paid by the Guarantor. (d) The Agent shall promptly notify the other Lessor Parties of any communication it receives from a Lessee Party, and shall promptly provide the other Lessor Parties with copies of any documents it receives from a Lessee Party relating to the Overall Transactions. (e) The Agent shall promptly notify the other Lessor Parties of any communication relating to the Overall Transaction it receives from any other Lessor Party, and shall promptly provide such other Lessor Parties with copies of any documents it receives from a Lessee Party relating to the Overall Transactions, in each case that it determines is material in its sole discretion. Section 14.2 Rights of the Agent. (a) The Agent may execute any of its duties pursuant to the Operative Document by or through agents or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. 69 (b) Neither the Agent nor any of its officers, directors, employees, agents, attorneys-in-fact or affiliates shall (i) be liable for any action lawfully taken or omitted to be taken by it under or in connection with any Operative Document or this Participation Agreement except for its gross negligence or willful misconduct, or (ii) be responsible in any manner to any Transaction Party for any recitals, statements, representations or warranties made by the Lessee or the Guarantor or any representative thereof contained in any Operative Document or in any certificate, report, statement or other document referred to or provided for in, or received by the Agent or in connection with, any Operative Document or this Participation Agreement or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of the Operative Documents or this Participation Agreement or for any failure of the Guarantor or the Lessee to perform their obligations thereunder. Except to the extent expressly provided in this Participation Agreement or any other Operative Document to which the Agent is a party, the Agent shall not be under any obligation to any Transaction Party to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, any Operative Document or this Participation Agreement, or to inspect the properties, books or records of the Lessee or the Guarantor. (c) The Agent shall be entitled to rely, and shall be fully protected in relying, upon any note, writing, resolution, notice, consent, certificate, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and statements of legal counsel, independent accountants and other experts selected by the Agent. In connection with any request of a Transaction Party, the Agent shall be fully justified in failing or refusing to take action under any Operative Document or this Participation Agreement (i) if such action would, in the reasonable opinion of the Agent, be contrary to law or the terms of this Participation Agreement or the other Operative Documents, (ii) if such action is not specifically provided for in such Operative Document or this Participation Agreement and it shall not have received the consent or concurrence it deems appropriate or, (iii) if, in connection with taking of any such action that would constitute an exercise of remedies under such Operative Document or this Participation Agreement, it shall not first be indemnified to its satisfaction against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. The Agent shall in all cases be fully protected in acting, or in refraining from acting, under any Operative Document or this Participation Agreement in accordance with any such request, and such request and any action taken or failure to act pursuant thereto shall be binding upon the other Transaction Parties. (d) The Agent shall not be deemed to have actual, constructive, direct or indirect knowledge or notice of the occurrence of any Event of Default unless and until it has received a written notice or a certificate from a Transaction Party stating that an Event of Default has occurred under the Operative Documents. The Agent shall have no obligation whatsoever either prior to or after receiving such notice or certificate to inquire whether an Event of Default has in fact occurred and shall be entitled to rely conclusively, and shall be fully protected in so relying, on any such notice or certificates furnished to it. No provision of this Participation Agreement or any other Operative Document shall require the Agent to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder or under any Operative Document or in the exercise of any of its rights or powers, if it shall have 70 reasonable grounds for believing that repayment of such funds or adequate indemnity against such risk or liability is not reasonably assured to it. (e) To the extent that such expenses shall not be reimbursed by the Lessee or the Guarantor where so required by the terms of the Operative Documents, the Agent shall be entitled to reimbursement from the other Lessor Parties (other than the Note Purchaser, the Conduit Agent and the Program Administrator) for reasonable out-of-pocket expenses, including the reasonable fees and expenses of its counsel (and any local counsel) and of any experts and agents, which the Agent may reasonably incur in connection with (i) the administration of this Participation Agreement and the other Operative Documents, (ii) the custody or preservation of, or the sale of, collection from, or other realization upon, the Property or the Related Security, or (iii) the exercise or enforcement (whether through negotiations, legal proceedings or otherwise) of any of the rights of the Agent or the other Transaction Parties hereunder or under the other Operative Documents. (f) Notwithstanding any provision herein or in any other Operative Document to the contrary, with the exception of Section 14.2(b), the Agent shall not be entitled to any payment or collection from any other Lessor Parties, but for all fees, expenses and indemnities irrevocably agrees to look solely and exclusively to the Lessee and the Guarantor. Section 14.3 Lack of Reliance on the Agent. Each of the Transaction Parties represents to the Agent that it has, independently and without reliance upon the Agent and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into the transactions contemplated by the Operative Documents. Each such party also represents that it will, independently and without reliance upon the Agent, and based on such documents and information as it shall deem appropriate at the time continue to make its own credit decisions with respect to this Participation Agreement or any of the other Operative Documents. Section 14.4 Resignation of the Agent. The Agent may resign as Agent upon thirty (30) days' notice to the Transaction Parties, with any such resignation to become effective only upon the appointment of a successor Agent hereunder. If the Agent shall resign as Agent, the Note Purchaser shall appoint