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ELECTRONIC ARTS INC. - 10-K - : Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW
The following overview is a high-level discussion of our operating results, as
well as some of the trends and drivers that affect our business. Management
believes that an understanding of these trends and drivers is important in order
to understand our results for the fiscal year ended March 31, 2012, as well as
our future prospects. This summary is not intended to be exhaustive, nor is it
intended to be a substitute for the detailed discussion and analysis provided
elsewhere in this Form 10-K, including in the "Business" section and the "Risk
Factors" above, the remainder of "Management's Discussion and Analysis of
Financial Condition and Results of Operations," or the Consolidated Financial
Statements and related Notes.
About Electronic Arts
We develop, market, publish and distribute game software content and services
that can be played by consumers on a variety of platforms, including video game
consoles (such as the Sony PLAYSTATION 3, Microsoft Xbox 360, and Nintendo Wii),
personal computers, mobile devices (such as the Apple iPhone and Google Android
compatible phones), tablets and electronic readers (such as the Apple iPad and
Amazon Kindle), and the Internet. Our ability to publish games across multiple
platforms, through multiple distribution channels, and directly to consumers
(online and wirelessly) has been, and will continue to be, a cornerstone of our
product strategy. We have generated substantial growth in new business models
and alternative revenue streams (such as subscription, micro-transactions, and
advertising) based on the continued expansion of our online and wireless
platform. Some of our games are based on our own wholly-owned intellectual
property (e.g., Battlefield, Mass Effect, Need for Speed, The Sims, Bejeweled,
and Plants v. Zombies), and some of our games are based on content that we
license from others (e.g., FIFA, Madden NFL, and Star Wars: The Old Republic).
Our goal is to turn our core intellectual properties into year-round businesses
available on a range of platforms. Our products and services may be purchased
through physical and online retailers, platform providers such as console
manufacturers and mobile carriers via digital downloads, as well as directly
through our own distribution platform, including online portals such as Origin
and Play4Free.
Financial Results
Total net revenue for the fiscal year ended March 31, 2012 was $4,143 million,
up $554 million as compared to the fiscal year ended March 31, 2011. At
March 31, 2012, deferred net revenue associated with sales of online-enabled
packaged goods and digital content increased by $43 million as compared to
March 31, 2011, directly reducing the amount of reported net revenue during the
fiscal year ended March 31, 2012. At March 31, 2011, deferred net revenue
associated with sales of online-enabled packaged goods and digital content
increased by $239 million as compared to March 31, 2010, directly reducing the
amount of reported net revenue during the fiscal year ended March 31, 2011.
Without these changes in deferred net revenue, reported net revenue would have
increased by approximately $358 million during fiscal year 2012 as compared to
fiscal year 2011. Net revenue for fiscal year 2012 was driven by FIFA 12,
Battlefield 3 and Madden NFL 12.
Net income for the fiscal year ended March 31, 2012 was $76 million as compared
to a net loss of $276 million for the fiscal year ended March 31, 2011. Diluted
earnings per share for the fiscal year ended March 31, 2012 was $0.23 as
compared to a diluted loss per share of $0.84 for the fiscal year ended
March 31, 2011. Net income increased for fiscal year 2012 as compared to fiscal
year 2011 primarily as a result of (1) a $455 million increase in gross profit
due to a decrease in the change in deferred net revenue related to certain
online-enabled packaged goods and digital content and a greater percentage of
net revenue from EA studio and digital products, which have higher margins than
our co-publishing and distribution products and (2) a $145 million decrease in
restructuring and other charges. The increase in net income was partially offset
by (1) a $106 million increase in marketing and sales costs, (2) a $59 million
increase in research and development costs, and (3) a $74 million increase in
general and administrative costs.
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Trends in Our Business
Digital Content Distribution and Services. Consumers are spending an
ever-increasing portion of their money and time on interactive entertainment
that is accessible online, or through mobile digital devices such as smart
phones, or through social networks such as Facebook. We provide a variety of
online-delivered products and services including through our Origin
platform. Many of our games that are available as packaged goods products are
also available through direct online download through the Internet. We also
offer online-delivered content and services that are add-ons or related to our
packaged goods products such as additional game content or enhancements of
multiplayer services. Further, we provide other games, content and services that
are available only via electronic delivery, such as Internet-only games and game
services, and games for mobile devices.
Advances in mobile technology have resulted in a variety of new and evolving
devices that are being used to play games by an ever-broadening base of
consumers. We have responded to these advances in technology and consumer
acceptance of digital distribution by offering different sales models, such as
subscription services, online downloads for a one-time fee, micro-transactions
and advertising-supported free-to-play games and game sites. In addition, we
offer our consumers the ability to play a game across platforms on multiple
devices. We significantly increased the revenues that we derive from wireless,
Internet-derived and advertising (digital) products and services from $743
million in fiscal year 2011 to $1,159 million in fiscal year 2012 and we expect
this portion of our business to continue to grow in fiscal 2013 and beyond.
Wireless and Other Emerging Platforms. Advances in technology have resulted in
a variety of platforms for interactive entertainment. Examples include wireless
technologies, streaming gaming services, and Internet platforms. Our efforts in
wireless interactive entertainment are focused in downloadable games for mobile
devices. These platforms grow the consumer base for our business while also
providing competition to existing established video game platforms. We expect
sales of games for wireless and other emerging platforms to continue to be an
important part of our business.
Growth of Casual and Social Games. The popularity of wireless and other
emerging gaming platforms such as smart phones, tablets and social networking
sites, such as Facebook, has led to the growth of casual and social gaming.
Casual and social games are characterized by their mass appeal, simple controls,
flexible monetization including free-to-play and micro-transaction business
models, and fun and approachable gameplay. These games appeal to a larger
consumer demographic of younger and older players and more female players than
video games played on console devices. These areas are among the fastest growing
segments of our sector and we have responded to this opportunity by developing
casual and social games based on our established intellectual properties such as
The Sims, FIFA and Battlefield, and with our acquisition of PopCap Games. We
expect sales of casual and social and casual games for wireless and other
emerging platforms to continue to be an important part of our business.
Concentration of Sales Among the Most Popular Games. We see a larger portion of
packaged goods games sales concentrated on the most popular titles, and those
titles are typically sequels of prior games. We have responded to this trend by
significantly reducing the number of games that we produce to provide greater
focus on our most promising intellectual properties. We published 36 primary
packaged goods titles in fiscal year 2011, 22 in fiscal year 2012 and in fiscal
year 2013, we expect to release 14 primary packaged goods titles and plan to
build additional online features, content and services around each of these
titles.
Evolving Sales Patterns. Our business has evolved from a traditional packaged
goods business model to one where our games are played on a variety of platforms
including mobile devices and social networking sites. Our strategy is to
transform our core intellectual properties into year-round businesses, with a
steady flow of downloadable content and extensions on new platforms. Our
increasingly digital, multi-platform business no longer reflects the retail
sales patterns associated with traditional packaged goods launches. For example,
we offer our consumers additional services and/or additional content available
through online services to further enhance the gaming experience and extend the
time that consumers play our games after their initial purchase. Our social and
casual games offer free-to-play and micro-transaction models. We also offer
subscription-based products, such as our MMO role-playing game Star Wars: The
Old Republic. The revenues we derive from these services has become increasingly
more significant year-over-year. Our service revenue represented 13 percent, 8
percent, and 6 percent of total net revenue in fiscal year 2012, 2011, and 2010,
respectively.
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Recent Developments
Stock Repurchase Program. In February 2011, we announced that our Board of
Directors authorized a program to repurchase up to $600 million of our common
stock over the next 18 months. We completed our program in April 2012. We
repurchased approximately 32 million shares in the open market since the
commencement of the program, including pursuant to pre-arranged stock trading
plans. During the fiscal year 2012, we repurchased and retired approximately
25 million shares of our common stock for approximately $471 million, net of
commissions.
International Operations and Foreign Currency Exchange Impact. International
sales (revenue derived from countries other than Canada and the United States),
are a fundamental part of our business. Net revenue from international sales
accounted for approximately 52 percent of our total net revenue during fiscal
year 2012 and approximately 49 percent of our total net revenue during fiscal
year 2011. Our net revenue is impacted by foreign exchange rates during the
reporting period associated with net revenue before revenue deferral, as well as
the foreign exchange rates associated with the recognition of deferred net
revenue of online-enabled packaged goods and digital content that were
established at the time we recorded this deferred net revenue on our
Consolidated Balance Sheets. The foreign exchange rates during the reporting
period may not always move in the same direction as the foreign exchange rate
impact associated with the recognition of deferred net revenue of online-enabled
packaged goods and digital content. During the fiscal year ended March 31, 2012,
foreign exchange rates had an overall favorable impact on our net revenue of
approximately $143 million, or 3 percent. In addition, our international
investments and our cash and cash equivalents denominated in foreign currencies
are subject to fluctuations in foreign currency exchange rates. If the U.S.
dollar strengthens against these currencies, then foreign exchange rates may
have an unfavorable impact on our results of operations and our financial
condition.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Consolidated Financial Statements have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these Consolidated Financial Statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
contingent assets and liabilities, and revenue and expenses during the reporting
periods. The policies discussed below are considered by management to be
critical because they are not only important to the portrayal of our financial
condition and results of operations, but also because application and
interpretation of these policies requires both management judgment and estimates
of matters that are inherently uncertain and unknown. As a result, actual
results may differ materially from our estimates.
Revenue Recognition, Sales Returns, Allowances and Bad Debt Reserves
We derive revenue principally from sales of interactive software games (1) on
video game consoles (such as the PLAYSTATION 3, Xbox 360 and Wii) and PCs,
(2) on mobile devices (such the Apple iPhone and Google compatible Android
phones), (3) on tablets and electronic readers such as the Apple iPad and Amazon
Kindle, and (4) from software and content and online game services associated
with these products. We evaluate revenue recognition based on the criteria set
forth in Financial Accounting Standards Board ("FASB") Accounting Standards
Codification ("ASC") 985-605, Software: Revenue Recognition, and Staff
Accounting Bulletin ("SAB") No. 101, Revenue Recognition, as revised by SAB
No. 104, Revenue Recognition. We classify our revenue as either Product revenue
or Service and other revenue.
We evaluate and recognize revenue when all four of the following criteria are
met:
• Evidence of an arrangement. Evidence of an agreement with the customer that
reflects the terms and conditions to deliver products must be present.
• Delivery. Delivery is considered to occur when a product is shipped and the
risk of loss and rewards of ownership have been transferred to the
customer. For services, delivery is considered to occur as the service is
provided.
• Fixed or determinable fee. If a portion of the arrangement fee is not fixed
or determinable, we recognize revenue as the amount becomes fixed or
determinable.
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• Collection is deemed probable. We conduct a credit review of each customer
involved in a significant transaction to determine the creditworthiness of
the customer. Collection is deemed probable if we expect the customer to be
able to pay amounts under the arrangement as those amounts become due. If
we determine that collection is not probable, we recognize revenue when
collection becomes probable (generally upon cash collection).
