UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

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

For the Quarterly Period Ended September 30,December 31, 2003

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period fromto

[ ] 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.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) 94-2838567
(I.R.S. Employer
Identification No.)
   
209 Redwood Shores Parkway
Redwood City, California
94065
(Address of principal executive offices) 94065
(Zip Code)

(650) 628-1500

(Registrant’s telephone number, including area code)

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

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

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

               
 Outstanding at  Outstanding as of
Class of Common Stock Par Value November 03, 2003  Par Value February 4, 2004
 
 
Class A common stock $0.01 148,934,841  $0.01 298,905,714 

 

TABLE OF CONTENTS

PART I —– FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
SIGNATURESSIGNATURE
EXHIBIT INDEX
EXHIBIT 10.293.02
EXHIBIT 10.30
EXHIBIT 10.31
EXHIBIT 10.3210.33
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

ELECTRONIC ARTS INC.
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30,DECEMBER 31, 2003

Table of Contents

         
      Page
Part I — FINANCIAL INFORMATIONPage
     
Part I — FINANCIAL INFORMATION    
Item 1. Unaudited Condensed Consolidated Financial Statements    
     
Condensed Consolidated Balance Sheets as of
September 30, December 31, 2003 and March 31, 2003		  3 
     
Condensed Consolidated Statements of Operations for
the Three Months Ended September 30,December 31, 2003 and 2002 and
the SixNine Months Ended September 30,December 31, 2003 and 2002		  4 
     
Condensed Consolidated Statements of Cash Flows for
the SixNine Months Ended September 30,December 31, 2003 and 2002		  5 
     
Notes to Condensed Consolidated Financial Statements  6
7 
Item 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations		  20
21 
Item 3. Quantitative and Qualitative Disclosures About Market Risk  41
43 
Item 4. Controls and Procedures  4346 
Part II — OTHER INFORMATION
    
Item 1. Legal Proceedings  44
Item 4.Submission of Matters to a Vote of Security Holders44
47 
Item 6. Exhibits and Reports on Form 8-K  4447 
Signature  
Signatures45
48 
Exhibit Index  4649 

2

PART I —– FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

ELECTRONIC ARTS INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED BALANCE SHEETS
         
(unaudited)September 30, March 31, 
(In thousands, except share data) 2003  2003 (a) 
 
 
ASSETS
        
Current assets:        
Cash and cash equivalents $376,125  $949,995 
Short-term investments  1,358,049   637,623 
Marketable equity securities  771   1,111 
Receivables, net of allowances of $126,806 and $164,634, respectively  202,802   82,083 
Inventories, net  39,209   39,679 
Deferred income taxes  117,682   117,180 
Other current assets  98,405   83,466 
       
Total current assets  2,193,043   1,911,137 
 
Property and equipment, net  273,305   262,252 
Investments in affiliates  12,909   20,277 
Goodwill  88,650   86,031 
Other intangibles, net  19,784   21,301 
Long-term deferred income taxes  13,840   13,523 
Other assets  15,503   45,012 
       
  $2,617,034  $2,359,533 
       
 
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
        
 
Current liabilities:        
Accounts payable $129,348  $106,329 
Accrued and other liabilities  416,251   464,547 
       
Total current liabilities  545,599   570,876 
 
Commitments and contingencies  —   — 
Minority interest in consolidated joint venture  —   3,918 
 
Stockholders’ equity:        
Preferred stock, $0.01 par value. 10,000,000 shares authorized  —   — 
Common stock        
Class A common stock, $0.01 par value. 400,000,000 shares authorized;
296,959,700 and 288,266,610 shares issued and outstanding, respectively		  2,970   2,883 
Class B common stock, $0.01 par value. 100,000,000 shares authorized;
200,130 and 225,130 shares issued and outstanding, respectively		  2   2 
Paid-in capital  1,036,717   856,428 
Retained earnings  1,018,848   923,892 
Accumulated other comprehensive income  12,898   1,534 
       
Total stockholders’ equity  2,071,435   1,784,739 
       
  $2,617,034  $2,359,533 
       
            
(unaudited) December 31,  March 31, 
(In thousands, except share data) 2003  2003 (a) 
  
  
 
ASSETS
        
 
 Current assets:        
  Cash and cash equivalents $573,010  $949,995 
  Short-term investments  1,251,659   637,623 
  Marketable equity securities  2,090   1,111 
  Receivables, net of allowances of $206,632 and $164,634, respectively  837,021   82,083 
  Inventories, net  64,766   39,679 
  Deferred income taxes  61,749   117,180 
  Other current assets  117,945   83,466 
  
  
 
   Total current assets  2,908,240   1,911,137 
 
 Property and equipment, net  280,026   262,252 
 Investments in affiliates  13,551   20,277 
 Goodwill  89,858   86,031 
 Other intangibles, net  19,150   21,301 
 Long-term deferred income taxes  13,614   13,523 
 Other assets  13,989   45,012 
  
  
 
  
TOTAL ASSETS
 $3,338,428  $2,359,533 
  
  
 
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
        
 
 Current liabilities:        
  Accounts payable $158,743  $106,329 
  Accrued and other liabilities  682,765   464,547 
  
  
 
   Total current liabilities  841,508   570,876 
 
 Commitments and contingencies  —   — 
 Minority interest in consolidated joint venture  —   3,918 
 
 Stockholders’ equity:        
 Preferred stock, $0.01 par value. 10,000,000 shares authorized  —   — 
 Common stock        
  Class A common stock, $0.01 par value. 400,000,000 shares authorized; 298,433,515 and 288,266,610 shares issued and outstanding, respectively  2,984   2,883 
  Class B common stock, $0.01 par value. 100,000,000 shares authorized; 200,130 and 225,130 shares issued and outstanding, respectively  2   2 
  Paid-in capital  1,065,001   856,428 
 Retained earnings  1,411,144   923,892 
 Accumulated other comprehensive income  17,789   1,534 
  
  
 
   Total stockholders’ equity  2,496,920   1,784,739 
  
  
 
  
TOTAL LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
 $3,338,428  $2,359,533 
  
  
 

See accompanying Notes to Condensed Consolidated Financial Statements.

(a) Derived from audited financial statements.

3

ELECTRONIC ARTS INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                   
    Three Months Ended  Nine Months Ended 
    December 31,  December 31, 
(unaudited) 
  
 
(In thousands, except per share data) 2003  2002  2003  2002 
  
  
  
  
 
Net revenue $1,475,323  $1,233,726  $2,358,709  $2,019,114 
Cost of goods sold  513,255   565,111   876,980   908,432 
  
  
  
  
 
 
 Gross profit  962,068   668,615   1,481,729   1,110,682 
 
Operating expenses:                
 Marketing and sales  180,174   139,492   303,299   260,380 
 General and administrative  71,992   42,250   138,784   95,366 
 Research and development  151,175   106,127   355,790   292,171 
 Amortization of intangibles  623   2,245   2,113   6,736 
 Restructuring charges  596   8,026   596   8,026 
 Asset impairment charges  —   1,352   —   1,352 
  
  
  
  
 
 
  Total operating expenses  404,560   299,492   800,582   664,031 
  
  
  
  
 
 
  Operating income  557,508   369,123   681,147   446,651 
 
Interest and other income (expense), net  948   (4,439)  14,927   (115)
  
  
  
  
 
 Income before provision for income taxes and minority interest  558,456   364,684   696,074   446,536 
Provision for income taxes  166,160   113,052   208,822   138,426 
  
  
  
  
 
 
 Income before minority interest  392,296   251,632   487,252   308,110 
Minority interest in consolidated joint venture  —   (1,413)  —   (253)
  
  
  
  
 
 
 Net income $392,296  $250,219  $487,252  $307,857 
  
  
  
  
 
 
Net earnings (loss) per share:                
 
 Class A common stock:                
 Net income:                
  Basic $392,296  $253,694  $487,252  $317,495 
  Diluted $392,296  $250,219  $487,252  $307,857 
 Net earnings per share:                
  Basic $1.32  $0.89  $1.66  $1.13 
  Diluted $1.26  $0.85  $1.59  $1.05 
 Number of shares used in computation:                
  Basic  297,787   283,777   294,001   280,386 
  Diluted  311,463   296,050   306,737   293,721 
 
 Class B common stock:                
 Net loss, net of retained interest in EA.com  N/A  $(3,475)  N/A  $(9,638)
 Net loss per share:                
  Basic  N/A  $(0.86)  N/A  $(1.84)
  Diluted  N/A  $(0.86)  N/A  $(1.84)
 Number of shares used in computation:                
  Basic  N/A   4,051   N/A   5,247 
  Diluted  N/A   4,051   N/A   5,247 
                 
  Three Months Ended  Six Months Ended 
(unaudited) September 30,  September 30, 
(In thousands, except per share data) 2003  2002  2003  2002 
 
 
Net revenue $530,005  $453,490  $883,386  $785,388 
Cost of goods sold  213,762   200,867   363,725   343,321 
             
 
Gross profit  316,243   252,623   519,661   442,067 
             
Operating expenses:                
Marketing and sales  64,041   55,514   123,125   120,888 
General and administrative  36,032   27,453   66,792   53,116 
Research and development  113,493   96,164   204,615   186,044 
Amortization of intangibles  810   2,246   1,490   4,491 
             
 
Total operating expenses  214,376   181,377   396,022   364,539 
             
 
Operating income  101,867   71,246   123,639   77,528 
Interest and other income, net  9,130   1,177   13,979   4,324 
             
 
Income before provision for income taxes and minority interest  110,997   72,423   137,618   81,852 
Provision for income taxes  34,409   22,451   42,662   25,374 
             
 
Income before minority interest  76,588   49,972   94,956   56,478 
Minority interest in consolidated joint venture  —   262   —   1,160 
             
 
Net income $76,588  $50,234  $94,956  $57,638 
             
 
Net earnings (loss) per share:                
Class A common stock:                
Net income:                
Basic $76,588  $53,407  $94,956  $63,801 
Diluted $76,588  $50,234  $94,956  $57,638 
Net earnings per share:                
Basic $0.26  $0.19  $0.32  $0.23 
Diluted $0.25  $0.17  $0.31  $0.20 
Number of shares used in computation:                
Basic  294,836   279,686   292,263   278,633 
Diluted  307,779   293,237   304,013   292,538 
 
Class B common stock:                
Net loss, net of retained interest in EA.com  N/A  $(3,173)  N/A  $(6,163)
Net loss per share:                
Basic  N/A  $(0.57)  N/A  $(1.07)
Diluted  N/A  $(0.57)  N/A  $(1.07)
Number of shares used in computation:                
Basic  N/A   5,547   N/A   5,759 
Diluted  N/A   5,547   N/A   5,759 

See accompanying Notes to Condensed Consolidated Financial Statements.

4

ELECTRONIC ARTS INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

         
  Six Months Ended 
(unaudited) September 30, 
(In thousands) 2003  2002 
 
 
OPERATING ACTIVITIES
        
 
Net income $94,956  $57,638 
Adjustments to reconcile net income to net cash provided by operating activities:        
Minority interest in consolidated joint venture  —   (1,160)
Depreciation and amortization  30,847   49,373 
Equity in net income of affiliates  (113)  (1,313)
Other-than-temporary impairment of assets  589   2,830 
Loss on sale of property, equipment and marketable equity securities  45   115 
Stock-based compensation  429   2,161 
Tax benefit from exercise of stock options  40,169   16,866 
Change in assets and liabilities:        
Accounts receivable, net  (133,034)  52,900 
Inventories, net  (406)  (38,586)
Other assets  13,167   (59,870)
Accounts payable  25,309   31,726 
Accrued and other liabilities  (43,711)  (27,111)
       
 
Net cash provided by operating activities  28,247   85,569 
       
 
INVESTING ACTIVITIES
        
Proceeds from sale of property and equipment  88   411 
Proceeds from sale of investments in affiliate  8,467   — 
Capital expenditures  (28,690)  (23,386)
Purchase of investments in affiliates  —   (405)
Purchase of short-term investments  (1,270,579)  (264,480)
Proceeds from maturities and sales of short-term investments  547,792   218,268 
Distribution from investment in affiliate  —   3,000 
Acquisition of subsidiary, net of cash acquired  —   (12,868)
       
 
Net cash used in investing activities  (742,922)  (79,460)
       
 
FINANCING ACTIVITIES
        
Proceeds from sales of common stock through employee stock plans and other plans  139,875   61,282 
Repurchase of Class B common stock  (225)  — 
Dividend to joint venture and purchase of minority interest  (5,100)  (751)
Repayment of Class B notes receivable  128   — 
       
 
Net cash provided by financing activities  134,678   60,531 
       
 
Effect of foreign exchange on cash and cash equivalents  6,127   8,005 
       
Increase (decrease) in cash and cash equivalents  (573,870)  74,645 
Beginning cash and cash equivalents  949,995   552,826 
       
Ending cash and cash equivalents  376,125   627,471 
Short-term investments  1,358,049   293,297 
       
 
Ending cash, cash equivalents and short-term investments $1,734,174  $920,768 
       
 
Supplemental cash flow information:
        
Cash paid during the period for income taxes $4,567  $4,052 
       
 
Non-cash investing activities:
        
Change in unrealized appreciation (loss) on investments and marketable equity securities $(2,186) $2,635 
       
 
Non-cash financing activities:
        
Conversion of 2,000,000 shares of Class B common stock for 412,908 shares of Class A common stock $—  $9,353 
       
             
      Nine Months Ended 
      December 31, 
(unaudited) 
 
(In thousands) 2003  2002 
  
  
 
OPERATING ACTIVITIES
        
 Net income $487,252  $307,857 
 Adjustments to reconcile net income to net cash provided by operating activities:        
  Depreciation and amortization  59,915   74,329 
  Equity in net income of investments in affiliates  (405)  (4,213)
  Non-cash restructuring and asset impairment charges  596   1,352 
  Other-than-temporary impairment of investments in affiliates  589   10,590 
  Loss on sale of property, equipment and marketable equity securities  583   379 
  Stock-based compensation  666   864 
  Minority interest in consolidated joint venture  —   253 
  Tax benefit from exercise of stock options  41,845   36,765 
  Change in assets and liabilities:        
   Accounts receivable, net  (786,595)  (416,763)
   Inventories, net  (26,057)  (19,086)
   Other assets  (5,340)  3,569 
   Accounts payable  54,124   58,222 
   Accrued and other liabilities  279,919   229,392 
  
  
 
 
    Net cash provided by operating activities  107,092   283,510 
  
  
 
 
INVESTING ACTIVITIES
        
 Capital expenditures  (55,937)  (34,470)
 Proceeds from sale of property and equipment  113   679 
 Purchase of investments in affiliates  (350)  (531)
 Proceeds from sale of investments in affiliate  8,467   — 
 Purchase of short-term investments  (1,890,779)  (596,845)
 Proceeds from maturities and sales of short-term investments  1,273,398   445,215 
 Proceeds from sale of marketable equity securities  2   4,794 
 Purchase of minority interest  (2,513)  — 
 Distribution from investment in affiliate  —   3,000 
 Acquisition of subsidiary, net of cash acquired  (958)  (12,868)
  
  
 
 
    Net cash used in investing activities  (668,557)  (191,026)
  
  
 
 
FINANCING ACTIVITIES
        
 Proceeds from sales of common stock through employee stock plans and other plans  166,260   109,877 
 Repurchase of Class B common stock  (225)  — 
 Repayment of Class B notes receivable  128   — 
 Dividend to joint venture  (2,587)  (751)
  
  
 
 
    Net cash provided by financing activities  163,576   109,126 
  
  
 
 
Effect of foreign exchange on cash and cash equivalents  20,904   11,632 
  
  
 
Increase (decrease) in cash and cash equivalents  (376,985)  213,242 
Beginning cash and cash equivalents  949,995   552,826 
  
  
 
Ending cash and cash equivalents  573,010   766,068 
Short-term investments  1,251,659   399,258 
  
  
 
 
Ending cash, cash equivalents and short-term investments $1,824,669  $1,165,326 
  
  
 

5

ELECTRONIC ARTS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CONTINUED

         
  Nine Months Ended 
  December 31, 
(unaudited) 
 
(In thousands, except share data) 2003  2002 
  
  
 
 
Supplemental cash flow information:
        
  
  
 
Cash paid during the period for income taxes $12,735  $5,358 
  
  
 
 
Non-cash investing activities:
        
  
  
 
Change in unrealized appreciation (loss) on investments and marketable equity securities $(3,464) $3,075 
  
  
 
 
Non-cash financing activities:
        
  
  
 
Conversion of 2,000,000 shares of Class B common stock for 412,908 shares of Class A common stock $—  $9,353 
  
  
 

See accompanying Notes to Condensed Consolidated Financial Statements.

56

ELECTRONIC ARTS INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1) BASIS OF PRESENTATION

The Condensed Consolidated Financial Statements are unaudited and reflect all adjustments (consisting only of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim periods are not necessarily indicative of results to be expected for the current year or any other period. Certain prior year amounts have been reclassified to conform to the fiscal 2004 presentation.

These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Electronic Arts Inc. (“EA”) Annual Report on Form 10-K for the fiscal year ended March 31, 2003 as filed with the Securities and Exchange Commission on June 10, 2003.

On October 20, 2003, EA’sour Board of Directors authorized a two-for-one stock split of itsour Class A common stock which will bewas distributed on or about November 17, 2003 in the form of a stock dividend for shareholders of record at the close of business on November 3, 2003. All issued and outstanding share and per share amounts related to EA’sthe Class A common stock in the accompanying Condensed Consolidated Financial Statements and Notes thereto have been restated to reflect the stock split for all periods presented.

(2) FISCAL YEAR AND FISCAL QUARTER

EA’sOur fiscal year is reported on a 52/53-week period that ends on the final Saturday of March in each year. The results of operations for fiscal 2004 and 2003 contain 52 weeks. The results of operations for the fiscal quarters ended September 30,December 31, 2003 and September 30,December 31, 2002 each contain 13 weeks ending on SeptemberDecember 27, 2003 and SeptemberDecember 28, 2002, respectively. For simplicity of presentation, all fiscal periods are treated as ending on a calendar month end.

(3) STOCK

Tracking Stock

On March 22, 2000, theour stockholders of EA authorized the issuance of a new series of common stock, designated as Class B common stock (“Tracking Stock”). The Tracking Stock, which was intended to reflect the performance of the EA.com business segment. As a result, of the approval of the Tracking Stock Proposal, EA’sour existing common stock was re-classified as Class A common stock and was intended to reflect the performance of the EAour core business segment (see discussion in Note 8 of the Notes to Condensed Consolidated Financial Statements). With the authorization of the Class B common stock, EATracking Stock, we transferred a portion of itsthe consolidated assets, liabilities, revenue, expenses and cash flows to EA.com Inc., a wholly owned subsidiary of EA.Electronic Arts Inc.

In March 2003, EAwe consolidated the operations of the EA.com business segment into EA’sour core operations in order to increase efficiency, simplify EA’sour reporting structure and more directly integrate EA’s online activities into itsour core console and PC business. As a result, EA haswe have eliminated dual class reporting starting in fiscal 2004. The substantial majority of outstanding Class B options and warrants not directly held by EA have been acquiredrepurchased or converted to Class A shares and warrants.

EA doesSince March 2003, we have not issued, and we do not intend to issue, additional Class B common stock, stock options or warrants to purchase Class B common stock. No further options are available for grant under EA’sthe Class B Equity Incentive Plan, and EA iswe are currently in the process of repurchasing the remaining outstanding Class B shares acquired pursuant to the Class B Equity Incentive Plan.

6

Stock Based Compensation to Employees

EA accountsWe account for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (“APB”) No. 25,“Accounting for Stock Issued to Employees”and related interpretations. EA hasWe have adopted the

7

disclosure-only provisions of StatementStatements of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation”.

In fiscal 2003, EA adopted the disclosure provisions ofand SFAS No. 148,“Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123”,which provides alternative methods of transition for a voluntary change to the fair-value-based method of accounting for stock-based employee compensation. The Statement also amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the methods used on reported results..

Had compensation cost for EA’sour stock option plans and employee stock purchase plans been determined based on the estimated fair value at the grant dates in accordance with the provisions of SFAS No. 123, EA’sour reported net income and net earnings per share would have been the amounts indicated below. The estimated fair value of each option grant is determined on the date of grant using the Black-Scholes option-pricing model.

The following weighted-average assumptions are used for grants made under the stock plans:

              
                 Three Months Ended Nine Months Ended
 Three Months Ended Six Months Ended  December 31, December 31,
 September 30, September 30,  
 
 2003 2002 2003 2002  2003 2002 2003 2002
 
 
 
 
Risk-free interest rate  2.24%  2.27%  2.11%  2.88%Risk-free interest rate  2.5%  2.0%  2.3%  2.4%
Expected volatility  54%  71%  55%  71%Expected volatility  48.0%  68.0%  50.9%  69.4%
Expected life (in years) 2.64 2.26 2.64 2.26 Expected life (in years)  3.12 2.90 3.08 2.90 
Assumed dividends None None None NoneAssumed dividends  None None None None
          
Our calculations are based on a multiple-option valuation approach and forfeitures are recognized when they occur.Our calculations are based on a multiple-option valuation approach and forfeitures are recognized when they occur.
         