a successor Agent, subject to the consent of the Guarantor if no Event of Default exists (which consent shall not be unreasonably withheld) and the consent of the Liquidity Banks. If no successor Agent shall have been so appointed within thirty (30) days, the resigning Agent or any Lessor Party may petition any court of competent jurisdiction for the appointment of a new Agent. Upon the appointment of a successor agent pursuant to this Section 14.4, such successor agent shall succeed to the rights, powers and duties of the "Agent," and the term "Agent" shall mean such successor agent, and the former Agent's rights, powers and duties as Agent shall be terminated, without any other or further act or deed on the part of such former Agent or any other Lessor Parties. After any retiring Agent's resignation hereunder as Agent, the provisions of this Participation Agreement shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent. Section 14.5 Successor Agent by Merger. If the Agent consolidates with, merges or converts into, or transfers substantially all of its assets to another corporation, the resulting, surviving or transferee corporation, without any further action, shall be the successor Agent. 71 Section 14.6 Eligibility of the Agent The Agent shall at all times have a combined capital and surplus of at least $100,000,000 (or a combined capital and surplus in excess of $50,000,000 and the obligations of which, whether or not in existence or hereafter incurred, are fully and unconditionally guaranteed by a corporation organized and doing business under the laws of the United States, any state or territory thereof or the District of Columbia that has a combined capital and surplus of at least $100,000,000). If such corporation publishes reports of condition at least annually, pursuant to law or to requirements of Federal, State, Territorial or District of Columbia supervising or examining authority, then for the purposes of this Section 14.6, the combined capital and surplus of such corporation shall be deemed to be its combined capital and surplus as set forth in its most recent report of conditions so published. The Agent shall not be an Affiliate of the Guarantor or the Lessee. Section 14.7 Collection of Payments Notwithstanding anything in this Participation Agreement, the Master Lease or the other Operative Documents to the contrary, all payments under this Participation Agreement, the Master Lease or under the other Operative Documents, including but not limited to, payments of Basic Rent, Supplemental Rent, interest (if any) on the Lessee Loans, Purchase Option Price, Remarketing Proceeds or Maximum Recourse Amount by the Lessee or the Guarantor under this Participation Agreement, the Master Lease or the other Operative Documents shall be made directly to the Agent and not the Lessor. The Agent shall immediately remit such amounts in accordance with the terms of Article XI of this Participation Agreement or, to the extent such funds cannot be remitted immediately, shall deposit such funds into an Eligible Account for distribution as soon as possible in accordance with the terms of Article XI of this Participation Agreement. Unless specifically provided herein or in any other Operative Documents that such payment is to be made directly to a particular Lessor Party or any other Person, upon payment by the Lessee (or the Guarantor) to the Agent of an amount required to be paid under the Operative Documents, the Lessee (or the Guarantor) shall be deemed to have satisfied its obligation with respect to such payment and neither the Lessee nor the Guarantor shall have any liability or responsibility for the Agent's failure or delay in remitting such amount to the Person or Persons entitled thereto. Section 14.8 Pledged Property (a) Grant of Security Interest in Pledged Property. In furtherance and not in limitation of any provisions of the Conveyance Instruments, the Lessor does hereby grant, bargain, sell, convey, mortgage, assign, transfer and warrant to the Agent under the Operative Documents for the benefit of the Lessor Parties (other than the New Partners and the Lessor), as their respective interests may appear, a continuing first priority security interest in and to all right, title and interest of the Lessor not otherwise conveyed to the Agent pursuant to the Conveyance Instruments executed by the Lessor in favor of the Agent for the benefit of the Lessor Parties (other than the New Partners and the Lessor), whether now owned, or hereafter acquired, in and to the Collateral of the type described in clause (b) of the definition of "Collateral", including, without limitation, all right, title and interest in and to any accounts maintained from time to time by the Agent in which the proceeds of any payments made to or for the account of the Lessor may be deposited from time to time (such property, rights and interests being hereinafter collectively called the "Pledged Property") to secure the repayment of the Secured Obligations. 72 (b) Duty of Care. The Agent shall exercise reasonable care in the custody and preservation of Pledged Property in its actual possession. At any time and from time to time, the Agent may at its option file in any jurisdiction, at the expense of the Lessee and the Guarantor, one or more financing, continuation and similar statements, and any amendments thereto, with or (to the extent permitted by Applicable Law) without the signature of the Lessor, the Lessee or the Guarantor, as the case may be, covering any or all of the Pledged Property. Each of the Lessor, the Lessee and the Guarantor hereby agrees to join with the Agent at the Agent's request in executing any such statements and amendments. ARTICLE XV MISCELLANEOUS Section 15.1 Survival of Agreements. The representations, warranties, covenants, indemnities and agreements of the parties provided for in the Operative Documents, and the parties' obligations under any and all thereof, shall survive the execution and delivery of this Participation Agreement, the transfer of the Partnership Interests to the New Partners, the execution and delivery by the Lessee and the Lessor of Amendment No.2 and any disposition of any interest of the Lessor in the Property and shall be and continue in effect notwithstanding any investigation made by any party and the fact that any party may waive compliance with any of the other terms, provisions or conditions of any of the Operative Documents. The indemnities of the parties provided for in the Operative Documents shall survive the termination of any Operative Documents. Section 15.2 No Broker, etc. Each of the parties hereto represents to the others that it has not retained or employed any broker, finder or financial adviser to act on its behalf in connection with this Participation Agreement or the transactions contemplated