Determining whether and when some of these criteria have been satisfied often
involves assumptions and management judgments that can have a significant impact
on the timing and amount of revenue we report in each period. Changes to any of
these assumptions and judgments, could cause a material increase or decrease in
the amount of revenue that we report in a particular period.
Multiple-element arrangements
We enter into multiple-element revenue arrangements in which we may provide a
combination of game software, updates or additional content and online game
services. For some software products we may provide updates or additional
content ("digital content") to be delivered via the Internet that can be used
with the original software product. In many cases we separately sell this
digital content for an additional fee. In other transactions, we may have an
obligation to provide incremental unspecified digital content in the future
without an additional fee (i.e., updates on a when-and-if-available basis) or we
may offer an online "matchmaking" service that permits consumers to play against
each other via the Internet. Collectively, we refer to these as software-related
offerings. In those situations where we do not require an additional fee for the
software-related offerings, we account for the sale of the software product and
software-related offerings as a "bundled" sale, or multiple element arrangement,
in which we sell both the software product and relating offerings for one
combined price. Generally, we do not have VSOE for the software-related
offerings and thus, we defer net revenue from sales of these games and recognize
the revenue from the bundled sales games over the period the offering will be
provided (the "offering period"). If the period is not defined, we recognize
revenue over the estimated offering period, which is generally estimated to be
six months, beginning in the month after delivery. In addition, determining
whether we have an implicit obligation to provide incremental unspecified future
digital content without an additional fee can be difficult. Determining the
estimated offering period is inherently subjective and is subject to regular
revision based on historical online usage.
Determining whether an element of a transaction constitutes an online game
service or a digital content download of a product requires judgment and can be
difficult. The accounting for these transactions is significantly different.
Revenue from product downloads is generally recognized when the download is made
available (assuming all other recognition criteria are met). Revenue from an
online game service is recognized as the service is rendered. If the period is
not defined, we recognize the revenue over the estimated service period. For
example, our MMO games have an estimated service period of eighteen months,
beginning in the month after delivery.
For our software and software-related multiple element arrangements (i.e.,
software game bundled with software-related offerings), we must make assumptions
and judgments in order to (1) determine whether and when each element is
delivered, (2) determine whether the undelivered elements are essential to the
functionality of the delivered elements, (3) determine whether VSOE exists for
each undelivered element, and (4) allocate the total price among the various
elements. Changes to any of these assumptions and judgments, or changes to the
elements in the arrangement, could cause a material increase or decrease in the
amount of revenue that we report in a particular period.
In some of our multiple element arrangements, we sell tangible products with
software and/or software-related offerings. These tangible products are
generally either peripherals or ancillary collectors' items. Prior to April 3,
2011, because either the software or other elements sold with the tangible
products were essential to the functionality of the tangible product and/or we
did not have VSOE for the tangible product, we did not separately account for
the tangible product. On April 3, 2011, we adopted FASB ASU 2009-13, Revenue
Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements and ASU
2009-14, Software (Topic 985): Certain Revenue Arrangements that Include
Software Elements. The new accounting principles establish a selling price
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hierarchy for determining the selling price of a deliverable and require the
application of the relative selling price method to allocate the arrangement
consideration to each deliverable in a multiple element arrangement that
includes tangible products.
Accordingly for our multiple element arrangements that include tangible products
entered into after April 2, 2011, revenue is allocated to each separate unit of
accounting for each deliverable using the relative selling prices of each
deliverable in the arrangement based on the selling price hierarchy described
below. If the arrangement contains more than one software deliverable, the
arrangement consideration is allocated to the software deliverables as a group
and then allocated to each software deliverable in accordance with ASC 985-605.
We determine the selling price for a tangible product deliverable based on the
following selling price hierarchy: VSOE (i.e., the price we charge when the
tangible product is sold separately) if available, third-party evidence ("TPE")
of fair value (i.e., the price charged by others for similar tangible products)
if VSOE is not available, or our best estimate of selling price ("BESP") if
neither VSOE nor TPE is available. Determining the BESP is a subjective process
that is based on multiple factors including, but not limited to, recent selling
prices and related discounts, market conditions, customer classes, sales
channels and other factors.
As the result of adopting ASU 2009-13 and ASU 2009-14, for the year ended
March 31, 2012, we recognized $23 million more revenue than would have been
recognized under previous accounting standards.
We reduce revenue for estimated future returns, price protection, and other
offerings, which may occur with our customers and channel partners. Price
protection represents the right to receive a credit allowance in the event we
lower our wholesale price on a particular product. The amount of the price
protection is generally the difference between the old price and the new price.
In certain countries, we have stock-balancing programs for our PC and video game
system software products, which allow for the exchange of these software
products by resellers under certain circumstances. It is our general practice to
exchange software products or give credits rather than to give cash refunds.
In certain countries, from time to time, we decide to provide price protection
for our software products. When evaluating the adequacy of sales returns and
price protection allowances, we analyze historical returns, current sell-through
of distributor and retailer inventory of our software products, current trends
in retail and the video game industry, changes in customer demand and acceptance
of our software products, and other related factors. In addition, we monitor the
volume of sales to our channel partners and their inventories, as substantial
overstocking in the distribution channel could result in high returns or higher
price protection costs in subsequent periods.
In the future, actual returns and price protections may materially exceed our
estimates as unsold software 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 software
products. While we believe we can make reliable estimates regarding these
matters, these estimates are inherently subjective. Accordingly, if our
estimates change, our returns and price protection reserves would change, which
would impact the total net revenue we report. For example, if actual returns
and/or price protection were significantly greater than the reserves we have
established, our actual results would decrease our reported total net revenue.
Conversely, if actual returns and/or price protection were significantly less
than our reserves, this would increase our reported total net revenue. In
addition, if our estimates of returns and price protection related to
online-enabled packaged goods software products change, the amount of deferred
net revenue we recognize in the future would change.
Significant management 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 and historical experience. Depending upon the overall
economic climate and the financial condition of our customers, the amount and
timing of our bad debt expense and cash collection could change significantly.
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Fair Value Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States often requires us to determine the fair
value of a particular item in order to fairly present our financial statements.
Without an independent market or another representative transaction, determining
the fair value of a particular item requires us to make several assumptions that
are inherently difficult to predict and can have a material impact on the
accounting.
There are various valuation techniques used to estimate fair value. These
include (1) the market approach where market transactions for identical or
comparable assets or liabilities are used to determine the fair value, (2) the
income approach, which uses valuation techniques to convert future amounts (for
example, future cash flows or future earnings) to a single present value amount,
and (3) the cost approach, which is based on the amount that would be required
to replace an asset. For many of our fair value estimates, including our
estimates of the fair value of acquired intangible assets, we use the income
approach. Using the income approach requires the use of financial models, which
require us to make various estimates including, but not limited to (1) the
potential future cash flows for the asset or liability being measured, (2) the
timing of receipt or payment of those future cash flows, (3) the time value of
money associated with the expected receipt or payment of such cash flows, and
(4) the inherent risk associated with the cash flows (risk premium). Making
these cash flow estimates are inherently difficult and subjective, and if any of
the estimates used to determine the fair value using the income approach turns
out to be inaccurate, our financial results may be negatively impacted.
Furthermore, relatively small changes in many of these estimates can have a
significant impact to the estimated fair value resulting from the financial
models or the related accounting conclusion reached. For example, a relatively
small change in the estimated fair value of an asset may change a conclusion as
to whether an asset is impaired.
While we are required to make certain fair value assessments associated with the
accounting for several types of transactions, the following areas are the most
sensitive to these assessments:
Business Combinations. We must estimate the fair value of assets acquired,
liabilities and contingencies assumed, acquired in-process technology, and
contingent consideration issued in a business combination. Our assessment of the
estimated fair value of each of these can have a material effect on our reported
results as intangible assets are amortized over various estimated useful lives.
Furthermore, a change in the estimated fair value of an asset or liability often
has a direct impact on the amount we recognize as goodwill, an asset that is not
amortized. Determining the fair value of assets acquired requires an assessment
of the highest and best use or the expected price to sell the asset and the
related expected future cash flows. Determining the fair value of acquired
in-process technology also requires an assessment of our expectations related to
the use of that asset. Determining the fair value of an assumed liability
requires an assessment of the expected cost to transfer the liability.
Determining the fair value of contingent consideration issued requires an
assessment of the expected future cash flows over the period in which the
obligation is expected to be settled, and applying a discount rate that
appropriately captures a market participant's view of the risk associated with
the obligation. This fair value assessment is also required in periods
subsequent to a business combination. Such estimates are inherently difficult
and subjective and can have a material impact on our Consolidated Financial
Statements.
Assessment of Impairment of Goodwill, Intangibles, and Other Long-Lived
Assets. Current accounting standards require that we assess the recoverability
of our finite lived acquisition-related intangible assets and other long-lived
assets whenever events or changes in circumstances indicate the remaining value
of the assets recorded on our Consolidated Balance Sheets is potentially
impaired. In order to determine if a potential impairment has occurred,
management must make various assumptions about the estimated fair value of the
asset by evaluating future business prospects and estimated future cash flows.
For some assets, our estimated fair value is dependent upon predicting which of
our products will be successful. This success is dependent upon several factors,
which are beyond our control, such as which operating platforms will be
successful in the marketplace. Also, our revenue and earnings are dependent on
our ability to meet our product release schedules.
On January 1, 2012, we adopted ASU 2011-08, Intangibles - Goodwill and Other
(Topic 350): Testing Goodwill for Impairment. ASU 2011-08 allows an entity to
first assess qualitative factors to determine whether it is more likely than not
that the fair value of a reporting unit is less than its carrying amount as a
basis for determining
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whether it is necessary to perform the two-step goodwill impairment test. If an
entity concludes it is more likely than not that the fair value of a reporting
unit exceeds its carrying amount, it need not perform the two-step impairment
test. If based on that assessment, we believe it is more likely than not that
the fair value of its reporting units is less than its carrying value, a
two-step goodwill impairment test is required to be performed. The first step
measures for impairment by applying fair value-based tests at the reporting unit
level. The second step (if necessary) measures the amount of impairment by
applying fair value-based tests to the individual assets and liabilities within
each reporting unit. Our reporting units are determined by the components of our
operating segments that constitute a business for which discrete financial
information is available and segment management regularly reviews the operating
results of that component.
To determine the fair value of each reporting unit used in the first step, we
use the market approach, which utilizes comparable companies' data, the income
approach, which utilizes discounted cash flows, or a combination thereof.