 Three Months Ended Nine Months Ended
ConsolidatedConsolidated December 31, December 31,
 
 
(In thousands)(In thousands) 2003 2002 2003 2002
 
 
 
 
Net income:Net income: 
As reported $392,296 $250,219 $487,252 $307,857 
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects  (25,080)  (21,824)  (69,003)  (59,292)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects 25 — 100 — 
 
 
 
 
 
 Proforma $367,241 $228,395 $418,349 $248,565 
 
 
 
 
 
Earnings per share:Earnings per share: 
Please see Class A common stock table below for earnings
per share information		 Please see Class A common stock table below for earnings
per share information		 

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

                 
  Three Months Ended  Six Months Ended 
Consolidated September 30,  September 30, 
(In thousands) 2003  2002  2003  2002 
 
 
Net income:                
As reported $76,588  $50,234  $94,956  $57,638 
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects  (23,750)  (20,689)  (43,923)  (37,468)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects  25   —   74   — 
  
 
Pro forma $52,863  $29,545  $51,107  $20,170 
  
Earnings per share:                
Please see Class A common stock table below for earnings per share information                

78

                 
  Three Months Ended  Six Months Ended 
Class A common stock September 30,  September 30, 
(In thousands, except per share data) 2003  2002  2003  2002 
 
 
Net income:                
 
As reported- basic $76,588  $53,407  $94,956  $63,801 
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects  (23,750)  (20,950)  (43,923)  (37,729)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects  25   —   74   — 
   
Pro forma — basic $52,863  $32,457  $51,107  $26,072 
   
 
As reported — diluted $76,588  $50,234  $94,956  $57,638 
 
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects  (23,750)  (21,023)  (43,923)  (37,802)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects  25   —   74   — 
   
 
Pro forma — diluted $52,863  $29,211  $51,107  $19,836 
   
Earnings (loss) per share:                
As reported — basic $0.26  $0.19  $0.32  $0.23 
Pro forma — basic  0.18   0.12   0.17   0.09 
As reported — diluted  0.25   0.17   0.31   0.20 
Pro forma — diluted  0.17   0.10   0.17   0.07 

                   
    Three Months Ended Nine Months Ended
Class A common stock December 31, December 31,
 
 
(In thousands, except per share data) 2003 2002 2003 2002
 
 
 
 
Net income:                
 As reported — basic $392,296  $253,694  $487,252  $317,495 
 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects  (25,080)  (22,094)  (69,003)  (59,824)
 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects  25   —   100   — 
   
   
   
   
 
  Pro forma — basic $367,241  $231,600  $418,349  $257,671 
   
   
   
   
 
                  
 As reported — diluted $392,296  $250,219  $487,252  $307,857 
 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects  (25,080)  (22,148)  (69,003)  (59,951)
 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects  25   —   100   — 
   
   
   
   
 
  Pro forma — diluted $367,241  $228,071  $418,349  $247,906 
   
   
   
   
 
Earnings per share:                
 As reported — basic $1.32  $0.89  $1.66  $1.13 
 Pro forma — basic $1.23  $0.82  $1.42  $0.92 
 As reported — diluted $1.26  $0.85  $1.59  $1.05 
 Pro forma — diluted $1.19  $0.78  $1.38  $0.86 

During the three and six month periodsnine months ended September 30,December 31, 2003 and 2002, compensation costexpense for EA’s Class B stock option plans, based on the estimated fair value at the grant dates in accordance with the provisions of SFAS No. 123, would not have had a material impact on EA’s reported net income and net earnings per share.

At EA’sour Annual Meeting of Stockholders, held on July 31, 2003, the stockholders elected (i) to amend the 2000 Equity Incentive Plan to increase by 11,000,000 the number of shares of EA’s Class A common stock reserved for issuance under the Plan and (ii) to amend the 2000 Employee Stock Purchase Plan to increase by 300,000 the number of shares of EA’s Class A common stock reserved for issuance under the Plan.

89

(4) GOODWILL AND OTHER INTANGIBLE ASSETS, NET

During the six months ended September 30,In May 2003, EAwe recorded an additional $1.2 million of goodwill as a result of EA’sour acquisition of Square Co., Ltd.’s (“Square”) 30 percent interest in Electronic Arts Square K.K. in May 2003. See Note 1314 of the Notes to Condensed Consolidated Financial Statements for further discussion on the Squarethis joint venture termination. Additionally, in October 2003, we recorded $0.9 million of goodwill as a result of our acquisition of Studio 33 (UK) Limited. Goodwill information is as follows (in thousands):

                 
 
          Effects of    
  Goodwill as      Foreign  Goodwill as of 
  of March 31,  Goodwill  Currency  September 30, 
  2003  Acquired  Translation  2003 
 
Goodwill $86,031  $1,182  $1,437  $88,650 
 
                     
          Effects of      
          Foreign      
  Goodwill as of Goodwill Currency Goodwill as of    
  March 31, 2003 Acquired Translation December 31, 2003    
  
 
 
 
    
Goodwill $86,031  $2,088  $1,739  $89,858 
   
   
   
   
     
                     
Other intangibles assets, net, consisted of the following (in thousands):
                     
  December 31, 2003
  
  Gross             Other
  Carrying Accumulated         Intangibles,
  Amount Amortization Impairment Other Net
  
 
 
 
 
Developed/Core Technology $28,263  $(18,886) $(9,377) $—  $— 
Tradename  35,169   (14,872)  (1,211)  —   19,086 
Subscribers and Other Intangibles  8,694   (6,302)  (1,776)  (552)  64 
   
   
   
   
   
 
Total $72,126  $(40,060) $(12,364) $(552) $19,150 
   
   
   
   
   
 
                     
  March 31, 2003
  
  Gross             Other
  Carrying Accumulated         Intangibles,
  Amount Amortization Impairment Other Net
  
 
 
 
 
Developed/Core Technology $28,263  $(18,886) $(9,377) $—  $— 
Tradename  35,169   (12,763)  (1,211)  —   21,195 
Subscribers and Other Intangibles  8,694   (6,298)  (1,776)  (514)  106 
   
   
   
   
   
 
Total $72,126  $(37,947) $(12,364) $(514) $21,301 
   
   
   
   
   
 
                     
Amortization expense for the three and nine months ended December 31, 2003 was $0.6 million and $2.1 million, respectively. Amortization expense for the three and nine months ended December 31, 2002 was $2.2 million and $6.7 million, respectively. Other intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from two to twelve years.
                     
As of December 31, 2003, future intangible asset amortization expense is estimated as follows (in thousands):
                     
Fiscal Year Ended March 31,                    
                    
2004 (remaining three months)                 $622 
2005                  2,489 
2006                  2,489 
2007                  2,489 
2008                  2,489 
Thereafter                  8,572 
                   
 
Total                 $19,150 
                   
 

Other intangibles consisted of the following (in thousands):

                     
 
  September 30, 2003 
  Gross              Other 
  Carrying  Accumulated          Intangibles, 
  Amount  Amortization  Impairment  Other  Net 
   
Developed/Core Technology $28,263  $(18,886) $(9,377) $—  $— 
Tradename  35,169   (14,249)  (1,211)  —   19,709 
Subscribers and Other Intangibles  8,694   (6,302)  (1,776)  (541)  75 
 
Total $72,126  $(39,437) $(12,364) $(541) $19,784 
 
                     
 
  March 31, 2003 
  Gross              Other 
  Carrying  Accumulated         Intangibles, 
  Amount  Amortization  Impairment  Other  Net 
   
Developed/Core Technology $28,263  $(18,886) $(9,377) $—  $— 
Tradename  35,169   (12,763)  (1,211)  —   21,195 
Subscribers and Other Intangibles  8,694   (6,298)  (1,776)  (514)  106 
 
Total $72,126  $(37,947) $(12,364) $(514) $21,301 
 

Amortization expense for the three and six months ended September 30, 2003 was $0.8 million and $1.5 million, respectively. Amortization expense for the three and six months ended September 30, 2002 was $2.2 million and $4.5 million, respectively. Other intangible assets are amortized using the straight-line method over the lesser of their estimated useful lives or the agreement terms, typically from two to twelve years.

As of September 30, 2003, future intangible asset amortization expense is estimated as follows (in thousands):

     
 
Fiscal Year Ended March 31,    
2004 (remaining six months) $1,245 
2005  2,489 
2006  2,489 
2007  2,489 
2008  2,489 
Thereafter  8,583 
 
  $19,784 
 

910

(5) PREPAID ROYALTIES, NET

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, and the long-term portion, included in Other assets, is as follows (in thousands):

                 
 December 31, March 31,
 September 30, 2003 March 31, 2003  2003 2003 
 
 
Other current assets $33,877 $25,371  $22,499 $25,371 
Other assets 5,288 7,382  4,375 7,382 
 
 
 
Prepaid royalties, net $39,165 $32,753  $26,874 $32,753 
 
 
 

(6) INVENTORIES, NET

Inventories, net, are stated at the lower of cost (first-in, first-out method) or market. Inventories, net, at September 30,as of December 31, 2003 and March 31, 2003 consisted of (in thousands):

                 
 December 31, March 31,
 September 30, 2003 March 31, 2003  2003 2003 
 
 
Raw materials and work in process $3,632 $2,762  $6,368 $2,762 
Finished goods 35,577 36,917  58,398 36,917 
 
 
 
Inventories, net $39,209 $39,679  $64,766 $39,679 
 
 
 

(7) ACCRUED AND OTHER LIABILITIES

Accrued and other liabilities at September 30,as of December 31, 2003 and March 31, 2003 consisted of (in thousands):

                 
 December 31, March 31,
 September 30, 2003 March 31, 2003  2003 2003
 
 
Accrued income taxes $154,573 $154,712  $249,141 $154,712 
Other accrued expenses 95,632 111,878  190,395 111,878 
Accrued compensation and benefits 71,004 109,687  111,619 109,687 
Accrued royalties 85,176 77,681  119,515 77,681 
Deferred revenue 9,866 10,589  12,095 10,589 
 
 
 
Accrued and other liabilities $416,251 $464,547  $682,765 $464,547 
 
 
 

(8) SEGMENT INFORMATION

SFAS No. 131,“Disclosures About Segments of An Enterprise And Related Information”, establishes standards for the reporting by public business enterprises of information about operating segments, 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 business enterprise for making operational decisions and assessments of financial performance.

EA’sOur Chief Operating Decision Maker is considered to be EA’sthe Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about net revenue by geographic region and by product lines for purposes of making operating decisions and assessing financial performance.

11

In fiscal 2003, EAwe operated and reviewed itsour business in two business segments:

EA Core business segment: creation, marketing and distribution of interactive entertainment software.

EA.com business segment: creation, marketing and distribution of interactive entertainment software which can be played or sold online, ongoing management of subscriptions of online games and website advertising.

10

In March 2003, EAwe consolidated the operations of the EA.com business segment into itsour core business. EA considersWe consider online functionality to be integral to itsour existing and future products. Accordingly, beginning April 1, 2003, EAwe no longer manages itsmanage our online products and services as a separate business segment, and hashave consolidated theour reporting related to its online products and services into our reporting for the overall development and publication of itsour core products for all reporting periods ending after that date. EA believesWe believe that this better reflects the way in which itsthe Chief Operating Decision Maker reviews and manages theour business and reflects the importance of the online products and services relative to the rest of theour business. Concurrently, EAwe also eliminated separate reporting for its Class B common stock for all reporting periods ending after April 1, 2003.

Information about EA’sour operations in North America and foreign areasinternational geographies for the three and sixnine months ended September 30,December 31, 2003 and 2002 is presented below (in thousands):

                                     
 Asia    
 Asia      Pacific    
 Pacific      North (excluding    
 North (excluding      America Europe Japan) Japan Total
 America Europe Japan) Japan Total  
 
 
 
 
  
Three months ended September 30, 2003
 
Three months ended December 31, 2003
 
Net revenue from unaffiliated customers $358,184 $145,002 $17,617 $9,202 $530,005  $753,456 $658,322 $42,775 $20,770 $1,475,323 
Interest income 6,013 690 27 — 6,730  6,231 863 33 — 7,127 
Depreciation and amortization 11,138 6,087 241 158 17,624  21,293 7,409 269 97 29,068 
Total assets 1,988,171 573,289 29,908 25,666 2,617,034  2,356,505 890,223 57,650 34,050 3,338,428 
Capital expenditures 12,610 3,621 324  (52) 16,503  22,112 4,734 272 129 27,247 
Long-lived assets 240,050 137,157 2,244 2,288 381,739  241,606 142,760 2,327 2,341 389,034 
Three months ended September 30, 2002
 
Three months ended December 31, 2002
 
Net revenue from unaffiliated customers $313,559 $116,654 $13,803 $9,474 $453,490  $695,630 $470,742 $38,208 $29,146 $1,233,726 
Interest income 4,012 421 41 1 4,475  4,404 575 34 — 5,013 
Depreciation and amortization 20,793 3,893 229 152 25,067  21,111 3,453 227 165 24,956 
Total assets 1,402,119 408,419 24,156 12,391 1,847,085  1,750,576 626,301 50,398 33,750 2,461,025 
Capital expenditures 11,507 3,281 102 87 14,977  8,550 1,894 470 170 11,084 
Long-lived assets 287,883 136,301 1,847 2,509 428,540  279,067 137,973 2,035 2,562 421,637 
Six months ended September 30, 2003
 
Nine months ended December 31, 2003
 
Net revenue from unaffiliated customers $557,025 $272,928 $32,088 $21,345 $883,386  $1,310,481 $931,250 $74,863 $42,115 $2,358,709 
Interest income 12,271 1,662 64 — 13,997  18,502 2,525 97 — 21,124 
Depreciation and amortization 20,226 9,831 477 313 30,847  41,519 17,240 746 410 59,915 
Capital expenditures 22,268 5,804 607 11 28,690  44,380 10,538 879 140 55,937 
Six months ended September 30, 2002
 
Nine months ended December 31, 2002
 
Net revenue from unaffiliated customers $487,138 $243,184 $28,992 $26,074 $785,388  $1,182,768 $713,926 $67,200 $55,220 $2,019,114 
Interest income 8,284 793 94 1 9,172  12,688 1,368 128 1 14,185 
Depreciation and amortization 41,299 7,318 462 294 49,373  62,410 10,771 689 459 74,329 
Capital expenditures 17,833 5,127 262 164 23,386  26,383 7,021 732 334 34,470 

1112

EA’s salesSales to Wal-mart Stores represented 1512 and 1413 percent of our total net revenue for the three and sixnine months ended September 30,December 31, 2003, respectively. EA’s salesSales to Wal-mart Stores represented 1710 and 1412 percent of our total net revenue for the three and sixnine months ended September 30,December 31, 2002, respectively.

Information about EA’sour net revenue by product line for the three and sixnine months ended September 30,December 31, 2003 and 2002 is presented below (in thousands):

                                
 Three Months Ended Nine Months Ended
 Three Months Ended Six Months Ended  December 31, December 31,
 September 30, September 30,  
 
 2003 2002 2003 2002
 2003 2002 2003 2002  
 
 
 
PlayStation® 2
 $221,180 $158,712 $339,549 $293,310 
PlayStation® 2 $731,587 $459,407 $1,071,136 $752,717 
PC 93,022 82,686 173,360 158,752  219,939 219,083 393,299 377,835 
Xbox™
 68,691 37,527 100,212 57,630 
Nintendo GameCube™
 24,553 27,838 45,707 42,794 
Xbox® 204,565 116,836 304,777 174,466 
Nintendo GameCube™ 103,804 111,103 149,511 153,897 
Game Boy® Advance 57,194 68,102 63,362 73,919 
Subscription Services 11,124 8,321 24,755 16,860  11,781 11,236 36,536 28,096 
PlayStation® 13,344 53,066 26,657 90,495 
Advertising, Programming, Licensing, and Other 7,552 14,161 16,263 29,508  10,804 37,424 27,067 66,932 
PlayStation®
 7,562 24,206 13,313 37,429 
Game Boy® Advance
 3,809 3,679 6,168 5,817 
Co-publishing and Distribution 92,512 96,360 164,059 143,288  122,305 157,469 286,364 300,757 
 
 
 
 
 
Total Net Revenue $530,005 $453,490 $883,386 $785,388 
Total net revenue $1,475,323 $1,233,726 $2,358,709 $2,019,114 
 
 
 
 
 

(9) COMPREHENSIVE INCOME

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

The components of comprehensive income, net of tax, for the three and sixnine months ended September 30,December 31, 2003 and 2002 are summarized as follows (in thousands):

                 
 
  Three Months Ended  Six Months Ended 
  September 30,  September 30, 
 
  2003  2002  2003  2002 
 
Net income $76,588  $50,234  $94,956  $57,638 
 
Other comprehensive income (loss):                
Change in unrealized appreciation (loss) on investments, net of tax (benefit)/expense of $(793), $843, $(675) and $1,471, respectively  (1,811)  1,249   (1,504)  1,164 
Adjustment for loss (gain) realized in net income, net of tax (benefit)/expense of $0, $441, $(3) and $441, respectively  —   1,918   (7)  1,918 
 
Foreign currency translation adjustments  1,174   (1,538)  12,875   7,772 
 
 
Total other comprehensive income (loss)  (637)  1,629   11,364   10,854 
 
 
Total comprehensive income $75,951  $51,863  $106,320  $68,492 
 
                  
   Three Months Ended Nine Months Ended
   December 31, December 31,
   
 
   2003 2002 2003 2002
   
 
 
 
Net Income $392,296  $250,219  $487,252  $307,857 
Other comprehensive income:                
 Change in unrealized appreciation (loss) on investments, net of tax (benefit)/expense of $(358), $165, $(1,033), and $1,636, respectively  (938)  153   (2,442)  1,317 
 Adjustments for loss (gain) on investments realized in net income, net of tax (benefit)/expense of $3, $(693), $0, and $(252), respectively  7   (1,544)  —   374 
 Foreign currency translation adjustments  5,822   3,737   18,697   11,509 
   
   
   
   
 
 Total other comprehensive income $4,891  $2,346  $16,255  $13,200 
   
   
   
   
 
   
   
   
   
 
Total comprehensive income $397,187  $252,565  $503,507  $321,057 
   
   
   
   
 

1213

(10) CHANGE IN PROJECTED EFFECTIVE TAX RATE

During the three months ended December 31, 2003, we changed our projected annual effective income tax rate for fiscal 2004 to 30 percent. We previously projected this rate to be 31 percent. This change is primarily attributable to a higher portion of our projected income being international taxable income, which is subject to lower statutory rates, than previously anticipated. As a result of the change to our projected effective tax rate for fiscal 2004, we recognized $7.0 million (or $0.02 per basic and diluted share) less income tax expense during the three months ended December 31, 2003 than we would have recognized had our projected annual effective tax rate remained at 31 percent.

(11) NET EARNINGS (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.