herein, nor has it authorized any broker, finder or financial adviser retained or employed by any other Person so to act. Any party who is in breach of this representation shall indemnify and hold the other parties harmless from and against any liability arising out of such breach of this representation. Section 15.3 Notices. Except as otherwise provided herein, all notices, requests, demands, consents, instructions or other communications to or upon any Transaction Party under this Participation Agreement or the other Operative Documents shall be in writing and faxed, mailed or delivered, if to such Person, at its respective facsimile number or address set forth on Schedule I hereto specified beneath the heading "Address for Notices" under the name of such Transaction Party (or to such other facsimile number or address for any party as indicated in any notice given by that party to the other parties). All such notices and communications shall be effective (a) when sent by Federal Express or other overnight service of recognized standing, on the Business Day following the deposit with such service; (b) when mailed, first class postage prepaid and addressed as aforesaid through the United States Postal Service, upon receipt; (c) when delivered by hand, upon delivery; and (d) when faxed, upon confirmation of receipt; provided, however, that any Funding Notice, Purchase Notice or Remarketing Notice shall not be effective until received by the Lessor or the Agent. Each Funding Notice, Purchase Notice and Remarketing Notice shall be given by the Lessee to the Agent's office located at its address referred to above during its normal business hours; provided, however, that any such notice received by the Agent on any Business Day after the time specified in the applicable Operative 73 Document for the giving of such notice (or, if no such time is specified, after 2:00 p.m.) shall be deemed received by the Agent on the next Business Day. In any case where this Participation Agreement authorizes notices, requests, demands or other communications by the Lessee or the Guarantor to any Lessor Party to be made by telephone or facsimile, any Lessor Party may conclusively presume that anyone purporting to be a person designated in any incumbency certificate or other similar document received by such Lessor Party is such a person. Section 15.4 Counterparts. This Participation Agreement may be executed by the parties hereto in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute but one and the same instrument. Delivery of an executed signature page hereto by facsimile or other electronic means shall be equally effective as delivery of an original signature page. Section 15.5 Amendments. Except as otherwise provided pursuant to Section 11.1 hereof, any term, covenant, agreement or condition of this Participation Agreement or any other Operative Document may be amended or waived if such amendment or waiver is in writing and is signed by the Lessor, the Lessee, the New Partners (if such New Partners are a party to such Operative Document), the Guarantor (if the Guarantor is a party to such Operative Document) and the Consenting Parties; provided, however that: (a) any amendment, waiver or consent which (i) increases the Aggregate Commitment Amount, the Aggregate Tranche B Commitment, the Aggregate Note Purchase Commitment or the Aggregate Equity Commitment, (ii) extends the Maturity Date, (iii) reduces the amount of Basic Rent or any other amounts to be paid by the Lessee under the Master Lease or any other Operative Documents or any fees or other amounts payable for the account of the Lessor Parties hereunder or thereunder, (iv) postpones any date scheduled for any payment of Basic Rent or any other amounts or any fees or other amounts payable for the account of the Lessor Parties hereunder or thereunder, (v) amends Article XI or this Section 15.5, (vi) amends the definition of , `Consenting Parties", (vii) releases the Lessor's interest in any material part of the Property or in any Lien thereon in favor of the Lessor Parties, (viii) releases the Lessee or the Guarantor from its indemnity obligations under the Operative Documents, or (ix) releases the Guarantor from its obligations under the Guaranty, must be in writing and signed or approved in writing by all of the Lessor Parties (other than each individual New Partner whose approval shall be evidenced by the approval of the Lessor); (b) any amendment, waiver or consent which increases or decreases the Commitment of any Lessor Party must be in writing and signed by such Lessor Party; (c) any amendment, waiver or consent which affects the rights or obligations of the Agent, any Tranche B Bank or any Liquidity Bank must be in writing and signed by the Agent, such Tranche B Bank or such Liquidity Bank, as applicable; (d) any amendment, waiver or consent which affects the rights or obligations of the Note Purchaser must be in writing and signed by the Note Purchaser; (e) any amendment, waiver or consent which affects the rights or obligations of the New Partners must be in writing and signed by each such New Partner; and 74 (f) any amendment, waiver or consent which terminates this Participation Agreement or any other Operative Document (except upon payment in full of the Outstanding Lease Balance and all other Obligations or the effective exercise and consummation of the Remarketing Option with respect to the Property in accordance with Section 12 of the Master Lease and payment in full of all amounts due in accordance therewith), must be in writing and signed by each Transaction Party. Notwithstanding the foregoing or any other provision to the contrary contained in this Participation Agreement or the other Operative Documents, the parties hereto acknowledge and agree that the aggregate "Commitments" (as defined in the Liquidity Agreement) of the Liquidity Banks may be increased without the consent of the Transaction Parties (other than the Note Purchaser) provided that (a) the Note Purchaser agrees to such amendments as may be necessary to the Liquidity Documents in order to allow for such increase, (b) the maximum aggregate "Commitments" of the Liquidity Banks after giving effect to any such increase does not exceed $119,925,000 plus all accrued discount on all related Commercial Paper (as such amount may be adjusted pursuant to the Liquidity Agreement) less the aggregate principal amount of outstanding Percentage Interest purchased by the Liquidity Banks pursuant to the Asset Purchase Agreement and (c) no allocated portion (restricted to the dollar amount) of the "Commitment" of any Liquidity Bank may be increased without the prior express written consent of such Liquidity Bank. Section 15.6 Headings, etc. The Table of Contents and headings of the various Articles and Sections of this Participation Agreement