Determining whether an event or change in circumstances does or does not
indicate that the fair value of a reporting unit is below its carrying amount is
inherently subjective. Each step requires us to make judgments and involves the
use of significant estimates and assumptions. These estimates and assumptions
include long-term growth rates, tax rates, and operating margins used to
calculate projected future cash flows, risk-adjusted discount rates based on a
weighted average cost of capital, future economic and market conditions and
determination of appropriate market comparables. These estimates and assumptions
have to be made for each reporting unit evaluated for impairment. As of our last
annual assessment of goodwill in the fourth quarter of fiscal year 2012, we
concluded that the estimated fair values of each of our reporting units
significantly exceeded their carrying amounts and we have not identified any
indicators of impairment since. Our estimates for market growth, our market
share and costs are based on historical data, various internal estimates and
certain external sources, and are based on assumptions that are consistent with
the plans and estimates we are using to manage the underlying business. Our
business consists of developing, marketing and distributing video game software
using both established and emerging intellectual properties and our forecasts
for emerging intellectual properties are based upon internal estimates and
external sources rather than historical information and have an inherently
higher risk of inaccuracy. If future forecasts are revised, they may indicate or
require future impairment charges. We base our fair value estimates on
assumptions we believe to be reasonable, but that are unpredictable and
inherently uncertain. Actual future results may differ from those estimates.
Assessment of Impairment of Short-Term Investments and Marketable Equity
Securities. We periodically review our short-term investments and marketable
equity securities for impairment. Our short-term investments consist of
securities with remaining maturities greater than three months at the time of
purchase and our marketable equity securities consist of investments in common
stock of publicly traded companies, both are accounted for as available-for-sale
securities. Unrealized gains and losses on our short-term investments and
marketable equity securities are recorded as a component of accumulated other
comprehensive income in stockholders' equity, net of tax, until either (1) the
security is sold, (2) the security has matured, or (3) we determine that the
fair value of the security has declined below its adjusted cost basis and the
decline is other-than-temporary. Realized gains and losses on our short-term
investments and marketable equity securities are calculated based on the
specific identification method and are reclassified from accumulated other
comprehensive income to interest and other income, net, and gains (losses) on
strategic investments, net, respectively. Determining whether the decline in
fair value is other-than-temporary requires management judgment based on the
specific facts and circumstances of each security. The ultimate value realized
on these securities is subject to market price volatility until they are sold.
We consider various factors in determining whether we should recognize an
impairment charge, including the credit quality of the issuer, the duration that
the fair value has been less than the adjusted cost basis, severity of the
impairment, reason for the decline in value and potential recovery period, the
financial condition and near-term prospects of the investees, and our intent to
sell and ability to hold the investment for a period of time sufficient to allow
for any anticipated recovery in market value, any contractual terms impacting
the prepayment or settlement process, as well as, if we would be required to
sell an investment due to liquidity or contractual reasons before its
anticipated recovery. Our ongoing consideration of these factors could result in
impairment charges in the future, which could have a material impact on our
financial results.
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Assessment of Inventory Obsolescence. We regularly review inventory quantities
on-hand. We write down inventory based on excess or obsolete inventories
determined primarily by future anticipated demand for our products. Inventory
write-downs are measured as the difference between the cost of the inventory and
market value, based upon assumptions about future demand that are inherently
difficult to assess. At the point of a loss recognition, a new, lower cost basis
for that inventory is established, and subsequent changes in facts and
circumstances do not result in the restoration or increase in that newly
established cost basis.
Adoption of ASU 2011-04. On January 1, 2012, we adopted the FASB Accounting
Standards Update ("ASU") 2011-04, Fair Value Measurement (Topic 820): Amendments
to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S.
GAAP and IFRSs. The guidance limits the highest-and-best-use measure to
nonfinancial assets, permits certain financial assets and liabilities with
offsetting positions in market or counterparty credit risks to be measured at a
net basis, and provides guidance on the applicability of premiums and
discounts. Additionally, the guidance expands the disclosures on Level 3 inputs
by requiring quantitative disclosure of the unobservable inputs and assumptions,
as well as description of the valuation processes and the sensitivity of the
fair value to changes in unobservable inputs. Adoption of this new guidance did
not have a material impact on our Consolidated Financial Statements.
Royalties and Licenses
Our royalty expenses consist of payments to (1) content licensors,
(2) independent software developers, and (3) co-publishing and distribution
affiliates. License royalties consist of payments made to celebrities,
professional sports organizations, movie studios and other organizations for our
use of their trademarks, copyrights, personal publicity rights, content and/or
other intellectual property. Royalty payments to independent software developers
are payments for the development of intellectual property related to our games.
Co-publishing and distribution royalties are payments made to third parties for
the delivery of products.
Royalty-based obligations with content licensors and distribution affiliates are
either paid in advance and capitalized as prepaid royalties or are accrued as
incurred and subsequently paid. These royalty-based obligations are generally
expensed to cost of revenue generally at the greater of the contractual rate or
an effective royalty rate based on the total projected net revenue for contracts
with guaranteed minimums. Significant judgment is required to estimate the
effective royalty rate for a particular contract. Because the computation of
effective royalty rates requires us to project future revenue, it is inherently
subjective as our future revenue projections must anticipate a number of
factors, including (1) the total number of titles subject to the contract,
(2) the timing of the release of these titles, (3) the number of software units
we expect to sell, which can be impacted by a number of variables, including
product quality, the timing of the title's release and competition, and
(4) future pricing. Determining the effective royalty rate for our titles is
particularly challenging due to the inherent difficulty in predicting the
popularity of entertainment products. Accordingly, if our future revenue
projections change, our effective royalty rates would change, which could impact
the amount and timing of royalty expense we recognize.
Prepayments made to thinly capitalized independent software developers and
co-publishing affiliates are generally made in connection with the development
of a particular product, and therefore, we are generally subject to development
risk prior to the release of the product. Accordingly, payments that are due
prior to completion of a product are generally expensed to research and
development over the development period as the services are incurred. Payments
due after completion of the product (primarily royalty-based in nature) are
generally expensed as cost of revenue.
Our contracts with some licensors include minimum guaranteed royalty payments,
which are initially recorded as an asset and as a liability at the contractual
amount when no performance remains with the licensor. When performance remains
with the licensor, we record guarantee payments as an asset when actually paid
and as a liability when incurred, rather than recording the asset and liability
upon execution of the contract. Royalty liabilities are classified as current
liabilities to the extent such royalty payments are contractually due within the
next 12 months.
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Each quarter, we also evaluate the expected future realization of our
royalty-based assets, as well as any unrecognized minimum commitments not yet
paid to determine amounts we deem unlikely to be realized through product sales.
Any impairments or losses determined before the launch of a product are charged
to research and development expense. Impairments or losses determined
post-launch are charged to cost of revenue. We evaluate long-lived royalty-based
assets for impairment generally using undiscounted cash flows when impairment
indicators exist. Unrecognized minimum royalty-based commitments are accounted
for as executory contracts, and therefore, any losses on these commitments are
recognized when the underlying intellectual property is abandoned (i.e., cease
use) or the contractual rights to use the intellectual property are terminated.
Income Taxes
We recognize deferred tax assets and liabilities for both the expected impact of
differences between the financial statement amount and the tax basis of assets
and liabilities and for the expected future tax benefit to be derived from tax
losses and tax credit carry forwards. We record a valuation allowance against
deferred tax assets when it is considered more likely than not that all or a
portion of our deferred tax assets will not be realized. In making this
determination, we are required to give significant weight to evidence that can
be objectively verified. It is generally difficult to conclude that a valuation
allowance is not needed when there is significant negative evidence, such as
cumulative losses in recent years. Forecasts of future taxable income are
considered to be less objective than past results, particularly in light of the
economic environment. Therefore, cumulative losses weigh heavily in the overall
assessment.
In addition to considering forecasts of future taxable income, we are also
required to evaluate and quantify other possible sources of taxable income in
order to assess the realization of our deferred tax assets, namely the reversal
of existing deferred tax liabilities, the carry back of losses and credits as
allowed under current tax law, and the implementation of tax planning
strategies. Evaluating and quantifying these amounts involves significant
judgments. Each source of income must be evaluated based on all positive and
negative evidence; this evaluation involves assumptions about future activity.
Certain taxable temporary differences that are not expected to reverse during
the carry forward periods permitted by tax law cannot be considered as a source
of future taxable income that may be available to realize the benefit of
deferred tax assets.
Based on the assumptions and requirements noted above, we have recorded a
valuation allowance against most of our U.S. deferred tax assets. In addition,
we expect to provide a valuation allowance on future U.S. tax benefits until we
can sustain a level of profitability or until other significant positive
evidence arises that suggest that these benefits are more likely than not to be
realized.
In the ordinary course of our business, there are many transactions and
calculations where the tax law and ultimate tax determination is uncertain. As
part of the process of preparing our Consolidated Financial Statements, we are
required to estimate our income taxes in each of the jurisdictions in which we
operate prior to the completion and filing of tax returns for such periods. This
process requires estimating both our geographic mix of income and our uncertain
tax positions in each jurisdiction where we operate. These estimates involve
complex issues and require us to make judgments about the likely application of
the tax law to our situation, as well as with respect to other matters, such as
anticipating the positions that we will take on tax returns prior to our
actually preparing the returns and the outcomes of disputes with tax
authorities. The ultimate resolution of these issues may take extended periods
of time due to examinations by tax authorities and statutes of limitations. In
addition, changes in our business, including acquisitions, changes in our
international corporate structure, changes in the geographic location of
business functions or assets, changes in the geographic mix and amount of
income, as well as changes in our agreements with tax authorities, valuation
allowances, applicable accounting rules, applicable tax laws and regulations,
rulings and interpretations thereof, developments in tax audit and other
matters, and variations in the estimated and actual level of annual pre-tax
income can affect the overall effective income tax rate.
We historically have considered undistributed earnings of our foreign
subsidiaries to be indefinitely reinvested outside of the United States, and
accordingly, no U.S. taxes have been provided thereon. We currently intend to
continue to indefinitely reinvest the undistributed earnings of our foreign
subsidiaries outside of the United States.
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RESULTS OF OPERATIONS
Our fiscal year is reported on a 52- or 53-week period that ends on the Saturday
nearest March 31. Our results of operations for the fiscal years ended March 31,
2012 and 2011 each contained 52 weeks and ended on March 31, 2012 and April 2,
2011, respectively. Our results of operations for the fiscal year ended
March 31, 2010 contained 53 weeks and ended on April 3, 2010. For simplicity of
disclosure, all fiscal periods are referred to as ending on a calendar
month-end.
Comparison of Fiscal Year 2012 to Fiscal Year 2011
Net Revenue
Net revenue consists of sales generated from (1) video games sold as packaged
goods or as digital downloads and designed for play on video game consoles (such
as the PLAYSTATION 3, Xbox 360 and Wii), and PCs, (2) video games for mobile
devices (such as the Apple iPhone and Google Android compatible phones),
(3) video games for tablets and electronic readers such as the Apple iPad and
Amazon Kindle, (4) software products and content and online game services
associated with these products, (5) programming third-party websites with our
game content, (6) allowing other companies to manufacture and sell our products
in conjunction with other products, and (7) advertisements on our online web
pages and in our games.
We provide three different measures of our Net Revenue. Two of these measures
are presented in accordance with accounting principles generally accepted in the
United States ("U.S. GAAP") - (1) Net Revenue by Product Revenue and Service and
Other Revenue and (2) Net Revenue by Geography. The third measure is a non-GAAP
financial measure - Net Revenue by Revenue Composition, which is primarily based
on method of distribution. We use this third non-GAAP financial measure
internally to evaluate our operating performance, when planning, forecasting and
analyzing future periods, and when assessing the performance of our management
team.