                 
(In thousands, except per share amounts):
  Three months ended  Six months ended 
  September 30, 2003  September 30, 2003 
    
  Class A common  Class A common  Class A common  Class A common 
  stock-Basic  stock-Diluted  stock-Basic  stock-Diluted 
 
Net income $76,588  $76,588  $94,956  $94,956 
 
 
Shares used to compute net earnings per share:
Weighted-average common shares  294,836   294,836   292,263   292,263 
Dilutive stock equivalents  —   12,943   —   11,750 
 
Dilutive potential common shares  294,836   307,779   292,263   304,013 
 
 
Net earnings per share:                
Basic $0.26   N/A  $0.32   N/A 
Diluted  N/A  $0.25   N/A  $0.31 
 
             
(In thousands, except per share amounts):
  Three months ended September 30, 2002 
 
  Class A common  Class A common  Class B common 
  Stock- Basic  stock-Diluted  Stock 
 
Net income (loss) before retained interest in EA.com $73,561  $50,234  $(23,327)
Net loss related to retained interest in EA.com  (20,154)  —   20,154 
 
Net income (loss) $53,407  $50,234  $(3,173)
 
 
Shares used to compute net earnings (loss) per share:            
Weighted-average common shares  279,686   279,686   5,547 
Dilutive stock equivalents  —   13,551   — 
 
Dilutive potential common shares  279,686   293,237   5,547 
 
 
Net earnings (loss) per share:            
Basic $0.19   N/A  $(0.57)
Diluted  N/A  $0.17  $(0.57)
 
                  
   Three Months Ended Nine Months Ended
   December 31, 2003 December 31, 2003
   
 
   Class A Class A Class A Class A
   common common common common
(In thousands, except per share amounts): stock - basic stock - diluted stock - basic stock - diluted
 
 
 
 
Net income $392,296  $392,296  $487,252  $487,252 
   
   
   
   
 
Shares used to compute net earnings per share:                
 Weighted-average common shares  297,787   297,787   294,001   294,001 
 Dilutive stock equivalents  —   13,676   —   12,736 
   
   
   
   
 
Dilutive potential common shares  297,787   311,463   294,001   306,737 
   
   
   
   
 
Net earnings per share:                
 Basic $1.32   N/A  $1.66   N/A 
 Diluted  N/A  $1.26   N/A  $1.59 

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(In thousands, except per share amounts):
 Six months ended September 30, 2002            
 Three Months Ended
 Class A common Class A common Class B common  December 31, 2002
 Stock- Basic stock-Diluted Stock  
 Class A Class A Class B
 common common common
(In thousands, except per share amounts):(In thousands, except per share amounts): stock - basic stock - diluted stock
 
 
 
Net income (loss) before retained interest in EA.com $100,897 $57,638 $(43,259)Net income (loss) before retained interest in EA.com $279,179 $250,219 $(28,960)
Net loss related to retained interest in EA.com  (37,096) — 37,096 Net loss related to retained interest in EA.com  (25,485) — 25,485 
 
 
 
 
Net income (loss) $63,801 $57,638 $(6,163)Net income (loss) $253,694 $250,219 $(3,475)
 
 
 
 
Shares used to compute net earnings (loss) per share:Shares used to compute net earnings (loss) per share: 
Weighted-average common shares 283,777 283,777 4,051 
Shares used to compute net earnings (loss) per share: 
Weighted-average common shares 278,633 278,633 5,759 
Dilutive stock equivalents — 13,905 — 
Dilutive stock equivalents — 12,273 — 
 
 
 
 
Dilutive potential common shares 278,633 292,538 5,759 Dilutive potential common shares 283,777 296,050 4,051 
 
 
 
 
Net earnings (loss) per share:Net earnings (loss) per share: 
Basic $0.89 N/A $(0.86)
Net earnings (loss) per share: 
Basic $0.23 N/A $(1.07)
Diluted N/A $0.20 $(1.07)
Diluted N/A $0.85 $(0.86)
              
   Nine Months Ended
   December 31, 2002
   
   Class A Class A Class B
   common common common
(In thousands, except per share amounts): stock - basic stock - diluted stock
  
 
 
Net income (loss) before retained interest in EA.com $380,076  $307,857  $(72,219)
Net loss related to retained interest in EA.com  (62,581)  —   62,581 
   
   
   
 
Net income (loss) $317,495  $307,857  $(9,638)
   
   
   
 
Shares used to compute net earnings (loss) per share:            
 Weighted-average common shares  280,386   280,386   5,247 
 Dilutive stock equivalents  —   13,335   — 
   
   
   
 
Dilutive potential common shares  280,386   293,721   5,247 
   
   
   
 
Net earnings (loss) per share:            
 Basic $1.13   N/A  $(1.84)
 Diluted  N/A  $1.05  $(1.84)

Excluded from the above computation of weighted-average shares for Class A Diluted EPS for the three and sixnine months ended September 30,December 31, 2003, were options to purchase 339,0003,084,000 and 574,0001,971,000 shares, respectively, as the options’ exercise prices were greater than the average market price of the common shares during the respective periods. For the three and sixnine months ended September 30,December 31, 2003, the weighted-average exercise prices of these options were $44.49$49.03 and $40.78$46.79 per share, respectively.

Excluded from the above computation of weighted-average shares for Class A Diluted EPS for the three and sixnine months ended September 30,December 31, 2002, were options to purchase 697,000551,000 and 462,0002,665,000 shares, respectively, as the options’ exercise prices were greater than the average market price of the common shares during the respective periods. For the three and sixnine months ended September 30,December 31, 2002, the weighted-average exercise prices of these options were $31.87$33.09 and $31.72$31.77 per share, respectively.

For the three and sixnine months ended September 30,December 31, 2002, the Diluted EPS calculation for Class A common stock, presented above, included the potential dilution from the conversion of Class B common stock to Class A common stock in the event that

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the initial public offering for Class B common stock did not occur. Net income used for the calculation of Diluted EPS for Class A common stock was $50.2$250.2 million for the three months ended September 30,December 31, 2002 and $57.6$307.9 million for the sixnine months ended September 30,December 31, 2002. This net income included the remaining interest in EA.com, which was directly attributable to outstanding Class B common stock owned by third parties, and would have been included in the Class A common stock EPS calculation in the event that the initial public offering for Class B common stock did not occur. The remaining interest in EA.com was approximately 15 percent through August 2002, 12 percent through February 2003 and one percent through March 2003.

Due to the net loss attributable for the three and sixnine months ended September 30,December 31, 2002 on a diluted basis to Class B common stock, stock options have been excluded from the Diluted EPS calculation as their inclusion would have been antidilutive. Had net income been reported for the three and sixnine months ended September 30,December 31, 2002, an additional 226,000 and 422,000297,000 shares respectively, would have been added to diluted potential common shares for Class B common stock.

(11)(12) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

2003 Studio Restructuring

During the third quarter of fiscal 2003, EAwe closed itsour office located in San Francisco, California and itsour studio located in Seattle, Washington. The office and studio closures were a result of EA’sa strategic decision to consolidate local development efforts in Redwood City, California and Vancouver, British Columbia, Canada. EAWe recorded total pre-tax charges of $9.4 million, consisting of $7.3 million for consolidation of facilities, $1.5 million for the impairment

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write-off of non-current assets and $0.6 million for workforce reductions. The facilities charge was net of a reduction in deferred rent of $0.5 million.

Additionally, during the fourth quarter of fiscal 2003, EAwe approved a plan to consolidate itsthe Los Angeles, California, Irvine, California and Las Vegas, Nevada, studios into one major game studio in Los Angeles. These measures were taken in order to maximize efficiencies and streamline the creative development process and operations of EA’sour studios. In connection with these consolidation activities, EAwe recorded a total pre-tax restructuring charge of $5.1 million, including $1.6 million for the shutdown of facilities related to non-cancelable lease payments for permanently vacated properties and associated costs, $2.0 million for the impairmentwrite-off of abandoned equipment and leasehold improvements at facilities that were permanently vacated and $1.5 million for employee severance expenses related to involuntary terminations.

Online Restructurings

Fiscal 2003 Restructuring
In March 2003, EAwe consolidated the operations of the EA.com business segment into itsour core business segment, and eliminated separate reporting for its Class B common stock for all reporting periods after fiscal 2003. During the fourth quarter of fiscal 2003, EAwe recorded restructuring charges of $67.0 million, consisting of $1.8 million for workforce reductions, $2.3 million for consolidation of facilities and other administrative charges, and $62.9 million for the impairment of non-current assets. The estimated costs for workforce reduction included severance charges for terminated employees, costs for certain outplacement service contracts and costs associated with the tender offer to retire employee Class B options. The consolidation of facilities resulted in the closure of EA.com’s Chicago, Illinois, and Charlottesville, Virginia facilities and an adjustment for the closure of EA.com’s San Diego, California studio in fiscal 2002.

The impairment charges on long-lived assets of $62.9 million included $24.9 million relating to customized internal-use software systems for the EA.com infrastructure, $25.6 million for other long-lived assets and $12.4 million of finite-lived intangibles relating to EA.com’s Kesmai and Pogo studios. The fair-value-based tests performed in accordance with EA’sour annual procedures did not indicate an impairment of the recorded goodwill at the EA.com reporting unit level.

Fiscal 2002 Restructuring
In October 2001, EAwe announced a restructuring plan for the EA.com business segment. The restructuring initiatives involved strategic decisions to discontinue certain product offerings and focus only on key online priorities that aligned with itsour fiscal 2003 operational objectives. During fiscal 2002, EAwe recorded restructuring charges of $20.3 million, consisting of $4.2 million for workforce reductions, $3.3 million for consolidation of facilities and other administrative charges, and $12.8 million for the write-off of non-current assets and facilities. 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

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of EA.com’s San Diego, California, studio and consolidation of its San Francisco, California, and Charlottesville, Virginia, facilities.

Impairment charges on long-lived assets amounted to $12.8 million, including $11.2 million relating to abandoned technologies consisting of customized internal-use software systems for the EA.com infrastructure, $1.0 million of Kesmai intangibles associated with discontinued products and services and $0.6 million of goodwill charges relating to EA.com’s San Diego studio closure.

The following table summarizes the activity in the accrued studio and online restructuring account for the three and sixnine months ended September 30,December 31, 2003 (in thousands):

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  Fiscal 2003  Fiscal 2002    
  Restructuring Plan  Restructuring Plan    
      Facilities-  Facilities-    
  Workforce  related  related  Total 
 
Accrued balance as of March 31, 2003 $1,692  $8,223  $840  $10,755 
Charges utilized in cash  (1,452)  (2,057)  (103)  (3,612)
   
 
 
Accrued balance as of September 30, 2003 $240  $6,166  $737  $7,143 
 
                 
  Fiscal 2003 Fiscal 2002  
  Restructuring Plan Restructuring Plan  
  
 
  
      Facilities - Facilities -  
  Workforce related related Total
  
 
 
 
Accrued restructuring balance as of March 31, 2003 $1,692  $8,223  $840  $10,755 
Adjustments  (71)  667   —   596 
Charges utilized in cash  (1,440)  (2,940)  (155)  (4,535)
   
   
   
   
 
   
   
   
   
 
Accrued restructuring balance as of December 31, 2003 $181  $5,950  $685  $6,816 
   
   
   
   
 

EA expectsWe expect the remaining accrued restructuring balance of $7.1$6.8 million to be fully utilized by December 31, 2006.

As of September 30,December 31, 2003, the estimated costs for consolidation of facilities included contractual rental commitments of $10.9$9.9 million under real estate leases for unutilized office space offset by $4.5$3.9 million of 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 restructuring accrual is included in other accrued expenses in Note 7 of the Notes to Condensed Consolidated Financial Statements.

(12)CONTINGENT LIABILITIES
(13) COMMITMENTS AND CONTINGENT LIABILITIES

Lease commitments

In July of 2003, EAwe entered into a lease agreement with Playa Vista-Water’s Edge LLCan independent third party (the “Landlord”) for a studio facility in Los Angeles, California, which commenced in October 2003 and expires in September 2013 with two five-year options to extend the lease term. Additionally, EA haswe have options to purchase the property after five and ten years based on the fair market value of the property at the date of sale, a right of first offer to purchase the property upon terms offered by the landlord, and a right to share in the profits from a sale of the property. EAWe accounted for this arrangement as an operating lease in accordance with SFAS No. 13, “Accounting for Leases”, as amended. Existing campus facilities comprise a total of 243,000 square feet and provide space for research and development functions. The rental obligation under this agreement is $50.2 million over the initial ten-year term of the lease. EAWe will take possession of the property over a period of 18 months as the facilities become available for use. The above commitment is offset by sublease income of $5.8 million for the sublet to Playa Capital Company, LLCan affiliate of the Landlord of 18,000 square feet of the Los Angeles facility, which commenced in October 2003 and expires in September 2013 with options of early termination by Playa Capital Company, LLCthe affiliate after five years and by EA after four and five years.

Residual Value Guarantees

In February of 1995, EAwe entered into a build-to-suit lease with Keybank National Association on itsour headquarters facility in Redwood City, California, which was extended in July 2001 and expires in July 2006. EAWe accounted for this arrangement as an operating lease in accordance with SFAS No. 13, 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. EA hasWe have an option to purchase the property (land and facilities) for $145.0 million or, at the end of the lease, to arrange for (i) an

17

additional extension of the lease or (ii) sale of the property to a third party while EA retainswe retain an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128.9 million if the sales price is less than this amount, subject to certain provisions of the lease.

In December 2000, EAwe entered into a second build-to-suit lease with Keybank National Association for a five-year term from December 2000 to expand itsour headquarters facilities and develop adjacent property adding approximately 310,000 square feet to itsour campus. Construction was completed in June 2002. EAWe accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. The facilities will provide space for marketing, sales and research and development. EA hasWe have an option to purchase the property for $127.0 million or, at the end of

16

the lease, to arrange for (i) an extension of the lease or (ii) sale of the property to a third party while EA retainswe retain an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118.8 million if the sales price is less than this amount, subject to certain provisions of the lease.

EA believesWe believe the estimated fair value of both properties under these operating leases are in excess of their respective guaranteed residual values based in part on an independent third party appraisal.at December 31, 2003.

See the Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations for a schedule of EA’s contractual obligations and commitments.

(13)SQUARE JOINT VENTURE
(14) SQUARE JOINT VENTURE

In May 1998, EA and Square, a leading developer and publisher of entertainment software in Japan,we completed the formation of two new joint ventures in North America and Japan 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 had exclusive publishing rights in North America for future interactive entertainment titles created by Square. Additionally, EAwe had the exclusive right to distribute in North America products published by this joint venture. EAWe contributed $3.0 million and owned a 30 percent minority interest in this joint venture while Square owned 70 percent. This joint venture was accounted for under the equity method. The joint venture agreements with Square expired as of March 31, 2003. EA’sOur distribution of Square products in North America terminated on June 30, 2003. On May 30, 2003, Square acquired EA’sour remaining 30 percent ownership interest in the joint venture for $8.5 million and EA’sthe investment was removed from the Condensed Consolidated Balance Sheet.

In Japan, the companies established Electronic Arts Square K.K. (“EA Square KK”) in 1998, which localized and published in Japan EA’s properties originally created in North America and Europe, as well as developed and published original videogames in Japan. EAWe contributed cash and had a 70 percent majority ownership interest, while Square contributed cash and owned 30 percent. Accordingly, the assets, liabilities and results of operations for EA Square KK were included in EA’sour Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations since June 1, 1998, the date of formation. Square’s 30 percent interest in EA Square KK has been reflected as “Minority interest in consolidated joint venture” on EA’sour Condensed Consolidated Balance Sheet as of March 31, 2003, and Condensed Consolidated Statements of Operations for the three and sixnine months ended September 30,December 31, 2002.

In May 2003, EAwe acquired Square’s 30 percent ownership interest in EA Square KK for approximately $2.5 million in cash. As a result of the acquisition, EA Square KK has become aour wholly owned subsidiary of EA and has been renamed Electronic Arts K.K. The acquisition was accounted for as a step acquisition purchase and the excess purchase price over fair value of the net tangible assets acquired, $1.2 million, was allocated to goodwill.

(14)AMERICA ONLINE, INC. (“AOL”) AGREEMENT
(15) AMERICA ONLINE, INC. (“AOL”) AGREEMENT

In November 1999, Electronic Arts Inc., EA.com and AOL entered into a five-year $81.0 million carriage fee agreement (the “Prior Agreement”) which gave EA.com the exclusive right to provide online games and interactive entertainment content on the “Games” channels/areas of certain AOL online services and gain access to and sell itsour products to AOL subscribers and to users of AOL properties. This agreement provided for carriage fees, advertising commitments, advertising revenue sharing and other fees.

During the three months ended June 30, 2003, EA and AOL terminated the Prior Agreement was terminated and we entered into a new two-year agreement (the “New Agreement”) under which EAwe will continue to provide its current online game content services, and launch new online game content and services, on the “Games” channels/areas of certain AOL online services in exchange for a programming fee from AOL.

18

Below is a discussion of the Prior Agreement and the changes in EA’sour relationship with AOL that are reflected in the New Agreement.

17

Carriage Fee

The Prior Agreement provided for EA’s payment of a total payments of $81.0 million in carriage fees to AOL over the term of the Prior Agreement.

Of this amount, $36.0 million was paid upon signing the Prior Agreement with the remainder due in four equal annual installments of $11.25 million beginning with the first anniversary of the initial payment. EAWe made carriage payments to AOL of $11.25 million in each of the fiscal years 2003, 2002 and 2001. Due to the termination of the Prior Agreement in June 2003, EA iswe are no longer required to make the last $11.25 million carriage payment. There was no carriage fee expense for the three and sixnine months ended September 30,December 31, 2003. Carriage fee expense for the three and sixnine months ended September 30,December 31, 2002 was $4.5 million and $8.9$13.4 million, respectively.

Carriage fee amounts paid under the Prior Agreement were capitalized as a prepaid asset as payments were made to AOL. Until April 1, 2003, the total carriage fee of $81.0 million that was provided for in the Prior Agreement was being expensed using the straight-line method over the remaining life of the Prior Agreement subsequent to EA.com’s site launch in October 2000. As the carriage fee was expensed, EAwe applied the portion that had been paid against the prepaid asset and recorded the remaining amount as a liability. Amortization expense was classified as “Marketing and sales” expense in EA’sour Condensed Consolidated Statements of Operations. The prepaid asset and liability balances were classified as “Other assets” and “Accrued and other liabilities”, respectively, on EA’sour Condensed Consolidated Balance Sheets.

Under the New Agreement, in July 2003, AOL refunded $18.0 million in carriage fees that EAwe had previously paid to AOL under the Prior Agreement. This refund was applied against the prepaid balance and the remaining asset, $6.4 million, is being amortized over the term of the New Agreement as a reduction to revenue.

Programming Fee

The New Agreement provides for AOL payments by AOL to EAus of $27.5 million over the two-year term of the New Agreement as a programming fee. $20.8Of the total $27.5 million, of this $27.5$20.8 million pertains to existing online games content and services that EAwe currently providesprovide on the “Games” channels/areas of the AOL properties, and is being recognized as revenue ratably over the term of the New Agreement. The remaining $6.7 million pertains to new online games content and services to be delivered during the term of the New Agreement. This portion of the programming fee will be recognized as revenue as the required new content and services are delivered. During the three and sixnine months ended September 30,December 31, 2003, $2.4$2.6 million and $4.9$7.5 million have been recognized as programming fee revenue, respectively.

Advertising Commitment

Under the Prior Agreement, EAwe also made a commitment to spend $15.0 million in offline media advertisements prior to March 31, 2005 consisting of:

$10.0 million on television, radio, print and outdoor advertising promoting the availability of EA.com games on certain AOL online services; and

$5.0 million ($1.0 million per year over the five year agreement) on television, radio, print and outdoor advertising promoting the availability of a specific category of EA.com games (so-called “parlor games”) on certain AOL online services.

Under the Prior Agreement, EA waswe were free to purchase this advertising from any television, radio, print or outdoor media property that itwe chose, not necessarily from any AOL-affiliated media property. EAWe did not purchase any advertisements from AOL, though itwe purchased some qualifying advertising from AOL affiliates. Through March 31, 2003, EAwe expensed the advertising as it was incurred. These costs were classified as “Marketing and sales” expense in EA’sour Condensed Consolidated Statements of Operations. As of March 31, 2003, EAwe had spent approximately $4.3 million against this commitment.

Upon the termination of the Prior Agreement, this advertising commitment was extinguished, and there is no similar commitment provided for in the New Agreement.

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Advertising Revenue and Revenue Sharing

Advertising revenue is derived principally from the sale of banner and in-game advertisements. Banner and in-game advertising is typically generated from contracts in which either EAwe or AOL providesprovide 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. Under the Prior Agreement, advertising revenue generated on the AOL Games Channel was recorded net of the applicable revenue share owed to AOL.

The Prior Agreement required that AOL pay EAus 50 percent of all revenue collected by AOL from the sale of advertisements on EA’sour online games sites, until advertising revenue reached $16.0 million in a year (measured from October 1 through the following September 30). Thereafter, the Prior Agreement provided that AOL would pay EAus 70 percent of all advertising revenue collected by AOL from the sale of advertisements on EA’sour game sites. Under the New Agreement, AOL is entitled to retain all advertising revenue collected by AOLthey collect from the sale of advertisements on EA’sour games sites on the AOL properties, until net advertising revenue reaches $20.0 million in the twelve months ended March 31, 2004, and until net advertising revenue reaches $35.0 million for the remainder of the term of the New Agreement. After advertising revenue exceeds these thresholds, AOL is required to pay EAus 50 percent of the additional net advertising revenue.

Other Fee Arrangements

Under the Prior Agreement, EA waswe were also required to pay AOL a percentage of itsour subscription, e-commerce and anchor tenancy revenue that exceeded certain amounts. These costs were expensed as incurred and were classified as “Cost of goods sold” in EA’sour Condensed Consolidated StatementStatements of Operations. EA doesWe do not net these costs against revenue because it maintainswe maintain responsibility for providing e-commerce products and subscription services directly to the consumer and retainsretain the primary inventory risk for itsour products and games service.

Under the New Agreement, EA iswe are required to pay AOL a percentage of its revenue derived from game service subscriptions, e-commerce, downloadable games and prize games that EAwe makes available on the AOL online services. EA accountsWe account for these amounts in a similar manner as described above.

(15)IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
(16) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In January 2003, the FASBFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” addresses consolidation by business enterprises of variable interest entities (“VIEs”) that either:either (i) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (ii) are owned by equity investors who lack an essential characteristic of a controlling financial interest. This interpretation applies immediately to VIEs created after January 31, 2003. With regard to VIE’sVIEs already in existence prior to February 1, 2003, the implementation of FIN 46 has been delayed and currently applies to the first fiscal year or interim period beginning after December 15, 2003. FIN 46 requires disclosure of VIEs in financial statements issued after January 31, 2003, if it is reasonably possible that as of the transition date:date (i) EAwe will be the primary beneficiary of an existing VIE that will require consolidation, or (ii) EAwe will hold a significant variable interest in, or have significant involvement with, an existing VIE. EA doesWe do not believe that it haswe have any entities that will require disclosure or new consolidation as a result of adopting the provisions of FIN 46.