are for convenience of reference only and shall not modify, define, expand or limit any of the terms or provisions hereof. Section 15.7 Parties in Interest. Except as expressly provided herein, none of the provisions of this Participation Agreement is intended for the benefit of any Person except the Transaction Parties. Neither the Lessee nor the Guarantor shall assign or transfer any of its rights or obligations under the Operative Documents without the prior written consent of the Transaction Parties. Except as provided in Section 12.1, the Lessor shall not assign or transfer any of its rights or obligations under the Operative Documents without the prior written consent of the Consenting Parties and, so long as no Default or Event of Default shall have occurred and be continuing, the Guarantor (which consent, in each case, shall not be unreasonably withheld). Section 15.8 Governing Law. THIS PARTICIPATION AGREEMENT SHALL IN ALL RESPECTS BE GOVERNED BY THE LAW OF THE STATE OF CALIFORNIA (EXCLUDING ANY CONFLICT -OF-LAW OR CHOICE-OF-LA W RULES WHICH MIGHT LEAD TO THE APPLICATION OF THE INTERNAL LAWS OF ANY OTHER JURISDICTION) AS TO ALL MATTERS OF CONSTRUCTION, VALIDITY AND PERFORMANCE. Section 15.9 Severability. Any provision of this Participation Agreement that is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. 75 Section 15.10 Liabi1ity Limited. None of the Lessor Parties shall have any obligation to any other party hereto with respect to transactions contemplated by the Operative Documents, except those obligations of such Person expressly set forth in the Operative Documents or except as set forth in the instruments delivered in connection therewith, and none of the Lessor Parties shall be liable for performance by any other party hereto of such other party's obligations under the Operative Documents except as otherwise so set forth. Section 15.11 Further Assurances. The parties hereto shall promptly cause to be taken, executed, acknowledged or delivered, at the sole expense of the Lessee and the Guarantor, all such further acts, conveyances, documents and assurances as the other parties may from time to time reasonably request in order to carry out and preserve the security interests and liens (and the priority thereof) intended to be created pursuant to this Participation Agreement, the other Operative Documents, and the transactions thereunder (including the preparation, execution and filing of any and all Uniform Commercial Code financing statements and other filings or registrations which the parties hereto may from time to time request to be filed or effected). The Lessee and the Guarantor, upon the written request from any other party to this Participation Agreement, shall take such action as may be necessary (including any action specified in the preceding sentence), as so requested, in order to maintain and protect all security interests provided for hereunder or under any other Operative Document. Expenses relating to any action to be taken by the Guarantor or the Lessee pursuant to the preceding sentence shall be the responsibility of the Guarantor and the Lessee; provided, however, that expenses relating to any such action with respect to any Lessor Lien shall be paid (or be promptly reimbursed to the Guarantor or the Lessee, as applicable) by the party requesting such action. Section 15.12 Submission to Jurisdiction. The Lessee and the Guarantor hereby submits to the nonexclusive jurisdiction of the United States District Court for the Northern District of California for purposes of all legal proceedings arising out of or relating to the Operative Documents or the transactions contemplated hereby. The Lessee and the Guarantor each irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum. Section 15.13 Waiver of Jury Trial. THE PARTIES HERETO VOLUNTARILY AND INTENTIONALLY WAIVE ANY RIGHTS THEY MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER, OR IN CONNECTION WITH, THIS PARTICIPATION AGREEMENT OR ANY OTHER OPERATIVE DOCUMENT, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY OF THE PARTIES HERETO. THE PARTIES HERETO HEREBY AGREE THAT THEY WILL NOT SEEK TO CONSOLIDATE ANY SUCH LITIGATION WITH ANY OTHER LITIGATION IN WHICH A JURY TRIAL HAS NOT OR CANNOT BE WAIVED. THE PROVISIONS OF THIS SECTION 15.13 HAVE BEEN FULLY NEGOTIATED BY THE PARTIES HERETO AND SHALL BE SUBJECT TO NO EXCEPTIONS. EACH OF THE LESSEE AND THE GUARANTOR ACKNOWLEDGES AND AGREES THAT IT HAS RECEIVED FULL AND SUFFICIENT CONSIDERATION FOR THIS PROVISION (AND EACH OTHER PROVISION OF EACH OTHER OPERATIVE DOCUMENT TO WHICH IT IS A PARTY) 76 AND THAT THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE LESSOR PARTIES ENTERING INTO THIS P ARTICIP ATION AGREEMENT AND EACH SUCH OTHER OPERATIVE DOCUMENT. Section 15.14 No Bankruptcy Petition Against the Note Purchaser. Each Transaction Party hereby covenants and agrees, on behalf of itself and each of its Affiliates, with the Note Purchaser that, prior to the date which is one year and one day after the payment in full of all commercial paper or other Indebtedness issued by the Note Purchaser, it will not institute against, or join any other Person in instituting against, the Note Purchaser any bankruptcy, reorganization, arrangement, insolvency or liquidation proceedings or other similar proceedings under the law of the United States or any state of the United States. Section 15.15 Limited Recourse to the New Partners, the Note Purchaser and the Lessor. (a) Notwithstanding anything to the contrary contained in this Participation Agreement or any other Operative Document, the obligations of the Note Purchaser under this Participation Agreement and the other Operative Documents are solely the corporate obligations of the Note Purchaser and, with respect to claims made by any other Lessor Party, shall be payable solely to the extent of funds or property received from the Lessee and/or the Guarantor in accordance with this Participation Agreement and the other Operative Documents; provided, however, that the foregoing obligations shall constitute a claim (as defined in Section 101 of the Bankruptcy Code) upon the Note Purchaser only to the extent of such funds or property actually received by the Note Purchaser and not required to repay Commercial Paper. No recourse shall be had for the payment of any amount owing hereunder or any other obligation or claim arising out of or based upon this Participation Agreement or any other Operative Document against any present or former stockholder, manager, member, employee or officer of the Note Purchaser or, unless such obligation or claim arises from the gross negligence or willful misconduct of the Note Purchaser, in such capacity or any employee, officer or director thereof; provided, however, that the foregoing shall not relieve any such person or entity from any