Management places a greater emphasis and focus on assessing our business through
a review of the Net Revenue by Revenue Composition than by Net Revenue by
Product Revenue and Service and Other Revenue. These two measures differ as
(1) Net Revenue by Product Revenue and Service and Other Revenue reflects the
deferral and recognition of revenue in periods subsequent to the date of sale
due to U.S. GAAP while Net Revenue by Revenue Composition does not, and (2) both
measures contain a different aggregation of sales from one another. For
instance, Service and other revenue does not include the majority of our
full-game digital download and mobile sales that are fully included in our
Digital revenue. Further, Service and other revenue includes all of our revenue
associated with MMO games while software sales associated with our MMOs are
included in either Digital revenue or Publishing and other revenue depending on
whether the sale was a full-game digital download or a packaged goods sale.
Net Revenue by Product Revenue and Service and Other Revenue
Our total net revenue by product revenue and service and other revenue for the
fiscal years ended March 31, 2012 and 2011 was as follows (in millions):
Year Ended March 31,
2012 2011 $ Change % Change
Net revenue:
Product $ 3,415 $ 3,181 $ 234 7 %
Service and other 728 408 320 78 %
Total net revenue $ 4,143 $ 3,589 $ 554 15 %
Product Revenue
Our product revenue includes revenue associated with the sale of game software,
whether delivered via a disc (i.e., packaged goods) or via the Internet (i.e.,
full-game download), that do not require our continuous hosting
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support, and licensing of game software to third-parties. This excludes game
software from our MMO games (both game and subscription sales), which is
included in service and other revenue as such game software requires continuous
hosting support. Product revenue also includes mobile games that do not have an
online service component and sales of tangible products such as hardware,
peripherals, or collectors' items.
For fiscal year 2012, product revenue was $3,415 million, primarily driven by
FIFA 12, Battlefield 3, and Madden NFL 12. Product revenue for fiscal year 2012
increased $234 million, or 7 percent, as compared to fiscal year 2011. This
increase was driven by a $937 million increase primarily from the Battlefield,
Crysis, and FIFA franchises. This increase was offset by a $703 million decrease
primarily from the FIFA World Cup, Medal of Honor, Rock Band, and Army of Two
franchises, as well as Dante's Inferno.
Service and Other Revenue
Our service revenue includes revenue recognized from games or related content
that requires our hosting support to provide substantial gaming experience, and
time-based subscriptions. This includes (1) subscriptions for our Pogo-branded
online game services, (2) MMO games (both game and subscription sales),
(3) entitlements to content that are delivered through hosting services (e.g.,
micro-transactions for Internet-based, social network and mobile games which
includes "freemium" games), and (4) allocated service revenue from sales of
online-enable packaged goods with an online service component (i.e.,
"matchmaking" services). Our other revenue includes non-software licensing and
advertising revenue.
For fiscal year 2012, service and other revenue was $728 million, primarily
driven by (1) Star Wars: The Old Republic, which was launched in the third
quarter, (2) our micro-transactions revenue from browser-based games including
games played on Facebook such as The Sims Social, and (3) our FIFA Ultimate Team
add-on game service. Service and other revenue for fiscal year 2012 increased
$320 million, or 78 percent, as compared to fiscal year 2011. This increase was
primarily driven by a $351 million increase from certain services associated
with the FIFA and The Sims franchises, as well as Star Wars: The Old Republic.
This increase was partially offset by a $31 million decrease in service revenue
generated by our Pogo-branded online game services and the Warhammer and Ultima
Online MMO franchises. In fiscal year 2013, we expect to increase our total
service revenue as compared to fiscal year 2012.
Net Revenue by Geography
Year Ended March 31,
(In millions) 2012 2011 $ Change % Change
North America $ 1,991 $ 1,836 $ 155 8 %
Europe 1,898 1,563 335 21 %
Asia 254 190 64 34 %
Total net revenue $ 4,143 $ 3,589 $ 554 15 %
Net revenue in North America was $1,991 million, or 48% of total net revenue for
fiscal year 2012, compared to $1,836 million, or 51% of total net revenue for
fiscal year 2011, an increase of $155 million, or 8%. Net revenue in Europe and
Asia was $2,152 million, or 52 percent of total net revenue for fiscal year
2012, compared to $1,753 million, or 49 percent of total net revenue for fiscal
year 2011, an increase of $399 million, or 23 percent. The rapid increase in
revenue outside of North America was primarily the result of increased sales
from our FIFA, Battlefield, and Crysis franchises in Europe. Additionally, the
value of the U.S. dollar relative to foreign currencies contributed to an
increase of total reported net revenue of approximately $143 million (primarily
the Swiss Franc and Australian Dollar), or 3 percent of total net revenue.
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Supplemental Net Revenue by Revenue Composition
As we continue to evolve our business and more of our products are delivered to
consumers digitally via the Internet, we place a greater emphasis and focus on
assessing our business through a review of net revenue by revenue composition.
Net Revenue before Revenue Deferral, a non-GAAP financial measure, is provided
in this section of MD&A, including a discussion of the components of this
measure: (1) publishing and other, (2) wireless, Internet-derived, and
advertising (digital), and (3) distribution. See "Non-GAAP Financial Measures"
below for an explanation of our use of this non-GAAP financial measure. A
reconciliation to the corresponding measure calculated in accordance with U.S.
GAAP is provided in the discussion below.
"Revenue Deferral" in this "Net Revenue" section includes the unrecognized
revenue from (1) bundled sales of software and software-related offerings for
which we do not have VSOE for the software-related offerings, (2) certain sales
of MMO games, and (3) entitlements to content that are delivered through hosting
services, which are types of "micro-transactions." Fluctuations in the Revenue
Deferral are largely dependent upon the amounts of products that we sell with
the online features and services previously discussed, while the Recognition of
Revenue Deferral for a period is also dependent upon (1) the amount deferred,
(2) the period of time the software-related offerings are to be provided, and
(3) the timing of the sale. For example, most Revenue Deferrals incurred in the
first half of a fiscal year are recognized within the same fiscal year; however,
substantially all of the Revenue Deferrals incurred in the last month of a
fiscal year will be recognized in the subsequent fiscal year.
Our total net revenue by revenue composition for the fiscal years ended
March 31, 2012 and 2011 was as follows (in millions):
Year Ended March 31,
2012 2011 $ Change % Change
Publishing and other $ 2,736 $ 2,781 $ (45 ) (2 %)
Wireless, Internet-derived, and
advertising (digital) 1,227 833 394 47 %
Distribution 223 214 9 4 %
Net Revenue before Revenue Deferral 4,186 3,828 358 9 %
Revenue Deferral (3,142 ) (2,769 ) (373 ) 13 %
Recognition of Revenue Deferral 3,099 2,530 569 22 %
Net Revenue $ 4,143 $ 3,589 $ 554 15 %
Net Revenue before Revenue Deferral
Publishing and Other Revenue
Publishing and other revenue includes (1) sales of our internally-developed and
co-published game software distributed physically through traditional channels
such as brick and mortar retailers, (2) our non-software licensing revenue, and
(3) our software licensing revenue from third parties (for example, makers of
personal computers or computer accessories) who include certain of our products
for sale with their products ("OEM bundles").
For fiscal year 2012, publishing and other Net Revenue before Revenue Deferral
was $2,736 million, primarily driven by Battlefield 3, FIFA 12, and Madden NFL
12. Publishing and other Net Revenue before Revenue Deferral for fiscal year
2012 decreased $45 million, or 2 percent, as compared to fiscal year 2011. This
decrease was driven by a $1,163 million decrease in sales primarily from the
Medal of Honor, Need for Speed, FIFA World Cup, Dragon Age, and Dead Space
franchises. This decrease was offset by a $1,118 million increase in sales
primarily from the Battlefield, Mass Effect, and FIFA franchises.
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Wireless, Internet-derived, and Advertising (Digital) Revenue
Digital revenue includes revenue from sales of our internally-developed and
co-published game software distributed through direct download through the
Internet, including through our direct-to-consumer platform Origin, or
distributed wirelessly through mobile carriers. This includes our full-game
downloads, mobile and tablet revenue (each of which are generally classified as
product revenue with the exception of our MMO game downloads which are
classified as service revenue) as well as subscription services,
micro-transactions, and advertising revenues (each of which is generally
classified as service and other revenue).
For fiscal year 2012, digital Net Revenue before Deferral was $1,227 million, an
increase of $394 million, or 47 percent, as compared to fiscal year 2011. This
increase was driven by a $452 million increase in sales primarily from the FIFA
and The Sims franchises, as well as Star Wars: The Old Republic. This increase
was offset by a $58 million decrease in sales primarily from the Tetris and
Warhammer franchises, as well as a decrease in sales generated by our
Pogo-branded online services.
Distribution Revenue
Distribution revenue includes (1) sales of game software developed by
independent game developers that we distribute and (2) sales through our
Switzerland distribution business. For fiscal year 2012, distribution Net
Revenue was $223 million and increased $9 million, or 4 percent, as compared to
fiscal year 2011 driven by an $89 million increase in sales in the Portal
franchise. This increase was offset by an $80 million decrease primarily driven
by a decrease in sales in the Rock Band franchise.
Revenue Deferral
Revenue Deferral for fiscal year 2012 increased $373 million, or 13 percent, as
compared to fiscal year 2011. This increase was primarily due to (1) a 47
percent increase in our current year digital sales and (2) a higher percentage
of both our publishing and digital sales being deferred and recognized over
time, due in part to a 135 percent increase in full-game download sales and a 47
percent increase in micro-transaction sales, of which both contain an online
service component which requires revenue recognition as the service is
delivered.
Recognition of Revenue Deferral
The vast majority of our sales are deferred and recognized over a six month
period, and therefore, the related revenue recognized in any fiscal year is
primarily due to sales that occurred during the respective twelve months period
ended December 31. The Recognition of Revenue Deferral for fiscal year 2012
increased $569 million, or 22 percent, as compared to fiscal year 2011. This
increase was primarily due to increased publishing and digital sales during the
twelve months ended December 31, 2012, and a higher percentage of those sales
being comprised of games sales that have an online service component, as
compared to the same period in fiscal year 2011.
Net Revenue
For fiscal year 2012, Net Revenue was $4,143 million and increased $554 million,
or 15 percent, as compared to fiscal year 2011. This increase was driven by a
$1,312 million increase in revenue primarily from the Battlefield, Crysis, and
FIFA franchises. This increase was offset by a $758 million decrease in revenue
primarily from the Medal of Honor, FIFA World Cup, and Army of Two franchises,
as well as Dante's Inferno, for which there were no iterations in fiscal year
2012.