19In January 2003, the Emerging Issues Task Force reached consensus on Issue No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables”. EITF 00-21 provides guidance on how to determine whether an arrangement involving multiple deliverables requires that such deliverables be accounted for separately. EITF 00-21 allows for prospective adoption for arrangements entered into after June 15, 2003 or adoption via a cumulative effect of a change in accounting principal. We adopted EITF 00-21 in the quarter ended June 30, 2003; however, it did not have a material impact on our consolidated financial position or results of operations.

In November 2003, the Emerging Issues Task Force reached consensus on paragraph 18 of Issue No. 03-01 (“EITF 03-01”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-01 requires that certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”and SFAS No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations”that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. We adopted EITF 03-01 in the quarter ended December 31, 2003; however, it did not have a material impact on the disclosures in our Condensed Consolidated Financial Statements.

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

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, made in this Quarterly Report onForm 10-Q are forward looking. We use words such as “anticipates”, “believes”, “expects”, “intends”, “future” and similar expressions to help identify forward-looking statements. These forward-looking statements are subject to business and economic risk and management’s expectations, and are inherently uncertain and difficult to predict. Our actual results could differ materially from management’s expectations due to such risks. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. Risks and uncertainties that may affect our future results include, but are not limited to, those discussed in this report below under the heading “Risk Factors”, as well as in our Annual Report onForm 10-K for the fiscal year ended March 31, 2003 as filed with the Securities and Exchange Commission (“SEC”) on June 10, 2003 and in other documents we have filed with the SEC.

CRITICAL ACCOUNTING POLICIES

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

Sales allowances and bad debt reserves

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

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

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

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We cannot predict customer bankruptcies or an inability of any of our customers to meet their financial obligations to us. Therefore, our estimates could differ materially from actual results.

Prepaid royalties

Prepaid royalties consist primarily of advances paid to our co-publishing and/or distribution affiliates and license fees paid to celebrities, professional sports organizations and other organizations for our use of their trade names 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 to determine amounts we deem unlikely to be realized through product sales. Any impairments determined before the launch of a product are charged to research and development expense. Impairments determined post launch are charged to cost of goods sold. In either case, we rely on forecasted revenue to evaluate the future realization of prepaid royalties. If actual revenue, or revised sales forecasts, falls below the initial forecasted sales, the charge taken may be larger than anticipated in any given quarter. If a charge has been taken prior to the product launch, that amount will not be expensed in future quarters when the product has shipped.

Valuation of long-lived assets

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

Under current accounting standards, we make judgments about the remaining useful lives of purchased intangible assets and other long-lived assets whenever events or changes in circumstances indicate a potential impairment in the remaining value of the assets recorded on our balance sheet. In order to determine if a potential impairment has occurred, management makes various assumptions about the future value of the asset by evaluating future business prospects and estimated cash flows. Our future net cash flows are primarily dependent on the sale of products for play on proprietary videogame consoles, hand-held game machines and PC’sPCs (“platforms”). The success of our products is affected by our ability to accurately predict which platforms and which products we develop will be successful. Also, our revenue and earnings are dependent on our ability to meet our product release schedules. Due to product sales shortfalls, we may not realize the future net cash flows necessary to recover our long-lived assets, which may result in an impairment charge being recorded in the future. During the six-month periodsnine months ended September 30,December 31, 2003 or September 30, 2002 nowe did not record impairment charges wereon long-lived assets. During the nine months ended December 31, 2002, we recorded $1.4 million of impairment charges on long-lived assets.

Income taxes

In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. As part of the process of preparing our Condensed Consolidated Financial Statements for each fiscal period, we are required to estimate our income taxes in each of the jurisdictions in which we operate.operate prior to the completion and filing of tax returns for such periods. This process involvesrequires estimating both our geographic mix of income and our current tax exposures in each jurisdiction includingwhere we operate. These estimates involve complex issues, require extended periods of time to resolve, and require us to make judgments, such as the impact, if any,determination of additional taxes resulting fromdeferred tax examinationsliabilities and making judgments regarding the recoverability of deferred tax assets. A valuation allowance is established to the extent recovery of deferred tax assets is not likely based on our estimation of future taxable income in each jurisdiction. Tax exposures can involve complex issues and may require an extended period to resolve. To determine the quarterlyour projected tax rate each quarter, we are required to estimatemake a projection of several items, including our projected mix of full-year income in each jurisdiction in which we operate and the related income tax expense in each jurisdiction. The estimated effective tax rate is also adjusted for the taxtaxes related to significant unusual items. Changes in theour valuation allowance, geographic mix, applicable tax laws and regulations, or estimated level of annual pre-tax income can also affect the overall effective tax rate. Finally, we are frequently audited by domestic and foreign taxing authorities. Developments in these audits are reflected in the effective tax rate as appropriate.

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RESULTS OF OPERATIONS

Revenue

We principally derive revenue from sales of packaged interactive software games designed for play on videogame platforms.platforms, PCs and handheld devices. We also derive additional revenue from selling subscriptions to some of our online games, selling advertisements on our online web pages, selling our packaged goods through our online store, receiving programming fees for integrated online content and by allowing other companies to manufacture and sell our products in conjunction with other products.

Geographically, our net revenue for the three and sixnine months ended September 30,December 31, 2003 and 2002 is presented below (in thousands):

                
                
Net Revenue for the Three September 30, September 30, Increase/    December 31, December 31, Increase/  
Months Ended 2003 2002 (Decrease) % change 2003 2002 (Decrease) % Change
   
 
 
 
  
North America $358,184 $313,559 $44,625  14% $753,456 $695,630 $57,826  8%
  
   
 
 
 
 
Europe 145,002 116,654 28,348  24% 658,322 470,742 187,580  40%
Asia Pacific 17,617 13,803 3,814  28% 42,775 38,208 4,567  12%
Japan 9,202 9,474  (272)  (3%) 20,770 29,146  (8,376)  (29%)
   
 
 
 
 
International 171,821 139,931 31,890  23% 721,867 538,096 183,771  34%
   
 
 
 
 
Consolidated Net Revenue $530,005 $453,490 $76,515  17% $1,475,323 $1,233,726 $241,597  20%
   
 
 
 
 
                                
Net Revenue for the Six September 30, September 30, Increase/   
Net Revenue for the Nine December 31, December 31, Increase/  
Months Ended 2003 2002 (Decrease) % change 2003 2002 (Decrease) % Change
   
 
 
 
  
North America $557,025 $487,138 $69,887  14% $1,310,481 $1,182,768 $127,713  11%
  
   
 
 
 
 
Europe 272,928 243,184 29,744  12% 931,250 713,926 217,324  30%
Asia Pacific 32,088 28,992 3,096  11% 74,863 67,200 7,663  11%
Japan 21,345 26,074  (4,729)  (18%) 42,115 55,220  (13,105)  (24%)
   
 
 
 
 
International 326,361 298,250 28,111  9% 1,048,228 836,346 211,882  25%
   
 
 
 
 
Consolidated Net Revenue $883,386 $785,388 $97,998  12% $2,358,709 $2,019,114 $339,595  17%
   
 
 
 
 

Net Revenue

Net revenue for the three and nine months ended September 30,December 31, 2003 increased by 20 and 17 percent, respectively, compared to the three and nine months ended December 31, 2002. A significant percentage of our business is transacted in foreign currencies which can have a material impact on our results of operations. For example, the average exchange rate for the Euro during the three and nine months ended December 31, 2003, increased approximately 19 percent, as compared towith the same period incorresponding periods of the prior fiscal year. ForeignWe estimate that foreign exchange rates (primarily the Euro and the Pound Sterling) strengthened reported net revenue by approximately $14.3$83 million, or 3.07 percent, in the current quarter. Strongthree months ended December 31, 2003, and approximately $119 million, or 6 percent, in the nine months ended December 31, 2003. The overall increase in net revenue can also be attributed to (1) strong sales of our PlayStation 2 and Xbox products, which we believe was driven by an increase in the installed base on these consoles and PC platform products(2) an 11 percent increase in the number of titles released on these platforms during the nine month period ended December 31, 2003, compared to the nine month period ended December 31, 2002. These increases were partially offset by a decline(1) declines in net revenue from PlayStation products as we transition away from that platform. In addition, based on reported amounts,platform, (2) declines in advertising revenue related to the revised terms of our renegotiated relationship with AOL during the three months ended June 30, 2003, and (3) declines in co-publishing and distribution net revenue increase was driven byprimarily due to the following:termination of our Square EA joint venture during the three months ended June 30, 2003.

•Tiger Woods PGA TOUR® 2004andNHL® 2004titles were released in the current quarter, while fiscal 2003’sTiger Woods PGA TOURandNHLtitles were not released until our fiscal third quarter. This accounted for an aggregate increase of $50.5 million.

•Strong sales of other current-quarter sports-related titles includingMadden NFL 2004, EA SPORT™ Rugby 2004andNCAA® Football 2004, as well as strong sales ofSoul Calibur IIandFreedom Fighters®in Europe and Asia Pacific. These products accounted for an aggregate increase of $59.6 million.

2223

•Partially offset by strong prior year sales ofKingdom Hearts, (from our Square EA joint venture, which was terminated in March 2003),Medal of HonorandThe Simsfranchise products for an aggregate decrease of $42.7 million.

Net revenue for the six months ended September 30, 2003 increased by 12 percent as compared to the same period in the prior fiscal year. Foreign exchange rates (primarily the Euro and the Pound Sterling) strengthened reported net revenue by approximately $35.5 million or 4.5 percent in the current period. Based on reported amounts, the net revenue increase was driven by the following:

•Strong sales of our PlayStation 2, Xbox and PC products for an aggregate increase of $103.4 million. The increase was driven primarily byNBA STREET Vol. 2, Def Jam VENDETTA, Tiger Woods PGA TOUR 2004, Madden NFL 2004andThe Simsfranchise products. These increases were partially offset by strong net revenue in the six months ended September 30, 2002 for2002 FIFA World Cupand theMedal of Honorfranchise products.

•Net revenue from co-publishing and distribution products increased $20.8 million in the current period. This increase was due in large part to sales ofSoul Calibur II, Aliens Natural Selection, Devil May Cry 2,theBattlefield 1942TM franchise products andFinal Fantasy Origins,partially offset by strong sales in the prior year ofKingdom Hearts(from our Square EA joint venture which was terminated in March 2003).

Partially offset by a 64 percent decrease in PlayStation net revenue from $37.4 million in the six months ended September 30, 2002 to $13.3 million in the same period of the current fiscal year. The decrease has been expected as we transition away from this platform.

North America

For the three and nine months ended September 30,December 31, 2003, net revenue from sales in North America increased by 148 and 11 percent, asrespectively, compared to the three and nine months ended September 30,December 31, 2002. Based upon reported amounts,Net revenue increased from sales of products on the PlayStation 2 and Xbox platforms by $158.7 million and $251.9 million for the three and nine months, ended December 31, 2003, respectively, but these increases were partially offset by decreases across other platforms.

The net revenue increase wasincreases in the three and nine months ended December 31, 2003 were primarily driven by sales of products released in the following:three months ended December 31, 2003 in the Need for Speed, Medal of Honor, The Sims, SSX and Lord of the Rings franchises, which were greater than sales of last year’s products in each of those franchises. Higher sales in these franchises resulted in increases in net revenue of $211.0 and $166.5 million for the three and nine months ended December 31, 2003, respectively, compared to the three and nine months ended December 31, 2002. Continued strong performance from our Madden NFL, Tiger Woods, NBA Street and Def Jam franchises, which had products released in the first six months of fiscal 2004, increased net revenue by $24.3 and $158.0 million in the three and nine months ended December 31, 2003, respectively.

This increase in net revenue was partially offset by:

 • StrongDecreased net revenue from our Bond franchise as a result of the scheduled release ofJames Bond 007™:Everything or Nothing™ (on all platforms except the Game Boy Advance) in the fourth quarter of fiscal 2004, compared to the strong prior-year sales of our Playstation 2 and Xbox products for an aggregate increaseJames Bond 007: NIGHTFIRE, which was released in the third quarter of $81.5 million. The increase was primarily due to strong EA Sports title net revenue onMadden, Tiger Woods PGA TOUR, NHL,andNCAA Footballfranchise products.fiscal 2003.

 • PCDecreased net revenue increasefrom our Harry Potter franchise, as the current release,Harry Potter™: Quidditch™ World Cup, had no associated movie release, while last year’s product,Harry Potter and the Chamber of 15 percent to $53.6 million from $46.5 millionSecrets, was released in conjunction with the three months ended September 30, 2002. The increase was due to strong salesblockbuster movie ofSimCityTM andCommand & ConquerTM franchise products, partially offset by lower net revenue onThe Simsfranchise products. the same title.

 • Partially offset by a 55 percentA decrease in net revenue from co-publishing and distribution products to $20.2 million from $44.7 million in the same period of the prior fiscal year. The decrease wasnet revenue, due in large part to strong prior-year sales in the three and nine months ended September 30,December 31, 2002 ofKingdom Hearts(from our Square EA joint venture which was terminated in Marchthe three months ended June 30, 2003) andBuffyTy the Vampire Slayer,Tazmanian Tiger, partially offset by the current fiscal year release ofAliens Natural SelectionFreedom Fighters..

ForTogether, these decreases accounted for $180.7 and $207.8 million for the sixthree and nine months ended September 30,December 31, 2003, net revenue from sales in North America increased by 14 percent asrespectively, compared to the sixthree and nine months ended September 30,December 31, 2002. The net revenue increase was driven by the following:

•Strong sales of our Playstation 2 and Xbox products for an aggregate increase of $93.2 million.NBA STREET vol. 2andDef Jam VENDETTAreleases plus additional strong sports title net revenue onMadden, Tiger Woods PGA TOUR, NHLandNCAA Footballfranchises were partially offset by a decrease in net revenue fromMedal of Honor Frontline.
International

•PC net revenue increase of 11 percent to $90.5 million versus $81.3 million in the six months ended September 30, 2002. Strong sales ofSimCityTM,Command & ConquerTM,Medal of HonorandTiger Woods PGA TOUR franchise products were partially offset by lower net revenue onThe Simsfranchise products.

Partially offset by an expected decrease in net revenue from products for Playstation of 68 percent or $17.3 million as we transition away from this platform.

•Also partially offset by a 26 percent decrease in net revenue from co-publishing and distribution products to $44.4 million versus $59.7 million in the six months ended September 30, 2002. The decrease was due in large part to net revenue in the six months ended September 30, 2002 forKingdom HeartsandBuffy the

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Vampire Slayer, partially offset by net revenue in the same period of the current fiscal year ofBattlefield 1942franchise products and the current fiscal year release ofAliens Natural Selection.

International

Europe

For the three and nine months ended September 30,December 31, 2003, net revenue from sales in Europe increased by 2440 and 30 percent, asrespectively, compared to the three and nine months ended September 30,December 31, 2002. ForeignWe estimate foreign exchange rates strengthened reported European net revenue by approximately $11.7$73 million or 10 percent. Based upon reported amounts,16 percent for the three months ended December 31, 2003 and approximately $105 million or 14 percent for the nine months ended December 31, 2003. Net revenue from products on the PlayStation 2, Xbox and PC platforms increased by $211.6 and $216.6 million for the three and nine months ended December 31, 2003, respectively, partially offset by a decrease in PlayStation and other net revenue of $24.4 and $32.4 million, respectively, compared to the three and nine months ended December 31, 2002.

The net revenue increases in the three and nine months ended December 31, 2003 were led by sales of products released in the three months ended December 31, 2003 in the Medal of Honor, Need for Speed, FIFA, The Sims, Lord of the Rings, SSX and Football Manager franchises. Higher sales in these franchises resulted in increases in net revenue of $264.9 and $271.5 million, respectively, for the three and nine months ended December 31, 2003, as compared to the three and nine months ended December 31, 2002. Continued strong performance from our fiscal 2004 second quarter releases in the Tiger Woods and Command & Conquer franchises increased net revenue by $11.6 and $22.6 million for the three and nine months ended December 31, 2003, respectively. In addition, co-publishing and distribution net revenue increased by $1.7 and $34.5 million for the three and nine months ended December 31, 2003, respectively, primarily due toFreedom Fighters, Looney Tunes Back in Actionand other European co-publishing and distribution products.

24

The increase in net revenue was driven by the following:partially offset by:

 • Co-publishing and distribution product sales increased by $20.4 million, or 48 percent, primarily due toDecreased net revenue from our Bond franchise, as a result of the scheduled release ofSoul Calibur IIJames Bond 007:Everything or NothingandFreedom Fighters,partially offset by decreases(on all platforms except the Game Boy Advance) in the currentfourth quarter of fiscal year onResident EvilandBuffy2004, compared to the Vampire Slayer.strong prior-year sales ofJames Bond 007: NIGHTFIRE, which was released in the third quarter of fiscal 2003.

 • Playstation 2, Xbox and PC product sales increased by $11.8 million, or 31 percent, primarily due to the additional titles available on the Xbox console and strong current fiscal yearDecreased net revenue onfrom our Harry Potter franchise, as the current product,EA SPORTS Rugby 2004Harry Potter: Quidditch World Cup, had no associated movie release, while last year’s release,Command & Conquer: Generals,Harry Potter and the Chamber of SecretsandTiger Woods PGA TOURfranchise products, as well asLord, was released in conjunction with the blockbuster movie of the Rings: The Two Towers, partially offset by strong sales in the same period of the prior fiscal year ofMedal of Honor Frontline.title.

•This increase was also partially offset by a $4.6 million decrease for our PlayStation and Nintendo GameCube products primarily due to stronger
An expected decrease in sales of our World Cup franchise due to strong sales in the three months ended September 30, 2002 from key titles, includingF1 Challenge, SSX Trickyand ourJames Bondfranchise products. The decrease in Playstation net revenue has been expected as we transition away from the Playstation platform.

For the sixnine months ended September 30,December 31, 2002 in conjunction with the World Cup event and no similar event in the nine months ended December 31, 2003.

Together, these decreases accounted for $98.2 and $127.6 million, respectively, for the three and nine months ended December 31, 2003, net revenue from sales in Europe increased by 12 percent as compared to the sixthree and nine months ended September 30,December 31, 2002. Foreign exchange rates strengthened reported European net revenue by approximately $30.8 million or 13 percent. Based upon reported amounts, the increase was driven by the following:

•Co-publishing and distribution product sales which increased by $32.8 million, or 48 percent, primarily due to net revenue fromSoul Calibur II,Freedom Fighters, Devil May Cry 2, Aliens Natural Selection andAnnofranchise products, partially offset by decreases in the current fiscal year onResident Evil, Onimusha WarlordsandBuffy the Vampire Slayer.

•Xbox, PC and Game Boy Advance product sales, which increased by $12.9 million, or 17 percent, primarily due to additional titles available on the Xbox and Game Boy Advance consoles as well as strong current fiscal year net revenue onThe SimsandCommand & Conquer franchise products.

•This increase was partially offset by an $8.2 million decrease for PlayStation 2 and Nintendo GameCube products primarily due to stronger sales in the six months ended September 30, 2002 from key titles, includingMedal of Honor Frontlineand2002 FIFA World Cup.Strong current fiscal year net revenue onThe Sims, Def Jam VENDETTAandEA SPORTS Rugby 2004partially offset these decreases.

Playstation product sales decreased by $6.7 million primarily due to our transition away from this platform.

Asia Pacific

For the three and nine months ended September 30,December 31, 2003, net revenue from sales in the Asia Pacific region, excluding Japan, increased by 2812 percent and 11 percent, respectively compared to $17.6 million versus $13.8 million for the three and nine months ended September 30,December 31, 2002. ForeignWe estimate foreign exchange rates strengthened reported Asia Pacific net revenue by approximately $2.4$8 million or 18 percent. Based upon reported amounts,20 percent, for the net revenue increase was driven by the following:

•PlayStation 2 product sales, which increased $2.2 million primarily due to stronger sales from key titles, includingEA SPORTS Rugby 2004 andTiger Woods PGA TOUR 2004.

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•Co-publishing and distribution product sales, which increased by $1.6 million, or 39 percent. The increase was due primarily to net revenue fromSoul Calibur II,Knights of the Old Republic,Aliens Natural SelectionandFreedom Fighters,partially offset by decreases in the current fiscal year onBuffy the Vampire SlayerandBattlefield 1942.