liability they might otherwise have as a result of fraudulent actions or omissions taken by them. (b) Notwithstanding anything to the contrary contained in this Participation Agreement or any other Operative Document, the obligations of the New Partners and the Lessor under this Participation Agreement and the other Operative Documents (including, without limitation, with respect to the Lessor, the Notes) are solely the corporate obligations of the Lessor and the New Partners, respectively, with respect to claims made by any other Lessor Party, shall be payable solely to the extent of funds or property received from the Lessee and/or the Guarantor in accordance with this Participation Agreement and the other Operative Documents or advanced or to be advanced pursuant to the Equity Investment; provided, however, that the foregoing obligations shall constitute a claim (as defined in Section 101 of the Bankruptcy Code) upon the New Partners or the Lessor (as applicable) only to the extent of such funds or property actually received by the New Partners or the Lessor (as applicable) and not required to repay Notes. No recourse shall be had for the payment of any amount owing hereunder or any other obligation or claim arising out of or based upon this Participation Agreement or any other Operative Document against any present or former stockholder, manager, member, employee or officer of the New Partners or Lessor or, unless such obligation or claim arises from the gross negligence or willful misconduct of such New Partner or the 77 Lessor (as applicable), in such capacity or any employee, officer or director thereof; provided, however, that the foregoing shall not relieve any such person or entity from any liability they might otherwise have as a result of fraudulent actions or omissions taken by them. (c) Each Transaction Party agrees that neither the Program Administrator nor the Conduit Agent shall have any liability hereunder as the Program Administrator or the Conduit Agent, as the case may be, for the Note Purchaser or otherwise following its ceasing to act as Program Administrator or the Conduit Agent for the Note Purchaser. Section 15.16 Confidentiality. No Lessor Party shall disclose to any Person any information with respect to the Guarantor or the Lessee which is furnished pursuant to this Participation Agreement or under any other Operative Document, except that any Lessor Party may disclose any such information (a) to its own directors, officers, employees, auditors, counsel and other advisors and to its Affiliates; (b) to any other Lessor Party; (c) which is otherwise available to the public; (d) if required or appropriate in any report, statement or testimony submitted to any Governmental Authority having or claiming to have jurisdiction over such Lessor Party; (e) if required in response to any summons or subpoena; (f) in connection with any litigation relating to the Operative Documents or the transactions contemplated thereby; (g) to comply with any Requirement of Law applicable to such Lessor Party; (h) to any assignee, participant or any prospective assignee or participant, provided that. such Person agrees to be bound by this Section 15.16; or (i) otherwise with the prior consent of the Guarantor or the Lessee; provided, however, that any disclosure made in violation of this Participation Agreement shall not affect the obligations of the Guarantor or the Lessee under this Participation Agreement and the other Operative Documents. Section 15.17 Renewal of Commitment under the Liquidity Agreement. The parties hereto acknowledge and agree that the Agent (and not the "Issuer", the "Administrator and Program Collateral Agent" or the "Administrative Agent" under the Liquidity Agreement) is responsible for Liquidity Bank renewals under the Liquidity Agreement. Section 15.18 Tax Representation: Tax Forms. (a) Each Lessor Party represents that, except for any withholding of U.S. federal income tax which results from the adoption of or a change in applicable law, regulation or, in each case, the interpretation or administration thereof by any Governmental Authority charged with the interpretation or administration thereof (whether or not having the force of law) (including any statute, treaty, ruling or regulation by a governmental, judicial or taxing authority), with respect to Indebtedness of the Lessee or any other party to the Operative Documents for federal income tax purposes (and assuming that the payments of (x) Basic Rent and (y) Purchase Option Price, Outstanding Lease Balance or Maximum Recourse Amount, as the case may be, are treated for federal income tax purposes as payments of interest and principal, respectively), such Lessor Party is entitled to receive any payments to be made to it by the Lessee or any other party to the Operative Documents without the withholding of any U.S. federal income tax and will furnish to the Agent upon the request of the Lessee such certifications, statements and other documents as are reasonably requested by the Lessee to evidence such Lessor Party's exemption from the withholding of any U.S. federal income tax or to enable the Lessee to comply with any applicable laws or regulations relating thereto. 78 (b) Without limiting the effect of the foregoing Section 15.18(a), if any Lessor Party is not created or organized under the laws of the United States or any state or political subdivision thereof, such Lessor Party will furnish to the Agent upon the request of the Lessee, to the extent required for U.S. federal income tax purposes, Internal Revenue Service Form W-8 BEN or Form W -8 ECI or any subsequent versions of such forms or successors thereto as evidence of such Lessor Party's complete exemption from the withholding of U.S. federal income tax with respect to indebtedness of the Lessee for federal income tax purposes. Such forms shall be delivered by such Lessor Party (i) on or before the date such Lessor Party becomes a party to any of the Operative Documents and promptly before the expiration, obsolescence or invalidity of any form previously delivered by such Lessor Party and (ii) before or promptly after the occurrence of any event requiring a change in the most recent form previously delivered by it to the Lessee pursuant to this Section 15.18, unless, in the case of either clause (i) or (ii), as a result of the adoption of or a change in applicable law, regulation or, in each case, the interpretation or administration thereof by any Governmental Authority charged with the interpretation or administration thereof (whether or not having the force of law) (including any statute, treaty, ruling or regulation by a governmental, judicial or taxing authority), such Lessor Party is not entitled to provide such a form. The Agent and the Lessee shall be entitled to rely on such forms in its