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Our product and service and other revenue by revenue composition for the fiscal
years 2012 and 2011 was as follows (in millions):
Year Ended March 31,
2012 2011
Product revenue:
Publishing and other $ 2,674 $ 2,558
Wireless, Internet-derived, and advertising (digital) 518 409
Distribution 223 214
Total product revenue 3,415 3,181
Service and other revenue:
Publishing and other 87 74
Wireless, Internet-derived, and advertising (digital) 641 334
Total service and other revenue 728 408
Total net revenue $ 4,143 $ 3,589
Non-GAAP Financial Measures
Net Revenue before Revenue Deferral is a non-GAAP financial measure that
excludes the impact of Revenue Deferral and the Recognition of Revenue Deferral
on Net Revenue related to sales of games and digital content.
Revenue Deferral includes the unrecognized revenue from (1) bundled sales of
software and software-related offerings for which we do not have VSOE for the
software-related offerings, (2) certain sales of MMO games, and (3) entitlements
to content that are delivered through hosting services, which are types of
"micro-transactions." We recognize the revenue from these games over the
estimated period.
We believe that excluding the impact of Revenue Deferral and the Recognition of
Revenue Deferral related to games and digital content from our operating results
is important to facilitate comparisons between periods in understanding our
underlying sales performance for the period, and understanding our operations
because all related costs of revenues are expensed as incurred instead of
deferred and recognized ratably. We use this non-GAAP financial measure
internally to evaluate our operating performance, when planning, forecasting and
analyzing future periods, and when assessing the performance of our management
team. While we believe that this non-GAAP financial measure is useful in
evaluating our business, this information should be considered as supplemental
in nature and is not meant to be considered in isolation from or as a substitute
for the related financial information prepared in accordance with GAAP. In
addition, this non-GAAP financial measure may not be the same as non-GAAP
financial measures presented by other companies.
Cost of Revenue
Total cost of revenue for fiscal years 2012 and 2011 was as follows (in
millions):
% of % of Change as a
March 31, Related Net March 31, Related Net % of Related
2012 Revenue 2011 Revenue % Change Net Revenue
Cost of revenue:
Product $ 1,374 40.2 % $ 1,407 44.2 % (2.3 %) (4.0 %)
Service and other 224 30.8 % 92 22.5 % 143.5 % 8.3 %
Total cost of revenue $ 1,598 38.6 % $ 1,499 41.8 % 6.6 % (3.2 %)
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Cost of Product Revenue
Cost of product revenue consists of (1) product costs, (2) certain royalty
expenses for celebrities, professional sports and other organizations, and
independent software developers, (3) manufacturing royalties, net of volume
discounts and other vendor reimbursements, (4) expenses for defective products,
(5) write-offs of post launch prepaid royalty costs, (6) amortization of certain
intangible assets, (7) personnel-related costs, and (8) warehousing and
distribution costs. We generally recognize volume discounts when they are earned
from the manufacturer (typically in connection with the achievement of
unit-based milestones); whereas other vendor reimbursements are generally
recognized as the related revenue is recognized.
Cost of product revenue decreased by $33 million, or 2.3 percent in fiscal year
2012, as compared to fiscal year 2011. The decrease was primarily due to a 135
percent increase in full-game downloads that have a lower cost than our other
products in fiscal year 2012 as compared to fiscal year 2011.
Cost of Service and Other Revenue
Cost of service and other revenue consists primarily of (1) data center and
bandwidth costs associated with hosting our online games and websites,
(2) platform processing fees from operating our website-based games on third
party platforms, (3) associated royalty costs, (4) credit card fees associated
with our service revenue, and (5) server costs related to our website
advertising business.
Cost of service and other revenue increased by $132 million, or 143.5 percent in
fiscal year 2012, as compared to fiscal year 2011. The increase was primarily
due to increased server and support costs due to the release of more
online-connected and subscription-based titles and related content during fiscal
year 2012 as compared to fiscal year 2011. As our service revenue in fiscal year
2013 is expected to increase as compared to fiscal year 2012, we expect a
corresponding increase in our service and support costs.
Total Cost of Revenue as a Percentage of Total Net Revenue
During fiscal year 2012, total cost of revenue as a percentage of total net
revenue decreased by 3.2 percent as compared to fiscal year 2011. This decrease
as a percentage of net revenue was primarily due to (1) a greater percentage of
net revenue from our digital products, that have a lower cost than our other
products, which positively impacted gross profit as a percentage of total
revenue by approximately 3.5 percent and (2) a $196 million decrease in the
change in deferred net revenue related to certain online-enabled packaged goods
and digital content for fiscal year 2012 as compared to fiscal year 2011, which
positively impacted gross profit as a percent of total net revenue by 2.2
percent. These decreases are partially offset by (1) increased expenses related
to our online and customer experience initiatives, which negatively impacted
gross profit as a percentage of total net revenue by 1.2 percent, (2) an
increase in amortization of our acquisition-related intangibles resulting mainly
from the PopCap acquisition in fiscal year 2012, which negatively impacted gross
profit as a percentage of total net revenue by 0.9 percent, and (3) an increase
in sales of our distribution products which carry a higher royalty percentage
than our other products, which negatively impacted gross profit as a percentage
of total net revenue by 0.9 percent.
Research and Development
Research and development expenses consist of expenses incurred by our production
studios for personnel-related costs, related overhead costs, contracted
services, depreciation and any impairment of prepaid royalties for pre-launch
products. Research and development expenses also include expenses associated
with the development of website content, software licenses and maintenance,
network infrastructure and management overhead.
Research and development expenses for fiscal years 2012 and 2011 were as follows
(in millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$1,212 29% $1,153 32% $59 5%
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Research and development expenses increase by $59 million, or 5 percent, in
fiscal year 2012, as compared to fiscal year 2011. This increase was primarily
due to (1) a $68 million increase in personnel-related costs and (2) a $13
million increase in facilities-related expenses both primarily resulting from an
increase in headcount in connection with recent acquisitions. These increases
were partially offset by a $23 million decrease in development costs primarily
due to a decrease in titles under development.
Marketing and Sales
Marketing and sales expenses consist of personnel-related costs, related
overhead costs and advertising, marketing and promotional expenses, net of
qualified advertising cost reimbursements from third parties.
Marketing and sales expenses for fiscal years 2012 and 2011 were as follows (in
millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$853 21% $747 21% $106 14%
Marketing and sales expenses increased by $106 million, or 14 percent, in fiscal
year 2012, as compared to fiscal year 2011. The increase was primarily due to
(1) a $50 million increase in additional personnel-related costs resulting from
an increase in headcount in connection with recent acquisitions, (2) a $29
million increase in marketing, advertising and promotional spending, and (3) a
$18 million increase in contracted service costs related to online and customer
relationship initiatives.
Marketing and sales expenses included vendor reimbursements for advertising
expenses of $39 million and $31 million in fiscal years 2012 and 2011,
respectively.
General and Administrative
General and administrative expenses consist of personnel and related expenses of
executive and administrative staff, related overhead costs, fees for
professional services such as legal and accounting, and allowances for doubtful
accounts.
General and administrative expenses for fiscal years 2012 and 2011 were as
follows (in millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$375 9% $301 8% $74 25%
General and administrative expenses increased by $74 million, or 25 percent, in
fiscal year 2012, as compared to fiscal year 2011. The increase was primarily
due to (1) a $34 million increase in contracted service costs related to online
initiatives, litigation, and recent acquisitions, (2) a $27 million accrual
related to a potential settlement of an on-going litigation matter, (3) a $13
million increase in bad debt expense, and (4) a $13 million increase in
additional personnel-related costs resulting from an increase in headcount in
connection with recent acquisitions. These increases were partially offset by a
$15 million decrease in facility overhead costs.
Acquisition-Related Contingent Consideration
Acquisition-related contingent consideration for fiscal years 2012 and 2011 were
as follows (in millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$11 - $(17) - $28 (165%)
Acquisition-related contingent consideration expense increased by $28 million,
or 165 percent, in fiscal year 2012, as compared to fiscal year 2011, primarily
related to (1) a $19 million prior year decrease of our accrual in
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connection with our Playfish acquisition resulting from revisions in our
estimate of the expected future cash flows over the period in which the
obligation was expected to be settled with no comparable revision to decrease
the accrual in fiscal year 2012 and (2) a contributing increase of $9 million
resulting from contingent consideration from other acquisitions in the current
year.
Amortization of Intangibles
Amortization of intangibles for fiscal years 2012 and 2011 were as follows (in
millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$43 1% $57 2% $(14) (25%)
Amortization of intangibles decreased by $14 million, or 25 percent, in fiscal
year 2012, as compared to fiscal year 2011. This decrease was primarily due to
certain intangible assets from our prior year acquisitions being fully amortized
during the fiscal year 2012.
Restructuring and Other Charges
Restructuring and other charges for fiscal years 2012 and 2011 were as follows
(in millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$16 - $161 4% $(145) (90%)
Restructuring and other charges decreased by $145 million, or 90 percent, in
fiscal year 2012, as compared to fiscal year 2011, due to (1) no new
restructuring initiatives in fiscal year 2012 and (2) a gain of $10 million
recognized during the second quarter of fiscal year 2012 on the sale of our
facility in Chertsey, England related to our fiscal year 2008 reorganization.
These items are partially offset by adjustments to the estimated loss for the
amendment of certain licensing agreements related to our fiscal 2011
restructuring.
We expect to incur between $12 million and $17 million non-cash related
accretion of interest expense through June 2016, related to the amendment of a
licensing agreement under our fiscal year 2011 plan. We do not expect to incur
any additional restructuring charges under any other preceding plans.
On May 7, 2012, we announced a plan of restructuring to align our cost structure
with our ongoing digital transformation. Under this plan, we anticipate reducing
our workforce and incurring other costs. We expect the majority of these actions
to be completed by September 30, 2012.
In connection with this plan, we anticipate incurring approximately $40 million
in total costs, of which approximately $31 million will result in future cash
expenditures. All of these charges are expected to occur during the fiscal year
ending March 31, 2013. These costs will consist of severance and other
employee-related costs (approximately $23 million), license termination costs
(approximately $11 million) and other costs (approximately $6 million).
Gains (Losses) on Strategic Investments, Net
Gains (losses) on strategic investments, net, for fiscal years 2012 and 2011
were as follows (in millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$ - - $23 1% $(23) (100%)
We did not recognize any impairment charges or losses during the year ended
March 31, 2012. During the year ended March 31, 2011, we realized a gain of $28
million, net of costs to sell, from the sale of our investment in Ubisoft.
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Interest and Other Income (Expense), Net
Interest and other income (expense), net, for fiscal years 2012 and 2011 were as
follows (in millions):
March 31, % of Net March 31, % of Net
2012 Revenue 2011 Revenue $ Change % Change
$(17) - $10 - $(27) (270%)
Interest and other income (expense), net decreased by $27 million, or 270
percent, during fiscal year 2012 as compared to the fiscal year 2011, primarily
due to (1) a $19 million increase in interest expense due to our 0.75%
Convertible Senior Notes due 2016, which were issued in July 2011 and (2) $8
million increase in foreign currency transaction losses as compared to the same
period in the prior year.