For the sixthree months ended September 30,December 31, 2003 net revenue from sales in the Asia Pacific region, excluding Japan, increased by 11and approximately $12 million or 17 percent, to $32.1 million versus $29.0 million for the sixnine months ended September 30, 2002. ForeignDecember 31, 2003. Excluding the effect of foreign exchange rates, strengthened reported Asia Pacific net revenue decreased by approximately $3.1 million or 8 percent and $3.9 million or 14 percent. Based upon reported amounts,6 percent, respectively, from the netthree and nine months ended December 31, 2003. Net revenue increaseincreased from sales of products on the PlayStation 2 and Xbox platforms by $8.9 and $11.7 million, for the three and nine months ended December 31, 2003, respectively, but was drivenpartially offset by decreases across other platforms. The top three titles wereMedal of Honor Rising Sun,Need for Speed UndergroundandThe Lord of the following:Rings; The Return of the King, partially offset by declines in the Bond and Harry Potter franchises.

•PlayStation 2 product sales, which increased $2.0 million primarily due to stronger sales from titles including EA SPORTSRugby 2004,The Simsfranchise products,Tiger Woods PGA TOUR 2004, NBA STREET Vol. 2, Madden NFL 2004, Def Jam VENDETTAandLord of the Rings: The Two Towers,partially offset by strong net revenue in the same period of the prior fiscal year forMedal of Honor Frontline.

•Co-publishing and distribution product sales, which increased by $1.1 million, or 13 percent, primarily due to net revenue fromSoul Calibur II.

Japan

For the three and nine months ended September 30,December 31, 2003, net revenue from sales in Japan decreased by 329 and 24 percent, respectively compared to $9.2 million from $9.5 million. Foreignthe three and nine months ended December 31, 2002. We estimate foreign exchange rates strengthened reported net revenue in Japan by approximately $0.1$2 million or 1 percent. Based upon reported amounts,8 percent, and approximately $3 million or 6 percent, respectively, for the net revenue decrease was driven by the following:

•Co-publishing and distribution product sales, which decreased by $1.4 million, or 26 percent, primarily due to strong prior year net revenue in the three months ended September 30, 2002 fromEver17,Tenkatouitsu 4andGundam Net Op,partially offset by the current fiscal year release ofMemo Off Mix.

•Partially offset by PlayStation 2 and PC product sales, which increased $0.9 million primarily due to stronger sales from key products, includingF1 Career Challenge, SimCity 4andDef Jam VENDETTA.

For the sixthree and nine months ended September 30,December 31, 2003, netcompared to the three and nine months ended December 31, 2002. Net revenue from sales in Japanproducts on the PlayStation 2 and Xbox platforms decreased by 18 percent to $21.3$1.6 and $8.9 million, versus $26.1 million forrespectively, from the sixthree and nine months ended September 30, 2002. Foreign exchange rates strengthened reported net revenueDecember 31, 2002, primarily due to declines in Japan by approximately $0.8 million or 3 percent. Based upon reported amounts, the net revenue decrease was driven by the following:FIFA, Harry Potter and World Cup franchises.

•PlayStation 2 product sales, which decreased $6.9 million, primarily due to reduced sales onFIFAfranchise products, partially offset byThe Sims, MVP BaseballandNBA STREET Vol. 2.
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•Offset partially by co-publishing and distribution product sales, which increased by $2.2 million, or 31 percent, primarily due to net revenue fromMax PayneandMemo Off Mix.

Net Revenue by Product Line

Our worldwide net revenue by product line for the three and sixnine months ended September 30,December 31, 2003 and 2002 is summarized below (in thousands):

25

                
               
Net Revenue for the Three September 30, September 30, Increase/    December 31, December 31, Increase/  
Months Ended 2003 2002 (Decrease) % change 2003 2002 (Decrease) % Change
  
   
 
 
 
PlayStation 2 $221,180 $158,712 $62,468  39.4% $731,587 $459,407 $272,180  59.2%
PC 93,022 82,686 10,336  12.5% 219,939 219,083 856  0.4%
Xbox 68,691 37,527 31,164  83.0% 204,565 116,836 87,729  75.1%
Nintendo GameCube 24,553 27,838  (3,285)  (11.8%) 103,804 111,103  (7,299)  (6.6%)
Game Boy Advance 57,194 68,102  (10,908)  (16.0%)
Subscription Services 11,124 8,321 2,803  33.7% 11,781 11,236 545  4.9%
PlayStation 13,344 53,066  (39,722)  (74.9%)
Advertising, Programming, Licensing, and Other 7,552 14,161  (6,609)  (46.7%) 10,804 37,424  (26,620)  (71.1%)
PlayStation 7,562 24,206  (16,644)  (68.8%)
Game Boy Advance 3,809 3,679 130  3.5%
   
 
 
 
 
 437,493 357,130 80,363  22.5% 1,353,018 1,076,257 276,761  25.7%
Co-publishing and Distribution 92,512 96,360  (3,848)  (4.0%) 122,305 157,469  (35,164)  (22.3%)
   
 
 
 
 
Total Net Revenue $530,005 $453,490 $76,515  16.9% $1,475,323 $1,233,726 $241,597  19.6%
   
 
 
 
 
                 
 
Net Revenue for the Six September 30,  September 30,  Increase/    
Months Ended 2003  2002  (Decrease)  % change
   
   
PlayStation 2 $339,549  $293,310  $46,239   15.8%
PC  173,360   158,752   14,608   9.2%
Xbox  100,212   57,630   42,582   73.9%
Nintendo GameCube  45,707   42,794   2,913   6.8%
Subscription Services  24,755   16,860   7,895   46.8%
Advertising, Programming, Licensing, and Other  16,263   29,508   (13,245)  (44.9%)
PlayStation  13,313   37,429   (24,116)  (64.4%)
Game Boy Advance  6,168   5,817   351   6.0%
   
   719,327   642,100   77,227   12.0%
Co-publishing and Distribution  164,059   143,288   20,771   14.5%
   
Total Net Revenue $883,386  $785,388  $97,998   12.5%
   
                     
PlayStation 2 Net Revenue(In thousands)
 
  September 30,  % of net September 30,  % of net   
  2003  revenue 2002  revenue % change
   
Three months ended $221,180   41.7% $158,712   35.0%  39.4%
   
Six months ended $339,549   38.4% $293,310   37.3%  15.8%
   
                 
Net Revenue for the Nine December 31, December 31, Increase/  
Months Ended 2003 2002 (Decrease) % Change
 
 
 
 
PlayStation 2 $1,071,136  $752,717  $318,419   42.3%
PC  393,299   377,835   15,464   4.1%
Xbox  304,777   174,466   130,311   74.7%
Nintendo GameCube  149,511   153,897   (4,386)  (2.8%)
Game Boy Advance  63,362   73,919   (10,557)  (14.3%)
Subscription Services  36,536   28,096   8,440   30.0%
PlayStation  26,657   90,495   (63,838)  (70.5%)
Advertising, Programming, Licensing, and Other  27,067   66,932   (39,865)  (59.6%)
   
   
   
   
 
   2,072,345   1,718,357   353,988   20.6%
Co-publishing and Distribution  286,364   300,757   (14,393)  (4.8%)
   
   
   
   
 
Total Net Revenue $2,358,709  $2,019,114  $339,595   16.8%
   
   
   
   
 

PlayStation 2 Net Revenue(In thousands)

                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $731,587   49.6% $459,407   37.2%  59.2%
Nine months ended $1,071,136   45.4% $752,717   37.3%  42.3%

For the three months ended September 30,December 31, 2003, net revenue from PlayStation 2 products increased by 3959 percent to $221.2$731.6 million versus $158.7$459.4 million for the three months ended September 30,December 31, 2002. The increase was primarily due to strong sales ofMadden Medal of Honor, Need for Speed, The Sims andTiger Woods PGA TOUR FIFA franchise products in the quarter ended December 31, 2003, as a result of current quarter releases ofMedal of Honor Rising Sun,Need for Speed UndergroundandFIFA Soccer 2004.This increase was These increases were partially offset by lowerdecreases in net revenue from theMedalsales of Honorour Bond and Harry Potter franchise compared toproducts. Eleven titles were released on the PlayStation 2 platform in the three months ended December 31, 2003 versus nine in the same period in the prior fiscal year.

For the sixnine months ended September 30,December 31, 2003, net revenue from PlayStation 2 products increased by 1642 percent to $339.5$1,071.1 million versus $293.3$752.7 million for the sixnine months ended September 30,December 31, 2002. The increase was primarily due to current fiscal

26

year sales of hit titlesDef Jam VENDETTA, The SimsMadden NFL 2004,Need for Speed Underground,FIFA Soccer 2004, and franchise products including The Sims, SSX and NBA STREET, Madden, Tiger Woods PGA TOUR, andNHL. This increase wasStreet. These increases were partially offset by lowerdecreases in net revenue fromMedal sales of Honor Frontlinecompared toour Bond and Harry Potter franchise products. Twenty titles were released on the PlayStation 2 platform in the nine months ended December 31, 2003 versus 17 in the same period in the prior fiscal year.

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Personal Computer Net Revenue(In thousands)

                     
Personal Computer Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $93,022   17.6% $82,686   18.2%  12.5%
   
Six months ended $173,360   19.6% $158,752   20.2%  9.2%
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $219,939   14.9% $219,083   17.8%  0.4%
Nine months ended $393,299   16.7% $377,835   18.7%  4.1%

For the three months ended September 30,December 31, 2003, net revenue from products for the PC remained relatively flat, increasing by 0.4 percent to $219.9 million versus $219.1 million in the three months ended December 31, 2002. The slight increase is primarily attributable to sales of our Lord of the Rings and Command & Conquer franchise products, specificallyThe Lord of the Rings; The Return of the King,Command & Conquer Generals Zero HourandCommand & Conquer Generals. These increases were substantially offset by lower net revenue from sales of our Harry Potter franchise products.

For the nine months ended December 31, 2003, net revenue from products for the PC increased by 134 percent to $93.0$393.3 million versus $82.7$377.8 million in the threenine months ended September 30, 2002. The increase was primarily due to strong sales of hit franchise products includingSimCityfranchise products, (particularlySimCity 4 DeluxeandSimCity 4 Rush Hour) andCommand & Conquer,Medal of HonorandNHLfranchise products. This was partially offset by a decrease in net revenue onThe Simsfranchise products. Ten titles were released in the current fiscal quarter versus three in the same period in the prior fiscal year.

For the six months ended September 30, 2003, net revenue from products for the PC increased by 9 percent to $173.4 million versus $158.8 million in the six months ended September 30,December 31, 2002. The increase was primarily due to stronger current year net revenue from sales of products fromour Command & Conquer,SimCityandMedal Lord of Honorthe Rings franchise products, partially offset by lower net revenue from prior fiscal year hit title2002 FIFA World Cup. Currentthe sales of our Harry Potter franchise products. Significant current fiscal year releases includedincludeCommand & Conquer Generals Zero Hour,Command & Conquer GeneralsandThe Sims Superstar,Lord of the Rings; The Sims Double Deluxe,SimCity 4 Deluxe, andSimCity 4 Rush HourReturn of the King. OtherIn addition, prior fiscal year releases continued to generate strong sales, particularlyThe Sims DeluxeandThe Sims Unleashed. TwelveNineteen titles were released on the PC platform in the sixnine months ended September 30,December 31, 2003 versus five14 titles released in the same period of the prior fiscal year.

Xbox Net Revenue(In thousands)

                     
Xbox Net Revenue(In thousands)
  September 30,  % of September 30,  % of  
  2003  net revenue 2002  net revenue % change
 
Three months ended $68,691   13.0% $37,527   8.3%  83.0%
   
Six months ended $100,212   11.3% $57,630   7.3%  73.9%
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $204,565   13.9% $116,836   9.5%  75.1%
Nine months ended $304,777   12.9% $174,466   8.6%  74.7%

For the three months ended September 30,December 31, 2003, net revenue of Xbox products increased by 8375 percent to $68.7$204.6 million versus $37.5$116.8 million in the three months ended September 30,December 31, 2002. The increase was primarily due to the higher installed basesales of Xbox consoles as well asour Need for Speed, Medal of Honor, Lord of the sales ofTiger Woods PGA TOUR,MaddenRings andNHL The Sims franchise products. Other significantSignificant titles contributing toreleased in the increase werecurrent quarter includedNeed for Speed Underground,Medal of Honor Frontline,FIFA 2003Rising SunandNBA STREET Vol. 2The Lord of the Rings; The Return of the King. FiveThese increases were partially offset by decreases in net revenue from sales of our Bond franchise products. Eleven titles were released in the three months ended December 31, 2003 versus eight in the same period in the prior fiscal year.

For the nine months ended December 31, 2003, net revenue of Xbox products increased by 75 percent to $304.8 million versus $174.5 million in the nine months ended December 31, 2002. The increase was primarily due to strong sales of our Lord of the Rings, Need for Speed, The Sims, Medal of Honor and Madden NFL franchise products. Significant titles released in the current fiscal quarteryear includedMadden NFL 2004,Need for Speed Underground,Medal of Honor Rising Sun andThe Lord of the Rings; The Return of the King. These increases were partially offset by decreases in net revenue from sales of our Bond franchise products. Eighteen titles were released on the Xbox platform in the nine months ended December 31, 2003 versus 13 in the same period in the prior fiscal year.

Nintendo GameCube Net Revenue(In thousands)

                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $103,804   7.0% $111,103   9.0%  (6.6%)
Nine months ended $149,511   6.3% $153,897   7.6%  (2.8%)

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For the three months ended December 31, 2003, net revenue from Nintendo GameCube products decreased by 7 percent to $103.8 million versus $111.1 million for the three months ended December 31, 2002. The decrease was primarily due to lower sales of our franchise products including Bond, Harry Potter and Madden NFL, partially offset by increased franchise sales of Lord of the Rings, The Sims and SSX.

For the nine months ended December 31, 2003, net revenue from Nintendo GameCube products decreased by 3 percent to $149.5 million versus $153.9 million for the nine months ended December 31, 2002. The slight decrease was attributable to lower sales of our Bond and Harry Potter franchise products in the current fiscal year, partially offset by increased sales of our Lord of the Rings, The Sims and Def Jam franchise products. Sixteen titles were released on the Nintendo GameCube platform in the nine months ended December 31, 2003 versus 15 in the same period in the prior fiscal year.

For the six months ended September 30, 2003, net revenue of Xbox products increased by 74 percent to $100.2 million versus $57.6 million in the six months ended September 30, 2002. The increase was primarily due toNBA STREET Vol. 2Game Boy Advance Net Revenue,The SimsandMedal of Honor Frontline, and strong sales ofTiger Woods PGA TOUR,MaddenandNHLfranchise products. This increase was partially offset by lower net revenue for prior fiscal year hit title2002 FIFA World Cup. Seven titles were released in the six months ended September 30, 2003 versus five in the same period in the prior fiscal year.(In thousands)

                     
Nintendo GameCube Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $24,553   4.6% $27,838   6.1%  (11.8%)
   
Six months ended $45,707   5.2% $42,794   5.4%  6.8%
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $57,194   3.9% $68,102   5.5%  (16.0%)
Nine months ended $63,362   2.7% $73,919   3.7%  (14.3%)

For the three and nine months ended September 30,December 31, 2003, net revenue from Nintendo GameCubeour Game Boy Advance products decreased by 12 percentwas $57.2 million and $63.4 million, respectively, compared to $24.6$68.1 million versus $27.8and $73.9 million, respectively, for the three and nine months ended September 30,December 31, 2002. TheThis represented a 16 and 14 percent decrease was

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for the three and nine months ended December 31, 2003, respectively. Net revenue from Game Boy Advance products decreased primarily due to strong sales ofFreekstyleHarry Potter and the Chamber of SecretsandNASCAR ThunderTM 2003in the prior year quarter,three and nine months ended December 31, 2002. This was partially offset by current quarter sales ofyear releases includingTiger Woods PGA TOUR 2004Harry Potter: Quidditch World Cup.

For the six months ended September 30, 2003, net revenue from Nintendo GameCube products increased by 7 percent to $45.7 million versus $42.8 million for the six months ended September 30, 2002. ,The slight increase was attributable to significant new releases in the current year includingNBA STREET Vol. 2andDef Jam VENDETTASims Bustin’ Out, partially offset by lower net revenue onJames Bond 007 in...Agent Under Fire007: Everything or NothingandMedal of Honor Infiltrator. Seven titles were released in the six months ended September 30, 2003 versus six in the same period in the prior fiscal year.

Subscription Services Net Revenue(In thousands)

                     
Subscription Services Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $11,124   2.1% $8,321   1.8%  33.7%
   
Six months ended $24,755   2.8% $16,860   2.1%  46.8%
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $11,781   0.8% $11,236   0.9%  4.9%
Nine months ended $36,536   1.5% $28,096   1.4%  30.0%

For the three and nine months ended September 30,December 31, 2003, net revenue from subscription fees for our online games increased 34 percent to $11.1was $11.8 million and $36.5 million, respectively, compared to $8.3$11.2 million and $28.1 million, respectively, for the three and nine months ended SeptemberDecember 31, 2002. This represented a 5 and 30 2002percent increase for the three and nine months ended December 31, 2003, respectively. Subscription services net revenue increased primarily due to subscription net revenue froma higher number of users forThe Sims Online(launched in December 2002) compared to the same periods a year ago, Club Pogo (launched in July 2003) andEarth & Beyond, Pogo Downloadables (launched in May 2003), partially offset by a decrease in subscription net revenue fromMotor City Online(which was discontinued duringin August 2003). In addition, a portion of the threeincrease for the nine months ended September 30, 2003).

For the six months ended September 30,December 31, 2003 net revenue from subscription fees for our online games increased 47 percentwas attributable to $24.8 million compared to $16.9 million for the six months ended September 30, 2002. This increase was primarily due toThe Sims OnlineEarth & Beyond™, which was launched in December 2002, and higher subscription net revenue fromEarth & Beyond.

                     
Advertising, Programming, Licensing and Other Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $7,552   1.4% $14,161   3.1%  (46.7%)
   
Six months ended $16,263   1.8% $29,508   3.8%  (44.9%)
   
September 2002.

For the three months ended September 30, 2003, net revenue from advertising, programming, licensing and other decreased 47 percent to $7.6 million versus $14.2 million in the three months ended September 30, 2002. The decrease was primarily due to the discontinuance (as of April 1, 2003) of advertising revenue received from AOL, partially offset by AOL programming fees initiated during the quarter ended June 30, 2003. PlayStation Net Revenue(In addition, Game Boy Color net revenue decreased in the current quarter compared to the same period in the prior fiscal year primarily due to lower net revenue from ourHarry Potter franchise products.

For the six months ended September 30, 2003, net revenue from advertising, programming, licensing and other decreased 45 percent to $16.3 million versus $29.5 million for the six months ended September 30, 2002. The decrease was primarily due to the discontinuance (as of April 1, 2003) of advertising revenue received from AOL, partially offset by AOL programming fees initiated during the quarter ended June 30, 2003. In addition, Game Boy Color net revenue decreased in the six months ended September 30, 2003 versus the same period in the prior fiscal year primarily due to lower net revenue for ourHarry Potterfranchise products.thousands)

                     
PlayStation Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $7,562   1.4% $24,206   5.3%  (68.8%)
   
Six months ended $13,313   1.5% $37,429   4.8%  (64.4%)
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $13,344   0.9% $53,066   4.3%  (74.9%)
Nine months ended $26,657   1.1% $90,495   4.5%  (70.5%)

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For the three and nine months ended September 30,December 31, 2003, net revenue from PlayStation products decreased 69 percentwas $13.3 million and $26.7 million, respectively, compared to $7.6$53.1 million versus $24.2and $90.5 million, respectively, for the three and nine months ended September 30,December 31, 2002. This represented a 75 and 71 percent decrease for the three and nine months ended December 31, 2003, respectively. As we expected, the decrease in net revenue from sales of PlayStation products for the three months ended September 30, 2003 was attributable to the market transition to newer generation console systems. Although our PlayStation products are playable on the PlayStation 2 console, we expect sales of current PlayStation products to continue to decline throughout the remainder of fiscal 2004. We released one and three new titles on the PlayStation platform in the three and nine months ended December 31, 2003, respectively, versus three and six titles in the three and nine months ended December 31, 2002, respectively.

Advertising, Programming, Licensing and Other Net Revenue(In thousands)

                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $10,804   0.7% $37,424   3.0%  (71.1%)
Nine months ended $27,067   1.1% $66,932   3.3%  (59.6%)

For the sixthree and nine months ended September 30,December 31, 2003, net revenue from PlayStation products decreased 64 percentadvertising, programming, licensing and other was $10.8 million and $27.1 million, respectively, compared to $13.3 million versus $37.4 million and $66.9 million, respectively, for the sixthree and nine months ended SeptemberDecember 31, 2002. This represented a 71 and 60 percent decrease, for the three and nine months ended December 31, 2003, respectively. Advertising net revenue decreased primarily due to the revised terms of our renegotiated relationship with AOL during the three months ended June 30, 2002. As we expected,2003. In addition, the decrease in other net revenue was attributableprimarily due to the market transition to newer generation console systems. Two new titles were releasednet revenue decrease from our Harry Potter franchise products on the Game Boy Color platform in the sixthree and nine months ended September 30,December 31, 2003 versus three titles in the same periodperiods in the prior fiscal year. Titles and franchises that generated lower net revenueNo titles were released on the Game Boy Color platform in the sixnine months ended September 30,December 31, 2003 includeversus one title released in the nine months ended December 31, 20022002 FIFA World Cup.