possession until receipt of any revised or successor form pursuant to the preceding sentence. (c) For any period with respect to which any Lessor Party is required under subsection (a) or (b) above to furnish the Agent with the appropriate forms described in such subsections but has failed to do so (other than if such failure is due to the adoption of or a change in applicable law as described in subsection (a) or (b) above), such Lessor Party shall not be entitled to any indemnification with respect to Impositions under Section 13.4 hereof, additional payments with respect to increased costs under Section 4.4 hereof, or additional payments with respect to Other Taxes under Section 4.6 hereof to the extent that such Impositions, increased costs or Other Taxes are imposed as a result of such failure; provided, however, that such limitation on indemnification shall not apply to Structural Impositions or Prior Impositions, and this Section 15.18 shall not otherwise be construed to limit any right to indemnification of any Lessor Party relating to Structural Impositions or Prior Impositions under any Operative Document or in connection with the Overall Transaction. ARTICLE XVI RELATIONSHIP BETWEEN MASTER LEASE AND OTHER OPERATIVE DOCUMENTS Section 16.1 Conflicts with Master Lease in General. The parties hereto acknowledge and agree that in the event there is deemed to be any conflict or ambiguity between the terms and provisions hereof and in the other Operative Documents (other than the Master Lease) and the terms and provisions of the Master Lease, the terms and provisions hereof and/or such other Operative Documents shall control. Section 16.2 Specific Provisions of the Master Lease. Without limiting the generality of the foregoing Section 16.1, with respect to certain terms and provisions of the Master Lease the parties hereto acknowledge and agree as follows: 79 (a) The following terms as defined in Section 1 of the Master Lease are no longer applicable and, to the extent such terms are otherwise defined in Appendix A, such terms are hereby replaced with the corresponding defined term set forth in Appendix A (or such other terms as noted below): (i) "Agreement for Lease"; (ii) "Aircraft"; (iii) "Consent"; (iv) "Consolidated Fixed Charges"; (v) "EBITDAR"; (vi) "Engine"; (vii) "Equipment" (viii) "Fixed Charge Coverage Ratio"; (ix) "Ground Lease"; (x) "Implied Senior Debt Rating"; (xi) "Indebtedness"; (xii) "Initial Term"; (xiii) "Lien"; (xiv) "Mortgageable Ground Lease"; (xv) "Permitted Liens"; (xvi) "Reconciliation Amount"; (xvii) "Responsible Officer"; (xviii) "Tangible Net Worth"; and (xix) "Unit Leasing Record"; provided, however, that the terms "Merrill", "Merrill Leasing" and "Merrill Lynch" as used in the Master Lease shall be interpreted to refer to "Agent" where the context so requires. (b) The representations, warranties and agreements of the Lessee contained in Section 2 of the Master Lease are no longer applicable, shall be disregarded, and are hereby replaced with the provisions set forth in Article VII hereof. (c) The covenants and agreements (if any) of the Lessor contained in Section 3 of the Master Lease providing, inter alia, that the Lessor lease to the Lessee any property or equipment, when and as the Lessee has need of such property or equipment shall be construed to only require that the Lessor lease to the Lessee the Property currently subject to the Master Lease. (d) Sections 5(a), (b), (c) and (d) of the Master Lease are no longer applicable and shall be disregarded. (e) Section 8(i) of the Master Lease is no longer applicable and shall be disregarded. (f) Section 9(f) of the Master Lease is no longer applicable and shall be disregarded. 80 (g) Sections 10 (a), (b), (d) and (e) of the Master Lease are no longer applicable and shall be disregarded (h) Sections 10(g) and (h) of the Master Lease are no longer applicable, shall be disregarded, and are hereby replaced with the following provisions: (i) Risk of Loss, Damage or Destruction During the Lease Term or Following the Occurrence and Continuance of a Default or Event of Default or To the Extent Arising as a Result of Any of the Lessee's Actions or Failures To Act. At all times during the Lease Term, the risk of loss of or decrease in the enjoyment and beneficial use of the Property as a result of the damage or destruction thereof by fire, the elements, casualties, thefts, riots, wars or other acts of God, taking, destruction, confiscation, requisition or commandeering, partial or complete, of or to the Improvements and any part thereof, however caused or occasioned, shall be borne by the Lessee until the Property has been returned to the Lessor in accordance with the provisions of the Master Lease or has been purchased by the Lessee or another Person in accordance with the provisions of the Master Lease. The Lessee agrees that no occurrence specified in the preceding sentencing shall impair, in whole or in part, any obligation of the Lessee hereunder or under the Master Lease, including the obligation to pay Basic Rent and Supplemental Rent. (ii) Casualty and Condemnation. (A) Subject to the provisions of this Section 16.2(h), including, without limitation, the second paragraph of this subclause (ii)(A), if all or a portion of the Property is damaged or destroyed in whole or in part by a Casualty (other than a Casualty constituting an Event of Loss), any insurance proceeds under the Lessee's policies payable with respect to such Casualty shall be paid directly to the Lessee (subject to the provisions of Section 10 of the Master Lease), or if received by any of the Lessor Parties, shall be paid over to the Lessee, for the reconstruction, refurbishment and for repair of the Property and if the use, access, occupancy, easement rights or title to the Property or any part thereof is the subject of a Condemnation (other than a Condemnation constituting an Event of Loss), then any award or compensation relating thereto shall be paid to the Lessee. All amounts held by the Lessor or any other Lessor Party on account of any award, compensation or insurance proceeds either paid directly to any Lessor Party or turned over to any Lessor Party, in each case in accordance with the preceding sentence, shall (in the absence of any Default or Event of Default) be paid to the Lessee for the repair of damage caused by such Casualty or Condemnation in accordance with subclause (ii)(D) of this Section 16.2(h). Notwithstanding the foregoing, if any Default, Event of Default, Acceleration Event or Unmatured Acceleration Event shall have occurred and be continuing, any award, compensation or insurance proceeds described above shall be paid directly to the Agent or, if received by the Lessee, shall be held in trust for the Agent and shall be paid over by the Lessee to the Agent to be distributed by the Agent in accordance with the relevant provisions of Article XI hereof. 