Income Taxes
Benefit from income taxes for fiscal years 2012 and 2011 was as follows (in
millions):
Effective
March 31, Effective March 31, Tax
2012 Tax Rate 2011 Rate
$(58) (322.2%) $(3) (1.1%)
Our effective tax rate for the fiscal year 2012 was a tax benefit of 322.2
percent. Our effective tax rate for the fiscal year 2011 was a tax benefit of
1.1 percent. In fiscal year 2012 we recorded approximately $58 million of
additional net deferred tax liabilities related to the PopCap and KlickNation
Corporation ("KlickNation") acquisitions. These additional deferred tax
liabilities create a new source of taxable income, thereby requiring us to
release a portion of our deferred tax asset valuation allowance with a related
reduction in income tax expense of $58 million. In addition, during the three
months ended March 31, 2012, we recorded $48 million of additional tax benefits
related to the expiration of statutes of limitations in non-U.S. tax
jurisdictions.
Consistent with prior years, the fiscal year 2012 effective tax rate continues
to differ from the statutory rate of 35.0 percent as a result of the utilization
of U.S. deferred tax assets subject to a valuation allowance and non-U.S.
profits subject to a reduced or zero tax rate, partially offset by
non-deductible stock-based compensation. In addition, the fiscal year 2012
effective tax rate is impacted by tax benefits related to the expiration of
statutes of limitations and the resolution of examinations by taxing
authorities, as well as a reduction in the U.S. valuation allowance related to
the PopCap and KlickNation acquisitions. In fiscal year 2011, the effective tax
rate differs from the statutory rate of 35.0 percent primarily due to U.S.
losses for which no benefit is recognized, non-U.S. losses with a reduced or
zero tax benefit and non-deductible stock-based compensation expenses, partially
offset by tax benefits related to the expiration of statutes of limitations and
resolution of examination by taxing authorities.
Our effective income tax rates for fiscal year 2013 and future periods will
depend on a variety of factors, including changes in the deferred tax valuation
allowance, as well as changes in our business such as acquisitions and
intercompany transactions, changes in our international structure, changes in
the geographic location of business functions or assets, changes in the
geographic mix of income, changes in or termination of our agreements with tax
authorities, applicable accounting rules, applicable tax laws and regulations,
rulings and interpretations thereof, developments in tax audit and other
matters, and variations in our annual pre-tax income or loss. We incur certain
tax expenses that do not decline proportionately with declines in our pre-tax
consolidated income or loss. As a result, in absolute dollar terms, our tax
expense will have a greater influence on our effective tax rate at lower levels
of pre-tax income or loss than at higher levels. In addition, at lower levels of
pre-tax income or loss, our effective tax rate will be more volatile.
Certain taxable temporary differences that are not expected to reverse during
the carry forward periods permitted by tax law have not been considered as a
source of future taxable income that is available to realize the benefit of
deferred tax assets.
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The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of
2010 (the "Act") was signed into law on December 17, 2010. The Act contains a
number of provisions including, most notably, a two year extension of the
research tax credit. The Act did not have a material impact on our effective tax
rate for fiscal 2012 due to the effect of the valuation allowance on our
deferred tax assets.
We historically have considered undistributed earnings of our foreign
subsidiaries to be indefinitely reinvested outside of the United States and,
accordingly, no U.S. taxes have been provided thereon. We currently intend to
continue to indefinitely reinvest the undistributed earnings of our foreign
subsidiaries outside of the United States.
Comparison of Fiscal Year 2011 to Fiscal Year 2010
Net Revenue
Net Revenue by Product Revenue and Service and Other Revenue
Our total net revenue by product revenue and service and other revenue for
fiscal years 2011 and 2010 was as follows (in millions):
Year Ended March 31,
2011 2010 $ Change % Change
Net Revenue:
Product $ 3,181 $ 3,332 $ (151 ) (5 %)
Service and other 408 322 86 (27 %)
Total net revenue $ 3,589 $ 3,654 $ (65 ) (2 %)
Product Revenue
For fiscal year 2011, product revenue was $3,181 million, primarily driven by
FIFA 11, Battlefield: Bad Company 2, and Madden NFL 11. Product revenue for
fiscal year 2011 decreased $151 million, or 5 percent, as compared to fiscal
year 2010. This decrease was driven by a $1,070 million decrease primarily from
the Rock Band, Half-Life, EA SPORTS Active, and Fight Night franchises. This
decrease was offset by a $919 million increase primarily from the Battlefield,
Medal of Honor, and FIFA World Cup franchises.
Service and Other Revenue
For fiscal year 2011, service and other revenue was $408 million, primarily
driven by FIFA Ultimate Team, Restaurant City, and Pet Society. Service and
other revenue for fiscal year 2011 increased $86 million, or 27 percent, as
compared to fiscal year 2010. This increase was driven by a $137 million
increase from certain franchises, including the FIFA, Madden, and The Sims
franchises. This increase was offset by a $51 million decrease from revenue
generated by our Pogo-branded online services and the Warhammer and NBA Live
franchises.
Net Revenue by Geography
Year Ended March 31,
(In millions) 2011 2010 $ Change % Change
North America $ 1,836 $ 2,025 $ (189 ) (9 %)
Europe 1,563 1,433 130 9 %
Asia 190 196 (6 ) (3 %)
Total net revenue $ 3,589 $ 3,654 $ (65 ) (2 %)
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Net revenue in North America was $1,836 million, or 51% of total net revenue for
fiscal year 2011, compared to $2,025 million, or 55% of total net revenue for
fiscal year 2010, a decrease of $189 million, or 9%. Net revenue in Europe and
Asia was $1,753 million, or 49 percent of total net revenue for fiscal year
2011, compared to $1,629 million, or 45 percent of total net revenue for fiscal
year 2010, an increase of $124 million, or 8 percent. The increase in revenue
outside of North America was the primarily the result of increased revenue from
the Battlefield, Medal of Honor, and FIFA World Cup franchises in Europe.
Additionally, the value of the U.S. dollar relative to foreign currencies
contributed to a net decrease of total reported net revenue of approximately $71
million (primarily the Euro), or 4 percent of total net revenue.
Supplemental Net Revenue by Revenue Composition
Our total net revenue by revenue composition for the fiscal years 2011 and 2010
was as follows (in millions):
Year Ended March 31,
2011 2010 $ Change % Change
Publishing and other $ 2,781 $ 2,983 $ (202 ) (7 %)
Wireless, Internet-derived, and
advertising (digital) 833 570 263 46 %
Distribution 214 606 (392 ) (65 %)
Net Revenue before Revenue Deferral 3,828 4,159 (331 ) (8 %)
Revenue Deferral (2,769 ) (2,358 ) (411 ) 17 %
Recognition of Revenue Deferral 2,530 1,853 677 37 %
Net Revenue $ 3,589 $ 3,654 $ (65 ) (2 %)
Net Revenue before Revenue Deferral
Publishing and Other Revenue
For fiscal year 2011, publishing and other Net Revenue before Revenue Deferral
was $2,781 million, primarily driven by FIFA 11, Madden 11, and Need for Speed
Hot Pursuit. Publishing and other Net Revenue before Revenue Deferral for fiscal
year 2011 decreased $202 million, or 7 percent, as compared to fiscal year 2010.
This decrease was driven by a $943 million decrease in sales primarily from the
Battlefield, Army of Two, Mass Effect, EA SPORTS Active, NBA Live, and Godfather
franchises, as well as Dante's Inferno. This decrease was offset by a $741
million increase in sales primarily from the Medal of Honor, FIFA World Cup, and
Crysis franchises.
Wireless, Internet-derived, and Advertising (Digital) Revenue
For fiscal year 2011, digital Net Revenue before Deferral was $833 million, an
increase of $263 million, or 46 percent, as compared to fiscal year 2010. This
increase was driven by a $318 million increase in sales primarily from the FIFA,
Battlefield, Madden, The Sims, Mass Effect, Need for Speed, Medal of Honor,
Dragon Age, and Dead Space franchises, as well as Scrabble. This increase was
offset by a $55 million decrease in sales primarily from the Warhammer and
Tetris franchises, as well as a decrease in sales generated from our
Pogo-branded online services.
Distribution Revenue
For fiscal year 2011, distribution Net Revenue was $214 million and decreased
$392 million, or 65 percent, as compared to fiscal year 2010 driven by a $403
million decrease in sales primarily in the Rock Band and Portal franchises. This
decrease was partially offset by an $11 million increase in sales primarily from
Rango.
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Revenue Deferral
Revenue Deferral for fiscal year 2011 increased $411 million, or 17 percent, as
compared to fiscal year 2010. This increase was primarily due to (1) a 46
percent increase in our digital sales and (2) a higher percentage of both our
publishing and digital sales being deferred and recognized over time, due in
part to a 148 percent increase in micro-transaction sales and a 27 percent
increase in full-game download sales, of which both contain an online service
component which requires revenue recognition as the service is delivered.
Recognition of Revenue Deferral
The vast majority of our sales are deferred and recognized over a six month
period, and therefore the related revenue recognized in any fiscal year is
primarily due to sales that occurred during the respective twelve months period
ended December 31. The Recognition of Revenue Deferral for fiscal year 2011
increased $677 million, or 37 percent, as compared to fiscal year 2010. This
increase was primarily due to increased publishing and digital sales during the
18 months ended March 31, 2011, and a higher percentage of those sales being
comprised of game sales that have an online service component, as compared to
fiscal year 2010.
Net Revenue
For fiscal year 2011, Net Revenue was $3,589 million and decreased $65 million,
or 2 percent, as compared to fiscal year 2010. This decrease was driven by a
$1,125 million decrease in revenue primarily from the Rock Band, Left 4 Dead,
and EA SPORTS Active franchises. This decrease was offset by a $1,060 million
increase in revenue primarily from the Battlefield and Medal of Honor
franchises.
Our product and service and other revenue by revenue composition for the fiscal
years 2011 and 2010 was as follows (in millions):
Change as a Change as a
Year Ended
March 31,
2011 2010
Product revenue:
Publishing and other $ 2,558 $ 2,431
Wireless, Internet-derived, and advertising (digital) 409 295
Distribution 214 606
Total product revenue 3,181 3,332
Service and other revenue:
Publishing and other 74 95
Wireless, Internet-derived, and advertising (digital) 334 227
Total service and other revenue 408 322
Total net revenue $ 3,589 $ 3,654
Cost of Revenue
Total cost of revenue for fiscal years 2011 and 2010 was as follows (in
millions):
Change as a Change as a Change as a Change as a Change as a Change as a
% of % of Change as a
March 31, Related Net March 31, Related Net % of Related
2011 Revenue 2010 Revenue % Change Net RevenueCost of revenue:
Product $ 1,407 44.2 % $ 1,788 53.7 % (21.3 %) (9.5 %)
Service and other 92 22.5 % 78 24.2 % 17.9 % (1.7 %)
Total cost of revenue $ 1,499 41.8 % $ 1,866 51.1 % (19.7 %) (9.3 %)
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Cost of Product Revenue
Cost of product revenue decreased by $381 million, or 21.3 percent in fiscal
year 2011, as compared to fiscal year 2010. The decrease was primarily due to
(1) a 27 percent increase in full-game digital downloads that have a lower cost
than our other products and (2) a decrease in sales of our distribution products
which carry a higher royalty cost.