Co-publishing andMadden Distribution Net Revenue,Medal of HonorandNASCAR franchise products.(In thousands)

                     
Game Boy Advance Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $3,809   0.7% $3,679   0.8%  3.5%
   
Six months ended $6,168   0.7% $5,817   0.7%  6.0%
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $122,305   8.3% $157,469   12.8%  (22.3%)
Nine months ended $286,364   12.1% $300,757   14.9%  (4.8%)

For the three months ended September 30, 2003, net revenue from Game Boy Advance increased 4 percent to $3.8 million versus $3.7 million in the three months ended September 30, 2002. Net revenue from Game Boy Advance products increased slightly due to strong sales of ourLord of the Ringsfranchise products, partially offset by lower net revenue from ourHarry Potterfranchise products. Twelve titles were available in the three months ended September 30, 2003 versus seven in the same period in the prior fiscal year.

For the six months ended September 30, 2003, net revenue from Game Boy Advance increased 6 percent to $6.2 million versus $5.8 million for the six months ended September 30, 2002. This slight increase in net revenue in the current fiscal year was primarily attributable to strong sales ofJames Bond 007: Nightfire, partially offset by lower net revenue on ourHarry Potterfranchise products.

                     
Co-publishing and Distribution Net Revenue(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $92,512   17.5% $96,360   21.2%  (4.0%)
   
Six months ended $164,059   18.6% $143,288   18.2%  14.5%
   

For the three months ended September 30,December 31, 2003, net revenue from co-publishing products and distribution products decreased 422 percent to $92.5$122.3 million compared to $96.4$157.5 million in the three months ended September 30,December 31, 2002. This decrease was primarily due to strong sales in the three months ended September 30,December 31, 2002, ofKingdom Hearts,andBuffyTy the Vampire Slayer,Resident EvilandFinal Fantasy XTazmanian Tigerpartially offset by a net revenue increase sales ofFreedom Fighterin the same period of the current fiscal year from current fiscal year releases,Soul Calibur IIandFreedom Fighters.three months ended December 31, 2003.

For the sixnine months ended September 30,December 31, 2003, net revenue from co-publishing products and distribution products increased 15decreased 5 percent to $164.1$286.4 million compared to $143.3$300.8 million in the sixnine months ended September 30,December 31, 2002. This increaseThe slight decrease was primarily due to strong net revenue fromsales in the nine months ended December 31, 2002, ofSoul Calibur IIKingdom Hearts,andTy the Tazmanian Tigerpartially offset by current year titles sales ofFreedom Fighters,Aliens Natural SelectionLooney Tunes: Back in ActionandDevil May Cry 2, partially offset by lower net revenue fromKingdom HeartsandFinal Fantasy X. the Battlefield franchise products.

Costs and Expenses, Interest and Other Income, Net, and Income Taxes

Cost of Goods Sold.Sold (In thousands)

Cost of goods sold for our disk-based and cartridge-based products consists of (1) actual product costs, (2) royalties expense for celebrities, professional sports and other organizations and independent software

29

developers, (3) manufacturing royalties, net of volume discounts, (4) expense for defective products, (5) write-off of post-launch prepaid royalty costs, and (6) operations expense. Cost of goods sold for our online product subscription business consists primarily of data center and bandwidth costs associated with hosting our websites, credit card fees and royalties for use of third party properties. Cost of goods sold for our website advertising business consists primarily of ad serving costs.

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  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $513,255   34.8% $565,111   45.8%  (9.2%)
Nine months ended $876,980   37.2% $908,432   45.0%  (3.5%)

For the three months ended December 31, 2003, cost of goods sold as a percentage of net revenue decreased by 11.0 percentage points to 34.8 percent from 45.8 percent for the three months ended December 31, 2002. In the three months ended December 31, 2002, we had significant sales fromHarry Potter and the Chamber of SecretsandJames Bond 007: NIGHTFIREtitles across multiple platforms, which included PlayStation 2, Nintendo GameCube, Xbox and PC.These two titles had significantly higher license royalty rates than the highest net revenue generating titles in the three months ended December 31, 2003.We also had lower development royalties due to a higher mix of titles that were developed internally versus externally. We estimate that lower development royalties increased gross margin by 2 percentage points, which was spread across multiple platforms including PlayStation 2, Nintendo GameCube, Xbox and PC. The decrease in development royalties classified in costs of goods sold was offset by an increase in internal development costs classified in research and development. By platform, the decrease in costs of goods sold is primarily due to:

•Higher gross margins for PlayStation 2 products contributing 4.4 percentage points to total gross margin. The increase in gross margins was due to lower royalties noted in the paragraph above. In addition,Need for Speed Undergroundhad a lower royalty rate in the three months ended December 31, 2003 thanNeed for Speed Hot Pursuit 2in the three months ended December 31, 2002.

Higher Nintendo GameCube gross margins contributing 1.4 percentage points to total gross margin. This increase in gross margin was due to the lower royalties noted in the paragraph above and pricing discounts from Nintendo on titles released in the nine months ended December 31, 2003.

•Higher Xbox gross margins contributing a 1.2 percentage point to total gross margin. The increase in gross margin was due to the lower royalties noted in the above paragraph and a volume discount received from Microsoft for theMedal of Honor Rising Sunproduct in the three months ended December 31, 2003.

Higher PC gross margins contributing a 0.9 percentage point increase to total gross margin. The increase in gross margins was due to lower royalties noted in the paragraph above and lower direct and indirect product costs as a result of lower packaging costs and improved efficiencies.

Favorable product mix contributing a 2.0 percentage point increase to total gross margin due to an increase in the percentage of net revenue being derived from higher-gross-margin product lines, such as products for the PlayStation 2 and Xbox and a decrease in the percentage of net revenue derived from lower-gross-margin product lines such as those for the PlayStation and co-publishing and distribution products. Also, within the co-publishing and distribution product line we had a higher proportion of net revenue from co-publishing titles that have a higher gross margin and a lower proportion of net revenue from distribution products that have a lower gross margin.

For the nine months ended December 31, 2003, cost of goods sold as a percentage of net revenue decreased by 7.8 percentage points to 37.2 percent from 45.0 percent for the nine months ended December 31, 2003. In the three months ended December 31, 2002, we had significant sales fromHarry Potter and the Chamber of SecretsandJames Bond 007: NIGHTFIREtitles across multiple platforms, which included PlayStation 2, Nintendo GameCube, Xbox and PC.These two titles had significantly higher license royalty rates than the highest net revenue generating titles in the nine months ended December 31, 2003.We also had lower development royalties due to a higher mix of titles that were developed internally versus externally. We estimate that lower development royalties increased gross margin by 2 percentage points, which was spread across multiple platforms including PlayStation 2, Nintendo GameCube, Xbox and PC. The decrease in development royalties classified in costs of goods sold is offset by an increase in internal development costs classified in research and development. By platform, the decrease in costs of goods sold is primarily due to:

•Higher gross margins for PlayStation 2 products contributing a 2.5 percentage point increase to the total gross margin. The increase in gross margins was due to the lower royalties noted in the paragraph above and lower royalty rates forNeed for Speed Undergroundin the nine months ended December 31, 2003 compared toNeed for Speed Hot Pursuit 2and2002 FIFA World Cupin the nine months ended December 31, 2002.

•Higher gross margins for Nintendo GameCube products contributing a 1.1 percentage point increase to the total gross margin. The increase in gross margins was due to lower royalties noted in the paragraph above, as well as a pricing discount received from Nintendo on titles released in the nine months ended December 31, 2003 and high returns onHarry Potter and the Chamber of Secretswhich resulted in lower effective royalty rates in the nine months ended December 31, 2003.

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Higher gross margins for PC products contributing a 0.7 percentage point increase to the total gross margin. The increase in gross margins was due to lower royalties noted in the paragraph above and lower direct and indirect product costs as a result of lower packaging costs and improved efficiencies.

•Higher gross margins for Xbox products contributing a 0.8 percentage point increase to the total gross margin. The increase in gross margin was due to lower royalties noted in the paragraph above and a volume discount received from Microsoft for theMedal of Honor Rising Sun product in the nine months ended December 31, 2003.

Favorable product mix contributing a 1.9 percentage point increase to total gross margin due to an increase in the percentage of net revenue being derived from higher-gross-margin product lines, such as products for the PlayStation 2 and Xbox and a decrease in the percentage of net revenue derived from lower-gross-margin product lines such as those for the PlayStation and co-publishing and distribution products. Also, within the co-publishing and distribution product line we had a higher proportion of net revenue from co-publishing titles that have a higher gross margin and a lower proportion of net revenue from distribution products that have a lower gross margin.

Marketing and Sales.Sales (In thousands)

Marketing and sales expenses consist of personnel-related costs and advertising, marketing and promotional expenses, net of co-op advertising expense reimbursements. In addition, marketing and sales expense in fiscal year 2003 included the amortization of the “carriage” fees payable for the distribution of our online games on AOL, which we are no longer required to pay.

                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $180,174   12.2% $139,492   11.3%  29.2%
Nine months ended $303,299   12.9% $260,380   12.9%  16.5%

For the three months ended December 31, 2003, marketing and sales expenses increased by 29.2 percent as compared to the three months ended December 31, 2002 primarily due to:

•An increase in our advertising, contract services and promotional expenses of $39.0 million as we incrementally increased our advertising and our television and video media campaigns, primarily in Europe, to support the release of our new titles during the quarter, which includedFIFA Soccer 2004, NBA Live 2004, Need for Speed Underground, SSX3, The Lord of the Rings; The Return of the King, Medal of Honor Rising Sun, andThe Sims Bustin’ Outon multiple platforms.

A 14 percent increase in headcount to support the growth of our marketing and sales functions worldwide, which resulted in personnel-related costs increasing by approximately $5.0 million.

Partially offset by the discontinuance of carriage fee payments to AOL, which resulted in a decrease of $4.5 million.

For the nine months ended December 31, 2003, marketing and sales expenses increased by 16.5 percent as compared to the nine months ended December 31, 2002 primarily due to:

•An increase in our advertising, contract services and promotional expenses of $44.8 million as we incrementally increased our advertising and our television and video media campaigns, primarily in Europe, to support the release of our new titles during the period, which includedFIFA Soccer 2004, NBA Live 2004, Need for Speed Underground, SSX3, The Lord of the Rings; The Return of the King, Medal of Honor Rising Sun, Tiger Woods PGA TOUR 2004, NASCAR Thunder 2004, NCAA Football 2004,andThe Sims Bustin’ Outon multiple platforms.

A 12 percent increase in headcount to support the growth of our marketing and sales functions worldwide, which resulted in personnel-related costs increasing by approximately $13.0 million.

Partially offset by the discontinuance of carriage fee payments to AOL, which resulted in a decrease of $13.4 million.

General and Administrative.Administrative (In thousands)

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.

                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $71,992   4.9% $42,250   3.4%  70.4%
Nine months ended $138,784   5.9% $95,366   4.7%  45.5%

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For the three months ended December 31, 2003, general and administrative expenses increased by 70.4 percent as compared to the three months ended December 31, 2002 due to:

An increase in depreciation expense of approximately $11.0 million primarily due to the one-time acceleration of depreciation on equipment and software that are being replaced and to write-off assets that were taken out of service.

An increase in contributions of $8.1 million as we invest in our strategic university relationships.

An increase of approximately 17 percent in personnel-related costs to support the continued growth of our business.

An increase of approximately $6.0 million in professional services, information technology and facilities expenses.

For the nine months ended December 31, 2003, general and administrative expenses increased by 45.5 percent as compared to the nine months ended December 31, 2002 due to:

An increase in depreciation expense of approximately $13.0 million primarily due to accelerated depreciation on equipment and software that are being replaced and to write-off assets that were taken out of service.

An increase in contributions of $8.3 million as we invest in our strategic university relationships.

An increase of approximately 17 percent in personnel-related costs to support the continued growth of our business.

An increase of approximately $14.0 million in professional services, information technology and facilities expenses.

Partially offset by a decrease in bad debt expense of $4.7 million, primarily as a result of being able to collect on accounts that we had previously deemed uncollectible. As of December 31, 2003, bad debt expense continued to be less than 0.5 percent of net revenue.

Research and Development.Development (In thousands)

Research and development expenses consist of expenses incurred by our production studios for personnel-related costs, consulting, equipment depreciation, customer relationship management expenses associated with our products and any impairmentsimpairment of prepaid royalties for pre-launch products. Research and development expenses for our online business include expenses incurred by our studios consisting of direct development costs and related overhead costs in connection with the development and production of our online games. NetworkResearch and development and support costs consist ofexpenses also include expenses associated with development of website 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(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $213,762   40.3% $200,867   44.3%  6.4%
   
Six months ended $363,725   41.2% $343,321   43.7%  5.9%
   
                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $151,175   10.2% $106,127   8.6%  42.4%
Nine months ended $355,790   15.1% $292,171   14.5%  21.8%

For the three and nine months ended September 30,December 31, 2003, costresearch and development expenses increased by 42.4 percent and 21.8 percent, respectively, compared to the three and nine months ended December 31, 2002. The increases were expected as we continue to support the global growth of goods sold asresearch and development. In recent quarters, we have begun to shift the development of a percentagegreater number of net revenue decreased by 4.0 percentage pointstitles in-house in order to 40.3 percent from 44.3 percent forbetter control the quality of the finished product and to spread the costs of development over a larger franchise base. The increases noted during the three months ended September 30, 2002December 31, 2003 were primarily due to:driven by the following:

Favorable product mix contributing 1.7 percentage points to total gross margin due to anIncreases in personnel-related costs of $29.8 million of which approximately $17.5 million resulted from a 29 percent increase in the percentage of net revenue being derived from our higher-gross-margin product lines, such as products for the PlayStation 2 and PC, and a decrease in the percentage of net revenue derived from lower-gross-margin product lines such as those for the PlayStation and co-publishing and distribution products. The increase was partially offset by a decrease in the percentage of net revenue from advertising, programming, licensing and other product lines that generally have higher gross margins.

•Higher overall gross margins by platform and on co-publishing and distribution products, contributing 1.8 percentage points to total gross margin. The increase was due to the higher volume of sales of co-publishing products, such asSoul Caliber II, Aliens Natural Selection, andFreedom Fightersin the three months ended September 30, 2003, which have a higher gross margin than distribution products, such asKingdom Hearts, which contributed a higher proportion of this category’s net revenue in the same period of the prior fiscal year.

•Higher PC gross margins contributing 0.7 percentage points to total gross margin. The increase was due to lower overall direct and indirect costs of goods sold primarily onThe Simsfranchise products and new products for the PC released in the current quarter compared to the same period of the prior fiscal year.

•Higher Nintendo GameCube gross margins contributing 0.4 percentage points to total gross margin due to pricing discounts from Nintendo on current year sales and higher royalties in the prior year due toF1 2002.

Partially offset by lower Xbox gross margins, which reduced total gross margin by 0.4 percentage points. This decrease was due to a higher percentage of net revenue from older titles at lower price points and lower margins compared to a higher percentage of net revenue from new titles in the same period of the prior fiscal year.

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For the six months ended September 30, 2003, cost of goods sold as a percentage of net revenue decreased by 2.5 percentage points to 41.2 percent from 43.7 percent for the six months ended September 30, 2002 primarily due to:

•Higher overall gross margins by platform and for co-publishing and distribution products contributing 1.4 percentage points to total gross margin. The increase was due to the higher volume of sales of co-publishing products, such asSoul Caliber II, Aliens Natural Selection, andFreedom Fightersin the six months ended September 30, 2003, which have a higher gross margin than distribution products, such asKingdom Hearts, which contributed a higher proportion of this category’s net revenue in the same period of the prior fiscal year.

•Higher gross margins for Nintendo GameCube products contributing a 0.6 percentage point increase to the total gross margin. The increase was due to pricing discounts received from Nintendo on current year sales. In addition, we also had lower royalty expenses in the current period. The decrease in royalties was due to higher sales in the current year of lower royalty bearing titles such asThe Simscompared with higher sales of higher royalty bearing titles such as2002 FIFA World CupandF1 2002in the same period in the prior fiscal year.In addition, high returns onHarry Potter and the Chamber of Secrets resulted in lower effective royalty rates in the current period.

•Higher gross margins for PC products contributing a 0.5 percentage point increase to total gross margin. The increase in PC product margins was due primarily to lower direct costs of goods sold and indirect cost of goods sold on new products released in current quarter. In addition, royalties on current year releases were lower than on products released in the same period of the prior fiscal year such as,2002 FIFA World CupandF1 2002.

                     
Marketing and Sales(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $64,041   12.1% $55,514   12.2%  15.4%
   
Six months ended $123,125   13.9% $120,888   15.4%  1.9%
   

For the three months ended September 30, 2003, marketing and sales expenses increased by 15.4 percent as compared to the three months ended September 30, 2002 primarily due to:

•The release of 11 titles in the current fiscal quarter versus eight titles in the same period of the prior fiscal year. The primary increase related to higher advertising spending of $6.5 million to support product releases includingTiger Woods PGA TOUR 2004,NASCAR Thunder 2004andNCAA Football 2004on multiple platforms.

Increase in headcount and related expenses by 18 percent and increases in promotional expenses to support the growth of our marketing and sales functions worldwide.regular full-time employee headcount.

Partially offset by the discontinuance of carriage fee payments to AOL, which resultedAn overall increase in a decrease of $4.5 million.

For the six months ended September 30, 2003, marketing and sales expenses increased by 1.9 percent as compared to the six months ended September 30, 2002 primarily due to:

Increase in headcount and related expenses by 20 percent and promotional expenses to support the growth of our marketing and sales functions worldwide.

Partially offset by the discontinuance of carriage fee payments to AOL, which resulted in a decrease of $8.9 million.
                     
General and Administrative(In thousands)
  September 30,  % of net September 30,  % of net  
  2003  revenue 2002  revenue % change
 
Three months ended $36,032   6.8% $27,453   6.1%  31.2%
   
Six months ended $66,792   7.6% $53,116   6.8%  25.7%
   

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For the three months ended September 30, 2003, general and administrative expenses increased by 31.2 percent as compared to the three months ended September 30, 2002 due to:

Increase in headcount related expenses, depreciation, professional services, information technology and facilities expenses for an aggregate increase of $12.9 million.

Partially offset by a $4.3 million decrease in bad debt expense.

For the six months ended September 30, 2003, general and administrative expenses increased by 25.7 percent as compared to the six months ended September 30, 2002 due to:

Increase in headcount related expenses, professional services, depreciation and information technology, and facilities relatedexternal development expenses of $20.4 million.$24.8 million related to development of new products.

Partially offset by a decrease in bad debt expense of $6.7 million.
                     
Research and Development(In thousands)
  September 30,  % of net September 30,  % of net   
  2003  revenue 2002  revenue % change
   
Three months ended $113,493   21.4% $96,164   21.2%  18.0%
   
Six months ended $204,615   23.2% $186,044   23.7%  10.0%
   

For the three months ended September 30, 2003, researchdepreciation and developmentother operating expenses increased by 18.0 percent as compared to the three months ended September 30, 2002 due to:

Increase in headcount and related expenses by 29 percent and outside services to support the growth of the research and development function.

Partially offset by a decrease in pre-launch write-offs of prepaid royalties and a decrease in depreciation expense due to $66.3 million of asset impairments recordedrecognized in the third and fourth quarters of fiscal 2003.

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For the sixnine months ended September 30,December 31, 2003, research andthe increases were primarily driven by the following:

Increases in personnel-related costs of $70.7 million of which approximately $47.7 million resulted from a 21 percent increase in regular full-time employee headcount.

An overall increase in external development expenses increased by 10.0 percent as comparedof $16.8 million related to the six months ended September 30, 2002 due to:

Increase in headcount and related expenses by 26 percent and outside services to support the growthdevelopment of the research and development function.new products.

Partially offset by a decrease in the pre-launch write-offs of prepaid royaltiesdepreciation and a decrease in depreciation expenseother operating expenses due to $66.3 million of asset impairments recordedrecognized in the third and fourth quarters of fiscal 2003.

The increase in research and development spending is expected to continue in fiscal 2004 due to an increase in development spending for current generation console products including the PlayStation 2, Xbox and Nintendo GameCube, as well as extending our investment in the PC and future platforms.

                     
Amortization of Intangibles(In thousands)
  September 30,  % of net September 30,  % of net   
  2003  revenue 2002  revenue % change
   
Three months ended $810   0.2% $2,246   0.5%  (63.9%)
   
Six months ended $1,490   0.2% $4,491   0.6%  (66.8%)
   

Amortization of intangibles decreased $1.4 millionInterest and $3.0 million for the three and six months ended September 30, 2003 compared to the same periods in the prior year. The decrease in amortization for both periods was due primarily to the impairment of certain finite-lived intangible assets recognized in the prior fiscal year.