81 Furthermore, if any Default shall have occurred and be continuing, any such award, compensation or insurance proceeds shall be paid directly to the Agent or, if received by the Lessee, shall be held in trust by the Lessee for the benefit of the Agent and shall be paid to the Agent for deposit in an Eligible Account until (i) such Default has been cured, in which case such money shall be paid to the Lessee for the uses described in the first sentence of this subclause (ii)(A} or (ii) such Default becomes an Event of Default, in which case, such money shall be distributed in accordance with the preceding sentence. (B) The Lessee may appear in any proceeding or action to negotiate, prosecute, adjust or appeal any claim for any award, compensation or insurance payment on account of any such Casualty or Condemnation and shall pay all expenses thereof. At the Lessee's reasonable request, and at the Lessee's sole cost and expense, the Lessor Parties shall participate in any such proceeding, action, negotiation, prosecution or adjustment. The Lessor and the Lessee agree that this Section 16.2(h) and the Master Lease shall control the rights of the Lessor and the Lessee in and to any such award or compensation payment. (C) If the Lessor or the Lessee shall receive notice of a Casualty for which the reasonable anticipated cost of restoration equals or exceeds $1,000,000 (whether individually or in the aggregate with all other Improvements affected by the event giving rise to such Casualty) or of an actual, pending or threatened Condemnation of any Land or Improvements or any interest therein (other than an interest which is not material), the Lessor or the Lessee, as the case may be, shall give notice thereof to the other party and to Agent who will in turn notify the other Lessor Parties promptly after the receipt of such notice. (D) If neither the Lessor nor any Lessor Party exercises its termination rights pursuant to Section 14 of the Master Lease following an Event of Loss, the Master Lease shall continue in full force and effect, the Lessee shall, at its sole cost and expense (and, without limitation, if any award, compensation or insurance payment is not sufficient to restore such affected Improvement in accordance with this subclause (ii)(D), the Lessee shall pay the shortfall), promptly and diligently repair any damage to the Property caused by such Casualty or Condemnation in conformity with the requirements of Section 9 of the Master Lease, so as to restore the Property to at least the same or similar condition, operation, function and value as existed immediately prior to such Casualty or Condemnation with such Modifications as the Lessee may elect in accordance with Section 9 of the Master Lease. In such event, title to such Property shall remain with the Lessor subject to the terms of the Master Lease. Upon completion of such restoration, the Lessee shall furnish the Lessor an architect's certificate of substantial completion or a Responsible Officer's Certificate confirming that such restoration has been completed pursuant to the Master Lease. 82 (E) In no event shall a Casualty or Condemnation affect the Lessee's obligations to pay Basic Rent or Supplemental Rent pursuant to Section 7 of the Master Lease or otherwise to perform its obligations and pay any amounts due on the Financing Termination Date or pursuant to Sections 12, 13 and 18 of the Master Lease. (F) Any excess Casualty Proceeds or Condemnation Proceeds received by the Lessor or any of the other Lessor Parties in respect of a Casualty or Condemnation constituting an Event of Loss with respect to the Property shall be turned over to the Agent for application in accordance with the provisions of Section 11.5 hereof; provided, however, if the Lessee elects to exercise its right to purchase the Property pursuant to Section 14 of the Master Lease, then such excess proceeds shall be not be applied pursuant to Section 11.5 hereof and instead, be returned to the Lessee upon payment of the full purchase price for the Property pursuant to Section 14 of the Master Lease. (i) The covenants and agreements of the Lessee with respect to indemnification, etc. contained in Section 11 of the Master Lease with respect to Claims for events or occurrences arising after the Documentation Date are no longer applicable, shall be disregarded, and are hereby replaced with the provisions set forth in Article XIII hereof. (j) With respect to the provisions set forth in Section 12 of the Master Lease, the Lessee and the Lessor hereby acknowledge and agree that unless the KeyBank Financing Term is extended, failure by the Lessee to deliver a Remarketing Notice or Purchase Notice on or prior to the date occurring three hundred and sixty-four (364) days prior to the expiration of the KeyBank Financing Term shall be deemed to be an election by the Lessee, without further act thereby, of the Purchase Option described in Section 13.1(a) of the Master Lease, with such purchase to be consummated on the Financing Termination Date. (k) Clauses (i) through (iii) of Section 14(a) of the Master Lease are no longer applicable and shall be disregarded. (1) Section 15 of the Master Lease is no longer applicable, shall be disregarded, and is hereby replaced with the provisions of clauses (i) and (ii) of Section 16.2(h) hereof. (m)Sections 17(b), (c) and (d) of the Master Lease are no longer applicable and shall be disregarded. (n) All references to "Equipment" or "Unit of Equipment" contained in the Events of Default set forth in Section 18 of the Master Lease are no longer applicable and shall be disregarded. (o) Section 20 of the Master Lease is no longer applicable and shall be disregarded. (p) Section 21 of the Master Lease is no longer applicable, shall be disregarded, and is hereby replaced with the provisions set forth in Article XII hereof. 