Cost of Service and Other Revenue
Cost of service and other revenue increased by $14 million, or 17.9 percent in
fiscal year 2011, as compared to fiscal year 2010. The increase was primarily
due to server and support costs due to the release of more online-connected and
subscription-based titles and related content during fiscal year 2011 as
compared to fiscal year 2010.
Total Cost of Revenue as a Percentage of Total Net Revenue
During fiscal year 2011, total cost of revenue as a percentage of total net
revenue decreased by 9.3 percent as compared to fiscal year 2010. This decrease
as a percentage of net revenue was primarily due to (1) a $266 million decrease
in the change in deferred net revenue related to certain online-enabled packaged
goods and digital content for fiscal year 2011 as compared to fiscal year 2010,
which positively impacted gross profit as a percent of total net revenue by 3.7
percent and (2) a greater percentage of net revenue from EA studio and digital
products, which have a higher margin than our co-publishing and distribution
products, which positively impacted gross profit as a percentage of total
revenue by approximately 3.3 percent.
Research and Development
Research and development expenses for fiscal years 2011 and 2010 were as follows
(in millions):
March 31, % of Net March 31, % of Net
2011 Revenue 2010 Revenue $ Change % Change
$1,153 32% $1,229 34% $(76) (6%)
Research and development expenses decreased by $76 million, or 6 percent, in
fiscal year 2011, as compared to fiscal year 2010. This decrease was primarily
due to decreases in expenses resulting from our cost reduction initiatives
including (1) a $38 million decrease in external development and contracted
services, (2) a $37 million decrease in additional personnel-related costs, and
(3) a $27 million decrease in facilities-related expenses primarily due to lower
depreciation expense. These decreases were partially offset by a $24 million
increase in incentive-based compensation expense.
Marketing and Sales
Marketing and sales expenses for fiscal years 2011 and 2010 were as follows (in
millions):
March 31, % of Net March 31, % of Net
2011 Revenue 2010 Revenue $ Change % Change
$747 21% $730 20% $17 2%
Marketing and sales expenses increased by $17 million, or 2 percent, in fiscal
year 2011, as compared to fiscal year 2010. The increase was primarily due to
(1) a $13 million increase in additional personnel-related costs and (2) a $5
million increase in stock-based compensation expense. These increases were
partially offset by a $5 million decrease in marketing, advertising and
promotional expenses reflecting fewer titles released during fiscal year 2011 as
compared to fiscal year 2010.
Marketing and sales expenses included vendor reimbursements for advertising
expenses of $31 million and $39 million in fiscal years 2011 and 2010,
respectively.
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General and Administrative
General and administrative expenses for fiscal years 2011 and 2010 were as
follows (in millions):
March 31, % of Net March 31, % of Net
2011 Revenue 2010 Revenue $ Change % Change
$301 8% $320 9% $(19) (6%)
General and administrative expenses decreased by $19 million, or 6 percent, in
fiscal year 2011, as compared to fiscal year 2010 primarily due to (1) a $25
million decrease in facilities-related expenses, primarily as a result of the
$14 million loss on our lease obligation related to our Redwood Shores
headquarters facilities in fiscal year 2010 and (2) an $18 million decrease in
contracted services due to costs related to the support of business development
projects in the prior year. These decreases were partially offset by (1) a $13
million increase in additional personnel-related costs, (2) a $12 million
increase in incentive-based compensation expense, and (3) a $7 million increase
in stock-based compensation expense.
Acquisition-Related Contingent Consideration
Acquisition-related contingent consideration related to Playfish decreased $19
million for the fiscal year 2011 as compared to the fiscal year 2010, resulting
from a revision in our estimate of the expected future cash flows over the
period in which the contingent obligation is expected to be settled.
Restructuring and Other Charges
Restructuring and other charges for fiscal years 2011 and 2010 were as follows
(in millions):
March 31, % of Net March 31, % of Net
2011 Revenue 2010 Revenue $ Change % Change
$161 4% $140 4% $21 15%
Fiscal 2011 Restructuring
In fiscal year 2011, we announced a plan focused on the restructuring of certain
licensing and developer agreements in an effort to improve the long-term
profitability of our packaged goods business. Under this plan, we amended
certain licensing and developer agreements. To a much lesser extent, as part of
this restructuring we had workforce reductions and facilities closures through
March 31, 2011. Substantially all of these exit activities were completed by
March 31, 2011.
During fiscal year 2011, we incurred charges of $148 million, consisting of
(1) $104 million related to the amendment of certain licensing agreements and
other intangible asset impairment costs, (2) $31 million related to the
amendment of certain developer agreements, and (3) $13 million in
employee-related expenses.
Fiscal 2010 Restructuring
In connection with our fiscal 2010 restructuring plan, during fiscal year 2011,
we incurred $13 million of restructuring charges primarily due to costs to
assist in the reorganization of our business support functions. During fiscal
year 2010, we incurred $116 million of restructuring charges of which (1) $62
million were for employee-related expenses, (2) $32 million related to
intangible asset impairment costs, abandoned rights to intellectual property,
and costs to assist in the reorganization of our business support functions, and
(3) $22 million related to the closure of certain of our facilities.
Other Restructuring and Reorganization
In connection with our fiscal 2009 restructuring plan and fiscal 2008
reorganization plan, during fiscal year 2010, we incurred $14 million and $10
million of charges, respectively, primarily for facilities-related expenses
under the fiscal 2009 plan and contracted services costs to assist in the
reorganization of our business support functions under the fiscal 2008 plan.
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Gains (Losses) on Strategic Investments, Net
Gains (losses) on strategic investments, net, for fiscal years 2011 and 2010
were as follows (in millions):
March 31, % of Net March 31, % of Net
2011 Revenue 2010 Revenue $ Change % Change
$23 1% $(26) (1%) $49 (188%)
Gains (losses) on strategic investments, net increased by $49 million, in fiscal
year 2011 as compared to the fiscal year 2010, primarily due to a realized gain
of $28 million, net of costs to sell, from the sale of our investment in
Ubisoft.
We recognized a $26 million impairment charge on our investment in The9 in
fiscal year 2010.
Income Taxes
Benefit from income taxes for fiscal years 2011 and 2010 was as follows (in
millions):
March 31, Effective March 31, Effective
2011 Tax Rate 2010 Tax Rate
$(3) (1.1%) $(29) (4.1%)
Our effective tax rate for the fiscal year 2011 was a tax benefit of 1.1
percent. Our effective tax rate for the fiscal year 2010 was a tax benefit of
4.1 percent. In fiscal year 2011, the effective tax rate differs from the
statutory rate of 35.0 percent primarily due to U.S. losses for which no benefit
is recognized, non-U.S. losses with a reduced or zero tax benefit and
non-deductible stock-based compensation expenses, partially offset by tax
benefits related to the expiration of statutes of limitations and resolution of
examination by taxing authorities. In fiscal year 2010, the effective tax rate
differs from the statutory rate of 35.0 percent primarily due to U.S. losses for
which no benefit is recognized, tax charges related to our integration of
Playfish, non-U.S. losses with a reduced or zero tax benefit, and non-deductible
stock-based compensation expenses, partially offset by benefits related to the
resolution of examinations by the taxing authorities and reductions in the
valuation allowance of U.S. deferred tax assets.
The Worker, Homeownership and Business Assistance Act of 2009 ("the Act") was
signed into law on November 6, 2009. The Act provides that taxpayers may elect
to increase the carry back period for tax losses incurred in a taxable year
beginning or ending in either 2008 or 2009. During the fiscal quarter ended
December 31, 2009, we elected to increase the carry back period for tax losses
incurred in fiscal year 2009. This election resulted in a reduction in the
valuation allowance on our U.S. deferred tax assets due to an increase in the
sources of taxable income from the extended carry back period. As a result, we
recorded a tax benefit of approximately $28 million in the fiscal quarter ended
December 31, 2009 for the reduction in the valuation allowance.
Impact of Recently Issued Accounting Standards
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220):
Presentation of Comprehensive Income. ASU 2011-05 requires one of two
alternatives for presenting comprehensive income and eliminates the option to
report other comprehensive income and its components as a part of the
Consolidated Statements of Stockholders' Equity. Additionally, ASU 2011-05
requires presentation on the face of the financial statements reclassification
adjustments for items that are reclassified from other comprehensive income to
net income in the statement(s) where the components of net income and the
components of other comprehensive income are presented. The requirement related
to the reclassification adjustments from other comprehensive income to net
income was deferred in December 2011, as a result of the issuance of ASU
2011-12, Deferral of the Effective Date for Amendments to the Presentation of
Reclassifications of Items Out of Accumulated Other Comprehensive Income in
Accounting Standards Update 2011-05 (Topic 220). The amendments in ASU 2011-05,
as amended by ASU 2011-12, do not change the items that must be reported in
other comprehensive
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income or when an item of other comprehensive income must be reclassified to net
income. ASU 2011-05, as amended by ASU 2011-12 is effective for fiscal years and
interim periods within those years beginning after December 15, 2011 and is to
be applied retrospectively. We will adopt ASU 2011-05 during the first quarter
of fiscal 2013. We do not expect the adoption of ASU 2011-05, as amended by ASU
2011-12 to have a material impact on our Consolidated Financial Statements.
In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting
Assets and Liabilities, which creates new disclosure requirements about the
nature of an entity's rights of offset and related arrangements associated with
its financial instruments and derivative instruments. The disclosure
requirements are effective for annual reporting periods beginning on or after
January 1, 2013, and interim periods therein, with retrospective application
required. The new disclosures are designed to make financial statements that are
prepared under U.S. Generally Accepted Accounting Principles more comparable to
those prepared under International Financial Reporting Standards. We are
evaluating the impact of ASU 2011-11 on our Consolidated Financial Statements.
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LIQUIDITY AND CAPITAL RESOURCES
As of
March 31,
(In millions) 2012 2011 Decrease
Cash and cash equivalents $ 1,293 $ 1,579 $ (286 )
Short-term investments 437 497 (60 )
Marketable equity securities 119 161 (42 )
Total $ 1,849 $ 2,237 $ (388 )
Percentage of total assets 34 % 45 %
Year Ended
March 31,
(In millions) 2012 2011 Change
Cash provided by operating activities $ 277 $ 320 $ (43 )
Cash used in investing activities (689 ) (15 ) (674 )
Cash provided by (used in) financing
activities 140 (23 ) 163
Effect of foreign exchange on cash and cash
equivalents (14 ) 24 (38 )
Net increase (decrease) in cash and cash
equivalents $ (286 ) $ 306 $ (592 )
Changes in Cash Flow
Operating Activities. Cash provided by operating activities decreased $43
million during the fiscal year ended March 31, 2012 as compared to the fiscal
year ended March 31, 2011 primarily due to (1) an increase in expenses due to
our online and customer experience initiatives, (2) an increase in
personnel-related costs from recent acquisitions, and (3) an increase in
marketing, advertising and promotional spending on our franchises. This
difference is partially offset by a greater percentage of net revenue from our
digital products, which have a higher margin than our other products.