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Other Income (Expense), Net (In thousands)

                     
Interest and Other Income, Net(In thousands)
  September 30,  % of net September 30,  % of net   
  2003  revenue 2002  revenue % change
   
Three months ended $9,130   1.7% $1,177   0.3%  675.7%
   
Six months ended $13,979   1.6% $4,324   0.6%  223.3%
   
                 
  December 31, % of net December 31, % of net
  2003 revenue 2002 revenue
  
 
 
 
Three months ended $948   0.1% $(4,439)  (0.4%)
Nine months ended $14,927   0.6% $(115)  (0.0%)

For the three months ended September 30,December 31, 2003, interest and other income (expense), net, increased from the three months ended September 30,December 31, 2002, primarily due to:

Foreign currency gains asOther-than-temporary impairment of investments in affiliates of $10.1 million, offset by income of $2.9 million recorded from our equity investment in Square EA LLC and a resultrealized gain of favorable rates primarily for$2.1 million on the Euro and British Pound atsale of marketable securities during the end of the current year quarter compared to losses on foreign exchange hedge contracts in the same period of the prior fiscal year for an aggregate increase of $4.7 million.three months ended December 31, 2002.

Higher interest income of $2.3$2.1 million, as a result of higher average cash balances partially offsetduring the three months ended December 31, 2003.

Offset by lower interestincreased foreign currency losses of $2.6 million, as a result of fluctuations in rates, inprimarily for the current fiscal quarter.Euro and British Pound, and the purchase of foreign currency options during the three months ended December 31, 2003.

For the sixnine months ended September 30,December 31, 2003, interest and other income (expense), net, increased from the sixnine months ended September 30,December 31, 2002 primarily due to:

Other-than-temporary impairment of investments in affiliates of $10.6 million, offset by income of 1.2 million recorded from our equity investment in Square EA LLC during the nine months ended December 31, 2002.

Higher interest income of $4.8$6.9 million, as a result of higher average cash balances partially offset by lower interest rates induring the current fiscal year.

Foreign currency gains as a result of favorable rates primarily for the Euro and British Pound as of September 30, 2003 compared to losses on foreign exchange hedge contracts in the sixnine months ended September 30, 2002 for an aggregate increase of $3.6 million.
                     
Income Taxes(In thousands)
  September 30,  Effective September 30,  Effective   
  2003  tax rate 2002  tax rate % change
   
Three months ended $34,409   31.0% $22,451   31.0%  53.3%
   
Six months ended $42,662   31.0% $25,374   31.0%  68.1%
   
December 31, 2003.

OurIncome Taxes (In thousands)

                     
  December 31, % of net December 31, % of net  
  2003 revenue 2002 revenue % Change
  
 
 
 
 
Three months ended $166,160   11.3% $113,052   9.2%  47.0%
Nine months ended $208,822   8.9% $138,426   6.9%  50.9%

During the three months ended December 31, 2003, we changed our projected annual effective income tax rate wasfor fiscal 2004 to 30 percent. We previously projected this rate to be 31 percent for the three and six months ended September 30, 2003 and 2002. The effective tax rate is the result of the mix of income earned in various tax jurisdictions that apply a broad range of tax rates. The effective tax rate may change period-to-period based on nonrecurring events, as well as recurring factors including the geographical mix of income before taxes, the timing and amount of foreign dividends, and state and local taxes. Future effective tax rates could be adversely affected if earnings are lower than anticipated in countries where we have lower statutory rates, by unfavorable changes in tax laws and regulations or by adverse rulings in tax related litigation. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2003, our working capital was $1.65 billion compared to $1.34 billion at March 31, 2003. Cash, cash equivalents and short-term investments increased by $146.6 million during the first six months of fiscal 2004. 2004 and all of fiscal 2003. This change is primarily attributable to a higher portion of our projected income being international taxable income, which is subject to lower statutory rates, than previously anticipated. As a result of the change to our projected effective tax rate for fiscal 2004, we recognized $7.0 million (or $0.02 per basic and diluted share) less income tax expense during the three months ended December 31, 2003 than we would have recognized had our projected annual effective tax rate remained at 31 percent. Accordingly, our effective income tax rate for the three months ended December 31, 2003 was 29.75 percent, reflecting the adjustment recognized during the quarter to reduce our effective income tax rate for the nine months ended December 31, 2003 to 30 percent.

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We intend to indefinitely reinvest our international earnings outside the U.S. and, accordingly, have not provided U.S. taxes that would be incurred if such earnings were repatriated back to the U.S. In addition, tax rates fluctuate and our actual effective tax rate for fiscal 2004 and for future periods could change because of several factors, including a change in mix of income between international and domestic operations, changes to applicable tax laws and regulations, or developments in tax audit matters with various tax authorities.

LIQUIDITY AND CAPITAL RESOURCES

              
   Nine Months Ended
   
   December 31, December 31,  
(In millions)  2003 2002 Change
 
 
 
Cash, cash equivalents and short-term investments $1,825  $1,165  $660 
Marketable equity securities  2   1   1 
   
   
   
 
  $1,827  $1,166  $661 
   
   
   
 
 Percentage of total assets  54.7%  47.4%    
              
   December 31, December 31,  
(In millions)  2003 2002 Change
 
 
 
Cash provided by operating activities $107  $284  $(177)
Cash used in investing activities   (669)    (191)  (478)
Cash provided by financing activities  164   109   55 
Effect of foreign exchange on cash and cash equivalents  21   11   10 
    
   
   
 
Net increase (decrease) in cash and cash equivalents $(377)  $213  $(590) 
    
   
   
 

Changes in Cash Flow

During the nine months ended December 31, 2003, we generated $139.9$107.1 million of cash throughfrom operating activities compared to $283.5 million for the nine months ended December 31, 2002. This decline was primarily the result of an increase in operating costs during the three months ended December 31, 2003. We expect a significant increase in operating cash flow during the fourth quarter of fiscal 2004, compared to the same period in fiscal 2003, due to the collection of our third quarter accounts receivable, partially offset by payments for advertising, royalties, income taxes and other related seasonal expenses. We expect this increase in operating cash flow to more than offset the decline in operating cash flow we experienced during the first nine months of fiscal 2004. For the nine months ended December 31, 2003, our primary uses of cash in non-operating activities consisted of net purchases of $617.4 million in short-term investments and $55.9 million in capital expenditures, primarily related to software and leasehold improvements. These non-operating expenditures were offset by $166.3 million in proceeds from the sale of equity securities under our common stock through employee stock and other plans during the nine months ended December 31, 2003.

Accounts Receivable

Our gross accounts receivable balance was $1,043.7 million and $28.2$246.7 million as of cash provided by operations, whichDecember 31, 2003 and March 31, 2003, respectively. Reserves for product returns, pricing allowances and doubtful accounts increased 25.5 percent from $164.6 million at March 31, 2003 to $206.6 million at December 31, 2003. The increase in our accounts receivable balance was primarily due to increased sales during the three months ended December 31, 2003, compared to the three months ended March 31, 2003. We expect to collect a substantial portion of these amounts in January and February 2004. The increase in the overall reserves as of December 31, 2003 was due to expected sales returns associated with our seasonal volume, partially offset by $28.7the return and price protection credits processed in the first nine months of fiscal 2004 for products sold in prior periods. Although the absolute dollar amounts of the sales return and price protection reserves had increased as of December 31, 2003, both remained constant compared to March 31, 2003 as a percentage of trailing six and nine months net revenue. We believe these reserves are adequate based on historical experience and our current estimate of potential returns and allowances.

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Inventories, net

Inventories, net, increased to $64.8 million at December 31, 2003 from $39.7 million at March 31, 2003 primarily due to the seasonality of cash usedour business and overall growth in Europe. We typically have a higher inventory balance, as a percentage of net revenue, on hand in Europe compared to North America, due to the need to provide multiple language versions of each title for capital expendituresthose countries. No title represented more than $6.0 million (or 10%) at December 31, 2003.

Other current assets

Other current assets increased to $117.9 million at December 31, 2003 from $83.5 million at March 31, 2003 primarily due to increases in volume rebates and advertising credits owed to us by our suppliers and VAT receivable, both relating to the seasonality of our business.

Accounts payable

Accounts payable increased to $158.7 million at December 31, 2003 from $106.3 million at March 31, 2003 due to higher inventory purchases, seasonality and the overall increase in our sales during the sixfirst nine months of fiscal 2004. We anticipate this balance to decline with our seasonal volume during the three months ended September 30, 2003.March 31, 2004.

AsAccrued and other liabilities

Our accrued and other liabilities increased to $682.8 million at December 31, 2003 from $464.5 million at March 31, 2003, as a result of September 30, 2003,the overall increase in our principal source of liquidity is $1.7 billionsales and related operational expenses and seasonality. The increase was due to increases in cash, cash equivalentsour accruals for advertising, royalties, VAT and short-term investments and $0.8 million in marketable equity securities. taxes payable. We anticipate this balance to decline with our seasonal volume during the three months ended March 31, 2004.

Financial Condition

We believe the existing cash, cash equivalents, short-term investments, marketable equity securities and cash generated from operations will be sufficient to meet cash and investmentour operating requirements for at least the next 12 months. twelve months, including working capital requirements, capital expenditures and potential future acquisitions or strategic investments. We may choose at any time to raise additional capital to strengthen our financial position, facilitate expansion, pursue strategic investments or to take advantage of business opportunities as they arise.

A portion of our cash is generated from operations domiciled in foreign tax jurisdictions (approximately $329.4 million)$177.5 million as of December 31, 2003) that is designated as permanently invested in

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the respective tax jurisdiction. While we do not currently believe there is a need to repatriate these funds to the United States in the short term, if these funds are required for our operations in the United States, we would be required to accrue and pay additional taxes to repatriate these funds.

On January 8, 2004, we filed an amended registration statement on Form S-3 with the Securities and Exchange Commission. This registration statement, including the base prospectus contained therein, became effective on January 15, 2004 and uses a “shelf” registration process. This shelf registration statement allows us, at any time, to offer any combination of securities described in the prospectus in one or more offerings up to a total amount of $2.0 billion. Unless otherwise specified in a prospectus supplement accompanying the base prospectus, we will use the net proceeds from the sale of any securities offered pursuant to the shelf registration statement for general corporate purposes, including for working capital, financing capital expenditures, research and development, marketing and distribution efforts and, if opportunities arise, for acquisitions or strategic alliances. We currently have no definitive plans, and are not in negotiations, relating to acquisitions, investments or strategic alliances to be financed through proceeds from the sale of securities under the shelf registration statement. Pending such uses, we may invest the net proceeds in interest bearing securities. In addition, we may conduct concurrent or other financings at any time.

Our ability to maintain sufficient liquidity could be affected by various risks and uncertainties including, but not limited to, those related to customer demand and acceptance of our titles on new platforms and new versions of our titles 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

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markets, seasonality in operating results, risks of product returns and the other risks listeddescribed in the “Risk Factors” section.section below.

Our gross accounts receivable balance was $329.6 million and $246.7 million as of September 30, 2003 and March 31, 2003, respectively. Reserves for product returns, pricing allowances and doubtful accounts decreased 23 percent from $164.6 million at March 31, 2003 to $126.8 million at September 30, 2003. The decrease in the overall reserves as of September 30, 2003 was due to the high volume of return and price protection credits processed in the first six months of fiscal year 2004, for products sold in prior periods. Although the absolute dollar amounts of the sales return and price protection reserves have decreased as of September 30, 2003, both have remained relatively constant compared to March 31, 2003 as a percentage of trailing nine months net revenue. We believe these reserves are adequate based on historical experience and our current estimate of potential returns and allowances.

Commitments

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 1995, we entered into a build-to-suit lease with Keybank National Association on our headquarters facility in Redwood City, California, which was extended in July 2001 and expires in July 2006. We accounted for this arrangement as an operating lease in accordance with StatementStatements of FinanceFinancial Accounting Standards (“SFAS”) No. 13,“Accounting for Leases”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 $145.0 million or, at the end of the lease, to arrange for (i) an extension of the lease or (ii) sale of the property to a third party while we retain an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $128.9 million if the sales price is less than this amount, subject to certain provisions of the lease.

In December 2000, we entered into a second build-to-suit lease with Keybank National Association for a five-year term beginning December 2000 to expand our Redwood City, California headquarters facilities and develop adjacent property adding approximately 310,000 square feet to our campus. Construction was completed in June 2002. We accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. The facilities provide space for marketing, sales and research and development. We have an option to purchase the property for $127.0 million or, at the end of the lease, to arrange for (i) an extension of the lease, or (ii) sale of the property to a third party while we retain an obligation to the owner for the difference between the sale price and the guaranteed residual value of up to $118.8 million if the sales price is less than this amount, subject to certain provisions of the lease.

We believe the estimated fair value of theboth properties under thethese operating leases are in excess of thetheir respective guaranteed residual values based in part on a independent third party appraisal.at December 31, 2003.

In July of 2003, we entered into a lease agreement with Playa Vista-Water’s Edge LLCan independent third party (“the Landlord”) for a studio facility in Los Angeles, California, which commenced in October 2003 and expires in September 2013 with two five-year options to extend the lease term. Additionally, we have options to purchase the property after five and ten years based on the fair market value of the property at the date of sale, a right of first offer to purchase the property upon terms offered by the landlord, and a right to share in the profits from a sale of the property. We have accounted for this arrangement as an operating lease in accordance with SFAS No. 13, as amended. Existing campus facilities comprise a total of 243,000 square feet and provide space for research and development functions. Our rental obligation under

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this agreement is $50.2 million over the initial ten-year term of the lease. We will take possession of the property over a period of 18 months as the facilities become available for use. The aboveThis commitment is offset by sublease income of $5.8 million for the sublet to Playa Capital Company, LLCan affiliate of the Landlord of 18,000 square feet of the Los Angeles facility, which commenced in October 2003 and expires in September 2013 with options of early termination by Playa Capital Company, LLCthe affiliate after five years and by EA after four and five years. The contractual obligations table below has been updated for this lease based onto include our gross lease commitment.commitment under this lease.

Lease rates are based upon the Commercial Paper Rate. The threetwo lease agreements with Keybank National Association, as described above, require us to maintain certain financial covenants related to consolidated net worth, fixed charge coverage ratio, total consolidated debt to total consolidated capital and quick ratio,as shown below, all of which we were in compliance with as of September 30,December 31, 2003.

          
   Minimum Actual as of
Financial Covenants Requirement December 31, 2003
 
 
Consolidated Net Worth $1,616 million $2,496 million
Fixed Charge Coverage Ratio  3.00   43.24 
Total Consolidated Debt to Capital  60%  9.1%
Quick Ratio — Q1 & Q2  1.00   N/A 
Q3 & Q4  1.75   10.69 

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Letters of Credit

In July 2002, we provided an irrevocable standby letter of credit to Nintendo of Europe. The standby letter of credit guarantees performance of our obligations to pay Nintendo of Europe for trade payables of up to 18.08.0 million Euros. The standby letter of credit expires in July 2005. As of September 30,December 31, 2003, we had $7.81.6 million Euros payable to Nintendo of Europe covered by this standby letter of credit.

In August 2003, we provided an irrevocable standby letter of credit to 300 California Associates II, LLC in replacement of our security deposit for office space. The standby letter of credit guarantees performance of our obligations to pay our lease commitment up to $1.1 million. The standby letter of credit expires in December 2006. As of September 30,December 31, 2003, we had nodid not have a payable balance on this standby letter of credit.

Development, Celebrity, League and Content Licenses: Payments and Commitments

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

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The following table summarizes our minimum contractual obligations and commercial commitments as of September 30,December 31, 2003 (in thousands), and the effect we expect them to have on our liquidity and cash flow in future periods:

                            
                    
 Commercial    Contractual Obligations Commercial Commitments 
 Contractual Obligations Commitments    
 
 
Fiscal Year Developer/ Bank and Letters    Developer/ Bank and Letters  
Ended Licensee Other of    Licensee Other of  
March 31, Leases Advertising Commitments Marketing Guarantees Credit Total  Leases Commitments Marketing Guarantees Credit Total
   
 
 
 
 
 
2004
(remaining
six months)		 $12,392 $— $16,711 $27,300 $220 $7,759 $64,382 
2004 (remaining three months) $7,072 $13,713 $5,421 $60 $1,976 $28,242 
2005 24,499 747 37,611 14,109 234 — 77,200  23,336 37,131 12,893 234 — 73,594 
2006 25,817 3,000 32,053 9,692 234 — 70,796  24,821 34,313 8,476 204 — 67,814 
2007 19,064 3,000 11,276 9,692 204 — 43,236  19,384 11,837 9,664 204 — 41,089 
2008 15,966 — 13,116 9,692 203 — 38,977  17,141 15,116 9,692 203 — 42,152 
Thereafter 43,820 — 14,521 16,952 203 — 75,496  45,200 20,021 22,095 203 — 87,519 
   
 
 
 
 
 
 
  
Total $141,558 $6,747 $125,288 $87,437 $1,298 $7,759 $370,087  $136,954 $132,131 $68,241 $1,108 $1,976 $340,410 
   
 
 
 
 
 
 

The lease commitments disclosed above exclude commitments included in our restructuring activities for contractual rental commitments of $10.9$9.9 million under real estate leases for unutilized office space, offset by $4.5$3.9 million of estimated future sub-lease income. These amounts were expensed in the periods of the related restructuring and are included in our accrued liabilities

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reported on our Condensed Consolidated Balance SheetSheets as of September 30,December 31, 2003. (See Note 1112 in the Notes to Condensed Consolidated Financial Statements.)

Transactions with Related Parties

Executive Officer Compensation
On June 24, 2002, we hired Warren Jenson as our Executive Vice President and Chief Financial and Administrative Officer and agreed to loan Mr. Jenson $4.0 million, to be forgiven over four years based on his continuing employment. Two million dollars of the note will be forgiven after two years employment, and the remainder forgiven after four years. The entire balance of the loan iswas outstanding as of September 30,December 31, 2003.

In April 2002, we agreed to pay certain taxes incurred by Bruce McMillan, Executive Vice President, Group Studio Head of EA Canada, arising from his temporary employment with us in the United Kingdom. Mr. McMillan agreed to reimburse us for those payments upon receipt of his corresponding tax refund from the Canadian taxing authorities. We subsequently paid approximately $168,704 and $32,931 in October 2002 and April 2003, respectively, to the UK Inland Revenue for taxes incurred by Mr. McMillan. In May 2003, Mr. McMillan became an executive officer of Electronic Arts. As of January 22, 2004, Mr. McMillan had repaid us the entire amount of the tax payments we made on his behalf.

Impact of Recently Issued Accounting Standards

In January 2003, the FASBFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This interpretation of Accounting Research Bulletin No. 51, “"Consolidated Financial Statements,” addresses consolidation by business enterprises of variable interest entities (“VIEs”) that either:either (i) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (ii) are owned by equity investors who lack an essential characteristic of a controlling financial interest. This interpretation applies immediately to VIEs created after January 31, 2003. With regard to VIE’sVIEs already in existence prior to February 1, 2003, the implementation of this FASBFIN 46 has been delayed and currently applies to the first fiscal year or interim period beginning after December 15, 2003. FIN 46 requires disclosure of VIEs in financial statements issued after January 31, 2003, if it is reasonably possible that as of the transition date:date (i) the companywe will be the primary beneficiary of an existing VIE that will require consolidation, or (ii) the companywe will hold a significant variable interest in, or have significant involvement with, an existing VIE. We do not believe that we will have any entities that will require disclosure or new consolidation as a result of adopting the provisions of FIN 46.

36In January 2003, the Emerging Issues Task Force reached consensus on Issue No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables”. EITF 00-21 provides guidance on how to determine whether an arrangement involving multiple deliverables requires that such deliverables be accounted for separately. EITF 00-21 allows for prospective adoption for arrangements entered into after June 15, 2003 or adoption via a cumulative effect of a change in accounting principal. We adopted EITF 00-21 in the quarter ended June 30, 2003; however, it did not have a material impact on our consolidated financial position or results of operations.

In November 2003, the Emerging Issues Task Force reached consensus on paragraph 18 of Issue No. 03-01 (“EITF 03-01”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-01 requires that certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”and SFAS No. 124, “Accounting for Certain Investments Held by Not-for-Profit Organizations”that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. We adopted EITF 03-01 in the quarter ended December 31, 2003; however, it did not have a material impact on the disclosures in our Condensed Consolidated Financial Statements.

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RISK FACTORS

Our business is subject to many risks and uncertainties, which may affect our future financial performance. TheseThe risks and uncertainties discussed below are discussed below.not the only ones we face. There may be additional risks and uncertainties not currently known to us or that we currently do not believe are material.material that could harm our business and financial performance. If any of the events or circumstances described below occurs, our business and financial performance could be harmed and the market value of our securities could decline.decline.

The success of our business is highly dependent on being able to predict which new videogame platforms will be successful, and on the market acceptance and timely release of those platforms.