83 (q) Section 26 of the Master Lease is no longer applicable, shall be disregarded, and is hereby replaced with the provisions set forth in Section 8.1(d) hereof. (r) Section 29 of the Master Lease is no longer applicable and shall be disregarded. (s) Section 30(i) of the Master Lease is no longer applicable and shall be disregarded. (t) Exhibits Band D of the Master Lease are no longer applicable and shall be disregarded. [Signature Page Follows] 84 IN WITNESS WHEREOF, the parties hereto have caused this Participation Agreement to be duly executed by their respective officers thereunto duly authorized as of the day and year first above written. ELECTRONIC ARTS REDWOOD, INC. as the Lessee By: /s/ Khuyen Dang --------------- Name : Khuyen Dang Title: Chief Financial Officer 85 ELECTRONIC ARTS, INC., as the Guarantor By: /s/ David L. Carbone ----------------------------------- Name: David L. Carbone Title: Senior Vice President - Finance 86 FLATIRONS FUNDING, LIMITED PARTNERSHIP, as the Lessor By:____________________________________ SELCO REDWOOD, LLC, its General Partner By:____________________________________ SELCO Service Corporation, an Ohio corporation doing business in California as Ohio SELCO Service Corporation, its sole member By: /s/ Donald C. Davis ------------------------------------ Name: Donald C. Davis Title: Vice President SELCO SERVICE CORPORATI0N, doing business in California as Ohio SELCO Service Corporation, as a New Partner By: /s/ Donald Davis ------------------------------------ Name: Donald Davis Title: Vice President SELCO REDWOOD, LLC, as a New Partner By:____________________________________ SELCO Service Corporation, an Ohio corporation doing business in California as Ohio SELCO Service Corporation, its sole member By: /s/ Donald C. Davis ------------------------------------ Name: Donald C. Davis Title: Vice President VICTORY RECEIVABLES CORPORATION, as the Note Purchaser By: /s/ Karen Anne Granquist ------------------------- Name: Karen Anne Granquist Title: Secretary KEYBANK NATIONAL ASSOCIATION, as the Agent, By: /s/ Thomas A. Crandell ------------------------------------ Name: Thomas A. Crandell Title: Senior Vice President 87 THE BANK OF TOKYO-MITSUBISHI, LTD., NEW YORK BRANCH, as the Conduit Agent By: /s/ Aditya Reddy ------------------------------------ Name: Aditya Reddy Title: Vice President KEYBANK NATIONAL ASSOCIATION, as a Liquidity Bank By: /s/ Thomas A. Crandell ------------------------------------ Name: Thomas A. Crandell Title: Senior Vice President 89 FLEET NATIONAL BANK, as a Liquidity Bank By: /s/ Greg Roux -------------- Name: Greg Roux Title: Director WELLS FARGO BANK, NATIONAL ASSOCIATION, as a liquidity Bank By: /s/ Eric C. Houser ------------------------------- Name: Eric C. Houser Title: Vice President THE CHASE MANHATTAN BANK, as a Liquidity Bank By: /s/ David Gibbs ------------------------------- Name: David Gibbs Title: Vice President U.S. BANK NATIONAL ASSOCIATION, as a Liquidity Bank /s/ Garrett Baker - ----------------- Name: Garrett Baker Title: Vice President BNP PARIBAS, as a Liquidity Bank By: /s/ Robert Mimaki ------------------------------- Name: Robert Mimaki Title: Vice President By: /s/ Sean T. Conlon ------------------------------- Name: Sean T. Conlon Title: Managing Director KEYBANK NATIONAL ASSOCIATION, as a Tranche B Bank By: /s/ Julien Michaels -------------------- Name: Julien Michaels Title: Vice President EX-21.01 7 dex2101.txt SUBSIDIARIES OF THE REGISTRANT SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21.01
Name in Jurisdiction Corporate Articles Doing Business As of Incorporation ------------------ ----------------- ---------------- ORIGIN Systems, Inc. ORIGIN Systems, Inc. Texas Electronic Arts, Proprietary Limited (formerly Electronic Arts, Pty. Ltd. (formerly Entertainment and Computer Proprietary, Entertainment and Computer Proprietary, Commonwealth of Limited) Limited) Australia Electronic Arts (Canada) Inc. Electronic Arts (Canada) Inc. (formerly British Columbia, (formerly Distinctive Software, Inc.) Distinctive Software, Inc.) Canada Electronic Arts, Limited Electronic Arts, Limited United Kingdom Electronic Arts GmbH Electronic Arts GmbH Germany EA Kabushiki Kaisha Electronic Arts K.K. Japan Electronic Arts Productions, Inc. Crocodile Productions Delaware Electronic Arts Puerto Rico Inc. Electronic Arts Puerto Rico Inc. Delaware Electronic Arts International Corporation Electronic Arts International Corporation California Electronic Arts Software S.L. (formerly Electronic Arts Software S.L. (formerly DROSoft) DROSoft) Spain Bullfrog Productions Ltd. Bullfrog Productions Ltd. United Kingdom Electronic Arts Productions Ltd. Electronic Arts Productions Ltd. United Kingdom Electronic Arts Nordic Aktienbolag Electronic Arts Nordic Aktienbolag Sweden Electronic Arts Asia Pacific PTE., LTD Electronic Arts Asia Pacific PTE., LTD Singapore Electronic Arts Seattle Inc. Electronic Arts Seattle Inc. Washington Vision Software (Pty) Limited Vision Software (Pty) Limited South Africa Electronic Arts V.I., Inc. Electronic Arts V.I., Inc. Virgin Islands (U.S.) Linear Arts, Inc. Linear Arts, Inc. Delaware EA UK Holding Co. EA UK Holding Co. Delaware
EA Islands Ltd. EA Islands Ltd. British Virgin Islands Electronic Arts Limitada EA Brazil Brazil Electronic Arts Nederland B.V. Electronic Arts BV The Netherlands Electronic Arts Portugal Electronic Arts Portugal Portugal Electronic Arts C.V. Electronic Arts C.V. Barbados Electronic Arts Project Inc. Electronic Arts Project Inc. Delaware Maxis K.K. Maxis K.K. Japan Electronic Arts Redwood Inc. Electronic Arts Redwood Inc. Delaware Electronic Arts Handelsges.m.b.H Electronic Arts Austria Austria Electronic Arts Square K.K. Electronic Arts Square Japan Electronic Arts Switzerland GmbH Electronic Arts Switzerland Switzerland Tiburon Entertainment, Inc. Tiburon Florida Westwood Studios, Inc. Westwood Nevada Kesmai Aries Ltd Kesmai Aries Ltd Virginia Kesmai Studios Inc. Kesmai Studios Inc. Virginia Kesmai Internet Game Resources Inc. Gamestorm Virginia Pogo Corporation Pogo.com Inc. Delaware Parnassus Data Inc. Parnassus Data Inc. Delaware EA.com Inc. (formerly EASV) EA.com Inc. Delaware ABC Software GmbH ABC Software GmbH Switzerland Electronic Arts World LLC Electronic Arts World LLC Delaware Electronic Arts Studio (UK) Limited Electronic Arts Studio (UK) Limited United Kingdom Electronic Arts Publishing SARL Electronic Arts Publishing SARL France Electronic Arts Marketing EURL Electronic Arts Marketing EURL France Electronic Arts Studio EURL Electronic Arts Studio EURL France Electronic Arts Distribution EURL Electronic Arts Distribution EURL France
EX-23.01 8 dex2301.txt CONSENT OF KPMG, LLP, INDEPENDENT AUDITORS EXHIBIT 23.01 Consent of KPMG, LLP, Independent Auditors The Board of Directors and Stockholders Electronic Arts Inc.: The audits referred to in our report dated May 3, 2002, include the related financial statement schedule as of March 31, 2002, and for each of the years in the three-year period ended March 31, 2002, included in Electronic Arts Inc.'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, 333-09683, 333-09893, 333-32239, 333-32771, 333-46937, 333-60513, 333-60517, 333-84215, 333-39430, 333-39432, 333-44222, 333-60256, 333-67430 and 333-82888) on Form S-8 of Electronic Arts Inc. of our reports dated May 3, 2002 relating to the consolidated balance sheets of Electronic Arts Inc. and subsidiaries as of March 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended March 31, 2002, and the related financial statement schedule, which reports appear in the March 31, 2002, annual report on Form 10-K of Electronic Arts Inc. KPMG LLP Mountain View, California June 28, 2002 -----END PRIVACY-ENHANCED MESSAGE-----