We derive most of our revenue from the sale of products for play on proprietary videogame platforms of third parties, such as Sony’s PlayStation 2. Therefore, the success of our products is driven in large part by the success of new videogame hardware systems and our ability to accurately predict which platforms will be most successful in the marketplace. We must make product development decisions and commit significant resources well in advance of the anticipated introduction of a new platform. A new platform for which we are developing products may be delayed, may not succeed or may have a shorter life cycle than anticipated. If the platforms for which we are developing products are not released when anticipated or do not attain wide market acceptance, our revenue growth will suffer.

Our platform licensors set the royalty rates and other fees that we must pay to publish games for their platforms, and therefore have significant influence on our costs. If one or more of the platform licensors adopt a different fee structure for future game consoles, our profitability may suffer.

In the next few years, we expect our platform licensors to introduce new game machines into the market. In order to publish products for a new game machine, we must take a license from the platform licensor which gives the platform licensor the opportunity to set the fee structure that we must pay in order to publish games for that platform. Similarly, the platform licensors have retained the flexibility to change their fee structures for online gameplay and features for their consoles. The control that platform licensors have over the fee structures for their future platforms and online access makes it difficult for us to predict our costs and profitability in the medium to long term. Because publishing products for videogame consoles is the largest portion of our business, any increase in fee structures would have a significant negative impact on our business model and profitability.

If we do not accurately predict the importance to consumers of online game play for different console products, our sales may be limited in the future.

Sony and Microsoft have introduced online game play for their respective PlayStation 2 and Xbox consoles. We anticipate that Nintendo will do so for its Nintendo GameCube console. We have agreed to support online game features for our Sony PlayStation 2 products but do not currently offer similar capability for our Xbox products. We currently cannot predict how important these features are (or will be) to consumers, or whether, and to what extent, our support for online game features will affect our sales of console products. For example, if consumers consider online play capability to be a “must have” component of games for the Xbox, our sales of products for the Xbox would decline significantly.

Our business is both seasonal and cyclical. If we or our platform licensors, fail to deliver our products at the right times, our sales will suffer.

Our business is highly seasonal, with the highest levels of consumer demand, and a significant percentage of our revenue, occurring in the December quarter. The timing of hardware platform introduction is often tied to the year-end holiday season and is not within our control. If we miss this key selling period, due to product delays or delayed introduction of a new platform for which we have developed products, our sales will suffer disproportionately. Our industry is also cyclical. Videogame platforms have historically had a life cycle of four to six years. As one group of platforms is reaching the end of its cycle and new platforms are emerging, consumers often defer game software purchases until the new platforms are available, causing sales to decline. This decline may not be offset by increased sales of products for the new platform. For example, the market for products for Sony’s older PlayStation game console has declined significantly since the launch of the PlayStation 2 platform.

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Our business is intensely competitive and increasingly “hit” driven. If we do not continue to deliver “hit” products, our success will be limited.

Competition in our industry is intense, and new products are regularly introduced. During calendar year 2002,2003, approximately 2219 percent of the sales of videogames in North America consisted of only 20 “hit” products out of thousands published. These “hit” titles are increasingly expensive to produce. If our competitors develop more successful products, or if we do not continue to develop consistently high-quality and popular products, our revenue will decline.

If we are unable to maintain or acquire licenses to intellectual property, we will publish fewer hit titles and our revenue will decline. Competition for these licenses may make them more expensive, and increase our costs.

Many of our products are based on or incorporate intellectual property owned by others. For example, ourEA SPORTSproducts include intellectual property licenses from the major sports leagues and players associations. Similarly, many of our hitEA Gamesfranchises, such asJames Bond, Harry PotterandLord of the Rings, are based on key film and literary licenses. Competition for these licenses is intense. If we are unable to maintain these licenses and obtain additional licenses with significant commercial value, we will be unable to increase our revenue in the future. Competition for these licenses may also drive up the advances, guarantees and royalties that must be paid to the licensor, which could significantly increase our costs.

If patent claims continue to be asserted against us, we may be unable to sustain our current business models or profits.

Many patents have been issued that may apply to widely used game technologies. Additionally, infringement claims under many recently issued patents are now being asserted against Internet implementations of existing games. Several such claims have been asserted against us. Such claims can harm our business. We incur substantial expenses in evaluating and defending against such claims, regardless of the merits of the claims. In the event that there is a determination that we have infringed a third-party patent, we could incur significant monetary liability and be prevented from using the rights in the future.

Other intellectual property claims may increase our product costs or require us to cease selling affected products.

Many of our products include extremely realistic graphical images, and we expect that as technology continues to advance, images will become even more realistic. Some of the images and other content are based on real-world examples that may inadvertently infringe upon the intellectual property rights of others. Although we believe that we make reasonable efforts to ensure that our products do not violate the intellectual property rights of others, it is possible that third parties still may claim infringement. From time to time, we receive communications from third parties regarding such claims. Existing or future infringement claims against us, whether valid or not, may be time consuming and expensive to defend. Such claims or litigations could require us to stop selling the affected products, redesign those products to avoid infringement, or obtain a license, all of which would be costly and harm our business.

Our business, our products and our distribution are subject to increasing regulation in key territories of content, consumer privacy and online delivery. If we do not successfully respond to these regulations, our business may suffer.

Legislation is continually being introduced that may affect both the content of our products and their distribution. For example, privacy laws in the United States and Europe impose various restrictions on our web sites. Those rules vary by territory although the Internet recognizes no geographical boundaries. Other countries, such as Germany, have adopted laws regulating content both in packaged goods and those transmitted over the Internet that are stricter than current United States laws. In the United States, the federal and several state governments are considering content restrictions on products such as ours, as well as restrictions on distribution of such products. Any one or more of these factors could harm our business by limiting the products we are able to offer to our customers and by requiring additional differentiation between products for different territories to address varying regulations. This additional product differentiation would be costly.

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If we do not consistently meet our product development schedules, we will experience fluctuations in our operating results.

Product development schedules, particularly for new hardware platforms, high-end multimedia PCs and the Internet, 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. We have in the past experienced development delays for several of our products. Failure to meet anticipated production or “go live” schedules may cause a shortfall in our revenue and profitability and cause our operating results to be materially different from expectations. Delays that prevent release of our products during peak selling seasons may reduce lifetime sales of those products.

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Technology changes rapidly in our business, and if we fail to anticipate new technologies, the quality, timeliness and competitiveness of our products will suffer.

Rapid technology changes in our industry require us to anticipate, sometimes years in advance, which technologies our products must take advantage of in order to make them competitive in the market at the time they are released. Therefore, we usually start our product development with a range of technical development goals that we hope to be able to achieve. We may not be able to achieve these goals, or our competition may be able to achieve them more quickly than we can. In either case, our products may be technologically inferior to competitive products, or less appealing to consumers, or both. If we cannot achieve our technology goals within the original development schedule of our products, then we may delay products until these technology goals can be achieved, which may delay or reduce revenue and increase our development expenses. Alternatively, we may increase the resources employed in research and development in an attempt to accelerate our development of new technologies, either to preserve our product launch schedule or to keep up with our competition, which would increase our development expenses.

If we do not continue to attract and retain key personnel, we will be unable to effectively conduct our business.

The market for technical, creative, marketing and other personnel essential to the development and marketing of our products and management of our businesses is extremely competitive. In the last fiscal year, notwithstanding the downturn of the economy generally, competitive recruiting efforts aimed at our employees and executives continued. For example, in fiscal 2003, a team of employees that developed one of our hitMedal of Honorproducts left the company to develop products for a competitor. Our leading position within the interactive entertainment industry makes us a prime target for recruiting of executives and key creative talent. In addition, the cost of real estate in the San Francisco Bay area – the location of our headquarters and one of our largest studios – remains 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.

Our platform licensors are our chief competitors and frequently control the manufacturing of and/or access to our videogame products. If they do not approve our products, we will be unable to ship to our customers.

Our agreements with hardware licensors (such as Sony for the PlayStation 2, Microsoft for the Xbox and Nintendo for the Nintendo GameCube), who are also our chief competitors, typically give significant control to the licensor over the approval and manufacturing of our products, which could, in certain circumstances, leave us unable to get our products approved, manufactured and shipped to customers. In most events, control of the approval and manufacturing process by the platform licensors increases both our manufacturing lead times and costs as compared to those we can achieve independently. While we believe that our relationships with our hardware licensors are currently good, the potential for delay or refusal to approve or manufacture our products exists. Such occurrences would harm our business and our financial performance.

In addition, as online capabilities for videogame platforms emerge, our platform licensors will control our ability to provide online game capabilities for our console platform products and will in large part establish the financial terms on which these services are offered to consumers. Currently, both Microsoft and Sony provide online capabilities for Xbox and PlayStation 2 products, respectively. In each case, compatibility code and the consent of the licensor are

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required for us to include online capabilities in our products. In addition, the business model for Microsoft’s and Sony’s online businesses for their videogame products may compete with our online business. As these capabilities become more significant, the failure or refusal of our licensors to approve our products, or the successful deployment by these licensors of services competitive to ours, may harm our business.

Our international net revenue is subject to currency fluctuations.

For the sixnine months ended September 30,December 31, 2003, international net revenue comprised 3744 percent of our total consolidated net revenue. For the fiscal year ended March 31, 2003, international net revenue comprised 42 percent of our total consolidated net revenue. We expect foreign sales to continue to account for a significant and growing portion of our revenue. Such sales are subject to unexpected regulatory requirements, tariffs and other barriers. Additionally, foreign sales are primarily made in local currencies, which may fluctuate against the dollar. While we utilize foreign exchange forward contracts to hedge foreign currency exposures of underlying assets and liabilities, primarily certain intercompany receivables that are denominated in foreign currencies, we cannot control translation issues.and foreign currency option contracts to hedge foreign currency forecasted transactions, primarily related to

41

revenue generated by our foreign subsidiaries, our results of operations and financial condition may, nonetheless, be adversely affected by foreign currency fluctuations.

Our reported financial results could be affected if significant changes in current accounting principles are adopted.

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. The FASB and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, such as accounting for stock options, some of which represent a significant change from current practices. Changes in our accounting for stock options could materially increase our reported expenses.

Our stock price has been volatile and may continue to fluctuate significantly.

As a result of the factors discussed in this report and other factors that may arise in the future, the market price of our common stock historically has been, and we expect will continue to be, subject to significant fluctuations. These fluctuations may be due to factors specific to us, to changes in analysts’ earnings estimates, or to factors affecting the computer, software, Internet, entertainment, media or electronics businesses.

The majority of our sales are made to a relatively small number of key customers. If these customers reduce their purchases of our products or become unable to pay for them, our business could be harmed.

In the U.S. in fiscal 2003, over 66 percent of our sales were made to six key customers. In Europe, our top ten customers accounted for over 40 percent of our sales in that territory in fiscal 2003. Worldwide, we had sales to one customer, Wal-Mart Stores, Inc., which represented 12 percent of net revenue in fiscal 2003. Though our products are available to consumers through a variety of retailers, the concentration of our sales in one, or a few, large customers could lead to short-term disruption in our sales if one or more of these customers significantly reduced their purchases or ceased to carry our products, and could make us more vulnerable to collection risk if one or more of these large customers became unable to pay for our products. Additionally, our receivables from these large customers increase significantly in the last quarter of the calendar year as they stock up for the holiday selling season. Also, having such a large portion of our net revenue concentrated in a few customers reduces our negotiating leverage with these customers.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

MARKET RISK

We are exposed to various market risks, including changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from changes in market rates and prices. Foreign exchange and option 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. Our foreign exchange contracts are accounted for as derivatives whereby the gains and losses on these contracts are reflected in the Condensed Consolidated Statements of Operations. Gains and losses on open contracts at the end of each accounting period resulting from changes in the forward rate are recognized in earnings and are designed to offset gains and losses on the underlying foreign currency denominated assets and liabilities. At September 30,As of December 31, 2003, we had foreign exchange contracts, all with maturities of less than one month, to sell approximately $144.8$635.1 million in foreign currencies, consisting primarily of British Pounds, Euros, Japanese Yen, Canadian DollarsSwedish Krona, and other currencies.Danish Krone. Of this amount, $127.0$554.8 million represents contracts to sell foreign currency in exchange for U.S. dollars and $17.8$80.3 million represents contracts to sell foreign currency in exchange for British Pounds.

From time-to-time, we hedge our foreign currency risk related to forecasted sales transactions by purchasing option contracts that generally have maturities of one year or less. If qualified, these transactions are designated as cash flow hedges. For the three and nine months ended December 31, 2003, we recognized a loss of $1.9 million.

The counterparties to these contracts and options are substantial and creditworthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts and options 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 and option contracts at September 30,as of December 31, 2003. The information is provided in U.S. dollar equivalents and presents the notional amount (forward or option amount), the weighted average contractual foreign currency exchange rates and fair value. Fair value represents the difference in value of the contracts at the spot rate and the forward or option rate.

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      Weighted-    
      Average    
  Contract  Contract    
  Amount  Rate  Fair Value 
 
Foreign currency to be sold under contract:            
British Pound $90,851   1.6518  $(237)
Euro  16,064   1.1475   (17)
Japanese Yen  14,738   0.0090   79 
Canadian Dollar  9,957   0.7375   (37)
Swedish Krona  5,497   0.1278   (44)
South African Rand  4,025   0.1388   (33)
Danish Krone  2,021   0.1554   9 
Norwegian Krone  1,693   0.1411   (15)
 
Total $144,846      $(295)
 
              
       Weighted  
   Notional Average  
(In thousands, except contract rates) Amount Contract Rate Fair Value
  
 
 
Foreign currency to be sold under contract:            
 British Pound $267,817   1.7504  $(1,310)
 Euro  254,280   1.2314   (1,777)
 Swedish Krona  36,457   0.1371   195 
 Danish Krone  19,020   0.1668   (1)
 Norwegian Krone  16,499   0.1514   295 
 Japanese Yen  15,322   0.0093   7 
 Australian Dollar  14,816   0.7408   164 
 Swiss Franc  6,361   0.7952   (14)
 South African Rand  4,534   0.1563   379 
    
   
   
 
Total $635,106      $(2,062)
    
   
   
 
Foreign currency to be purchased under contract:            
 British Pound $80,330   1.7630  $924 
    
   
   
 
Option contracts purchased Euro $93,064   1.2409  $464 
    
   
   
 

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. TheAs these contracts can be settled on a net basis at our option, 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.obligations. We control credit risk through credit approvals, limits and monitoring procedures.

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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. Though we maintain sufficient cash and cash equivalent balances such that we are typically able to hold our investments to maturity, currently, the majority of our short-term investments are callable by the issuer. As there can be no assurance as to how long these investments will be held, classification of these securities as short-term investments is based on call date.

At September 30,As of December 31, 2003, our cash equivalents and short-term investments included $1.5 billion of debt securities, typicallyconsisting primarily of government agency bonds and money market funds, of $1.4 billion.funds. Notwithstanding our efforts to manage interest rate risks, there can be no assurances that we will be adequately protected against the risks associated with interest rate fluctuations.

The table below presents the amounts (in thousands) and related weighted average interest rates of our investment portfolio at September 30,as of December 31, 2003:

             
 
  Average      
  Interest Rate Cost  Fair Value 
 
Cash equivalents            
Fixed rate  1.86% $503,701  $503,873 
Variable rate  1.18% $496,251  $496,241 
Short-term investments            
Fixed rate  2.16% $295,658  $295,262 
Fixed-step rate  1.53% $85,293  $84,387 
              
   Average    
   Interest Rate Cost Fair Value
   
 
 
Cash equivalents            
 Fixed rate  1.22% $44,600  $44,600 
 Variable rate  1.00% $284,307  $284,307 
Short-term investments            
 Fixed rate  2.05% $963,814  $962,742 
 Fixed-step rate  1.53% $85,000  $83,958 
 Variable rate  1.52% $205,000  $204,959 

Maturity dates for short-term investments range from 85 months to 3532 months, with call dates ranging from 3 months1 month to 812 months.

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Item 4. Controls and Procedures

DEFINITION AND LIMITATIONS OF DISCLOSURE CONTROLS

Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)),amended) are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report,report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s (the “SEC”)SEC’s rules and forms. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Executive Vice President, Chief Financial and Administrative Officer, as appropriate to allow timely decisions regarding required disclosure. Our management evaluates these controls and procedures on an ongoing basis.

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, includingprocedures. These limitations include the possibility of human error, and the circumvention or overriding of the controls and procedures. Becauseprocedures and reasonable resource constraints. In addition, because we have designed our system of controls based on certain assumptions, which we believe are reasonable, about the likelihood of future events, which we believe are reasonable, our system of controls may not achieve its desired purpose under all possible future conditions. Further, the design ofAccordingly, our system of controls reflects reasonable resource constraints - the benefits of controls must be considered relative to their costs. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance, but not absolute assurance, of achieving our controltheir objectives.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Our Chief Executive Officer and Executive Vice President, Chief Financial and Administrative Officer, after evaluating the effectiveness of our disclosure controls and procedures, have concludedbelieve that as of the end of the period covered by this report, our disclosure controls and procedures were effective and designed to ensurein providing the requisite reasonable assurance that material information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Executive Vice President, Chief Financial and Administrative Officer, as appropriate to allow timely decisions regarding the required disclosure.

CHANGES IN INTERNAL CONTROLS

During outour last fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. However, inover the last several months,past year, in response to the certification requirements of the Sarbanes-Oxley Act and new SEC Regulations, we have enhanced our internal controls and disclosure systems, through various measures including: detailing certain internal accounting policies; establishing a formal disclosure committee for the preparation of all periodic SEC reports; establishing a formal internal audit function; and requiring certifications from various trial balance controllers and other financial personnel responsible for our financial statements.

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PART II – OTHER INFORMATION

Item 1.
Legal Proceedings

 
The Company isWe are subject to pending claims and litigation. Management,Our management, after review and consultation with counsel, considers that any liability from the disposition of such lawsuits, individually or in the aggregate would not have a material adverse effect upon theour consolidated financial position or results of operations of the Company.operations.

Item 4.
Submission of Matters to a Vote of Security Holders
None.

Item 6.
Exhibits and Reports on Form 8-K

(a) The following exhibits, other than exhibits 32.1 and 32.2, are filed as part of this report:

   
Exhibit  
Number Title
10.29
 Lease Agreement by
3.02Amended and between Playa Vista-Waters Edge, LLC and Electronic Arts Inc., dated July 31, 2003.Restated Bylaws.
   
10.3010.33 Amending Agreement Re: Right of First Offer to Purchase and Option to Purchase by and between Playa Vista-Waters Edge, LLCamong Ontrea Inc. (the “Landlord”), Electronic Arts (Canada), Inc. (the “Tenant”), and Electronic Arts Inc. (the “Indemnifier”), dated July 31, 2003.
10.31Profit Participation Agreement by and between Playa Vista-Waters Edge, LLC and Electronic Arts Inc., dated July 31, 2003.
10.32Sublease Agreement by and between Electronic Arts Inc. and Playa Capital Company, LLC, dated July 31,October 30, 2003.
   
31.1 Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (a)13a-14(a) of the Exchange Act.Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (a)13a-14(a) of the Exchange Act.Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
Additional exhibits accompanyingfurnished with this report:
   
32.1 Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (b)13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as Adoptedadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2 Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (b)13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as Adoptedadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K:

 On July 23,October 22, 2003, the Companywe filed a current report on Form 8-K relating to the announcement of itsour financial results for the quarter ended JuneSeptember 30, 2003.2003 and a two-for-one stock split of our Class A common stock.

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SIGNATURESSIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

   
  ELECTRONIC ARTS INC.
(Registrant)
  (Registrant)
   
  /s/ Warren C. Jenson
  
DATED: WARREN C. JENSON
November 7, 2003February 10, 2004 Executive Vice President,
  Chief Financial and Administrative Officer

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ELECTRONIC ARTS INC.
FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30,DECEMBER 31, 2003

EXHIBIT INDEX

   
EXHIBIT  
NUMBER EXHIBIT TITLE
10.29
 Lease Agreement by
3.02Amended and between Playa Vista-Waters Edge, LLC and Electronic Arts, Inc., dated July 31, 2003.Restated Bylaws.
   
10.3010.33 Amending Agreement Re: Right of First Offer to Purchase and Option to Purchase by and between Playa Vista-Waters Edge, LLCamong Ontrea Inc. (the “Landlord”), Electronic Arts (Canada), Inc. (the “Tenant”), and Electronic Arts Inc. (the “Indemnifier”), dated July 31,October 30, 2003.
10.31Profit Participation Agreement by and between Playa Vista-Waters Edge, LLC and Electronic Arts Inc., dated July 31, 2003.
10.32Sublease Agreement by and between Electronic Arts, Inc. and Playa Capital Company, LLC, dated July 31, 2003.
   
31.1 Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (a)13a-14(a) of the Exchange Act.Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
31.2 Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (a)13a-14(a) of the Exchange Act.Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
Additional exhibits accompanyingfurnished with this report:
   
32.1 Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14 (b)13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as Adoptedadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2 Certification of Executive Vice President, Chief Financial and Administrative Officer pursuant to Rule 13a-14 (b)13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as Adoptedadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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