Investing Activities. Cash used in investing activities increased $674 million
during the fiscal year ended March 31, 2012 as compared to the fiscal year ended
March 31, 2011 primarily due to a $660 million increase in cash used for
acquisitions, the majority of which was used to fund our acquisition of PopCap,
and a $113 million increase in capital expenditures. Contributing to this
increase, we received $132 million in proceeds from the sale of our Ubisoft and
The9 investments during the fiscal year ended March 31, 2011 with no comparable
sale of our investments during the fiscal year ended March 31, 2012. These items
were partially offset by (1) a $84 million increase in proceeds received from
the maturities and sales of short-term investments, (2) a $75 million increase
due to the release of restriction on previously classified restricted cash due
to the achievement of certain performance milestones in connection with our
acquisition of Playfish, (3) a $46 million decrease in the purchase of
short-term investments, and (4) $26 million proceeds received from the sale of
our facility in Chertsey, England.
Financing Activities. Cash provided by financing activities increased $163
million during the fiscal year ended March 31, 2012 as compared to the fiscal
year ended March 31, 2011 primarily due to (1) $617 million in proceeds received
from the sale of 0.75% Convertible Senior Notes due 2016, net of issuance costs
and (2) $65 million proceeds received from the issuance of Warrants in
connection with the Notes. These items were partially offset by (1) a $413
million increase in the repurchase and retirement of our common stock, net of
commissions, pursuant to our Stock Repurchase Program and (2) $107 million paid
for the purchase of the Convertible Note Hedge.
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Short-term Investments and Marketable Equity Securities
Due to our mix of fixed and variable rate securities, our short-term investment
portfolio is susceptible to changes in short-term interest rates. As of
March 31, 2012, our short-term investments had gross unrealized gains of $1
million, or less than 1 percent of the total in short-term investments, and
gross unrealized losses of less than $1 million, or less than 1 percent of the
total in short-term investments. From time to time, we may liquidate some or all
of our short-term investments to fund operational needs or other activities,
such as capital expenditures, business acquisitions or stock repurchase
programs. Depending on which short-term investments we liquidate to fund these
activities, we could recognize a portion, or all, of the gross unrealized gains
or losses.
The fair value of our marketable equity securities decreased to $119 million as
of March 31, 2012 from $161 million as of March 31, 2011 primarily due to a
decrease in the value of our investment in Neowiz.
Restricted Cash and Contingent Consideration
As of March 31, 2012, primarily in connection with our acquisitions of PopCap,
KlickNation, and Chillingo Limited ("Chillingo"), we may be required to pay an
additional $572 million of cash consideration based upon the achievement of
certain performance milestones through March 31, 2015. In fiscal year 2010, in
connection with our Playfish acquisition, we deposited $100 million into an
escrow account related to the contingent consideration. During the three months
ended March 31, 2012, $25 million was paid to settle performance milestones
earned through December 31, 2011 in connection with the Playfish acquisition,
and $50 million was reclassified and converted to available cash and cash
equivalents. As of March 31, 2012, $25 million remains in restricted cash
related to the Playfish performance milestones, which we expect to pay in the
second quarter of fiscal 2013. In addition, in connection with our PopCap
acquisition, we acquired an additional $6 million of restricted cash which is
held in an escrow account in the event that certain liabilities become due. As
these deposits are restricted in nature, they are excluded from cash and cash
equivalents. As of March 31, 2012, the restricted cash of $31 million is
included in other current assets in our Consolidated Balance Sheets.
Fiscal 2011 Restructuring
In connection with our fiscal 2011 restructuring plan, we expect to incur cash
expenditures through June 2016 of approximately (1) $24 million in both fiscal
years 2013 and 2014, (2) $17 million in fiscal year 2015, (3) $3 million in
fiscal year 2016, and (4) $20 million in fiscal year 2017. The actual cash
expenditures are variable as they will be dependent upon the actual revenue we
generate from certain games.
Fiscal 2013 Restructuring
On May 7, 2012, we announced a plan of restructuring to align our cost structure
with our ongoing digital transformation. Under this plan, we anticipate reducing
our workforce and incurring other costs. We expect the majority of these actions
to be completed by September 30, 2012.
In connection with this plan, we anticipate incurring approximately $40 million
in total costs, of which approximately $31 million will result in future cash
expenditures. All of these charges are expected to occur during the fiscal year
ending March 31, 2013. These costs will consist of severance and other
employee-related costs (approximately $23 million), license termination costs
(approximately $11 million) and other costs (approximately $6 million).
Financing Arrangement
In July 2011, we issued $632.5 million aggregate principal amount of 0.75%
Convertible Senior Notes due 2016 (the "Notes"). The Notes are senior unsecured
obligations which pay interest semi-annually in arrears at a rate of 0.75
percent per annum on January 15 and July 15 of each year, beginning on
January 15, 2012 and will mature on July 15, 2016, unless earlier purchased or
converted in accordance with their terms prior to such date. The Notes are
convertible into cash and shares of our common stock based on an initial
conversion value of 31.5075 shares of our common stock per $1,000 principal
amount of Notes (equivalent to an initial conversion price of
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approximately $31.74 per share). Upon conversion of the Notes, holders will
receive cash up to the principal amount of each Note, and any excess conversion
value will be delivered in shares of our common stock. We used the net proceeds
of the Notes to finance our acquisition of PopCap, which closed in August 2011.
Prior to April 15, 2016, the Notes will be convertible only upon the occurrence
of certain events and during certain periods, and thereafter, at any time until
the close of business on the second scheduled trading day immediately preceding
the maturity date of the Notes. The Notes do not contain any financial
covenants.
The conversion rate is subject to customary anti-dilution adjustments, but will
not be adjusted for any accrued and unpaid interest. Following certain corporate
events described in the indenture governing the notes (the "Indenture") that
occur prior to the maturity date, the conversion rate will be increased for a
holder who elects to convert its Notes in connection with such corporate event
in certain circumstances. The Notes are not redeemable prior to maturity, and no
sinking fund is provided for the Notes.
If we undergo a "fundamental change," as defined in the Indenture, subject to
certain conditions, holders may require us to purchase for cash all or any
portion of their Notes. The fundamental change purchase price will be 100
percent of the principal amount of the Notes to be purchased plus any accrued
and unpaid interest up to but excluding the fundamental change purchase date.
The Indenture contains customary terms and covenants, including that upon
certain events of default occurring and continuing, either the trustee or the
holders of at least 25 percent in principal amount of the outstanding Notes may
declare 100 percent of the principal and accrued and unpaid interest on all the
Notes to be due and payable.
In addition, in July 2011, we entered into privately negotiated convertible note
hedge transactions (the "Convertible Note Hedge") with certain counterparties to
reduce the potential dilution with respect to our common stock upon conversion
of the Notes. The Convertible Note Hedge, subject to customary anti-dilution
adjustments, provide us with the option to acquire, on a net settlement basis,
approximately 19.9 million shares of our common stock at a strike price of
$31.74, which corresponds to the conversion price of the Notes and is equal to
the number of shares of our common stock that notionally underlie the Notes. As
of March 31, 2012, we have not purchased any shares under the Convertible Note
Hedge. We paid $107 million for the Convertible Note Hedge.
Separately, we have also entered into privately negotiated warrant transactions
with the certain counterparties whereby we sold to independent third parties
warrants (the "Warrants") to acquire, subject to customary anti-dilution
adjustments that are substantially the same as the anti-dilution provisions
contained in the Notes, up to 19.9 million shares of our common stock (which is
also equal to the number of shares of our common stock that notionally underlie
the Notes), with a strike price of $41.14. The Warrants could have a dilutive
effect with respect to our common stock to the extent that the market price per
share of its common stock exceeds $41.14 on or prior to the expiration date of
the Warrants. We received proceeds of $65 million from the sale of the Warrants.
See Note 11 to the Consolidated Financial Statements for additional information
related to our 0.75% Convertible Senior Notes due 2016.
Financial Condition
We believe that cash, cash equivalents, short-term investments, marketable
equity securities, cash generated from operations and available financing
facilities will be sufficient to meet our operating requirements for at least
the next 12 months, including working capital requirements, capital
expenditures, and potentially, future acquisitions, stock repurchases, or
strategic investments. We may choose at any time to raise additional capital to
strengthen our financial position, facilitate expansion, repurchase our stock,
pursue strategic acquisitions and investments, and/or to take advantage of
business opportunities as they arise. There can be no assurance, however, that
such additional capital will be available to us on favorable terms, if at all,
or that it will not result in substantial dilution to our existing stockholders.
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As of March 31, 2012, approximately $878 million of our cash, cash equivalents,
and short-term investments and $57 million of our marketable equity securities
were domiciled in foreign tax jurisdictions. While we have no plans to
repatriate these funds to the United States in the short term, if we choose to
do so, we would be required to accrue and pay additional taxes on any portion of
the repatriation where no United States income tax had been previously provided.
In February 2011, we announced that our Board of Directors authorized a program
to repurchase up to $600 million of our common stock over the next 18 months. We
completed our program in April 2012. We repurchased approximately 32 million
shares in the open market since the commencement of the program, including
pursuant to pre-arranged stock trading plans. During the fiscal year 2012, we
repurchased and retired approximately 25 million shares of our common stock for
approximately $471 million, net of commissions.
We have a "shelf" registration statement on Form S-3 on file with the SEC. This
shelf registration statement, which includes a base prospectus, allows us at any
time to offer any combination of securities described in the prospectus in one
or more offerings. Unless otherwise specified in a prospectus supplement
accompanying the base prospectus, we would use the net proceeds from the sale of
any securities offered pursuant to the shelf registration statement for general
corporate purposes, including for working capital, financing capital
expenditures, research and development, marketing and distribution efforts, and
if opportunities arise, for acquisitions or strategic alliances. Pending such
uses, we may invest the net proceeds in interest-bearing securities. In
addition, we may conduct concurrent or other financings at any time.
Our ability to maintain sufficient liquidity could be affected by various risks
and uncertainties including, but not limited to, those related to customer
demand and acceptance of our products, 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
acquisitions and other strategic transactions in which we may engage, the impact
of competition, economic conditions in the United States and abroad, the
seasonal and cyclical nature of our business and operating results, risks of
product returns and the other risks described in the "Risk Factors" section,
included in Part I, Item 1A of this report.
Contractual Obligations and Commercial Commitments
Development, Celebrity, League and Content Licenses: Payments and Commitments
The products we produce in our studios are designed and created by our employee
designers, artists, software programmers and by non-employee software developers
("independent artists" or "third-party developers"). We typically advance
development funds to the independent artists and third-party developers during
development of our games, usually in installment payments made upon the
completion of specified development milestones. Contractually, these payments
are generally considered advances against subsequent royalties on the sales of
the products. These terms are set forth in written agreements entered into with
the independent artists and third-party developers.
In addition, we have certain celebrity, league and content license contracts
that contain minimum guarantee payments and marketing commitments that may not
be dependent on any deliverables. Celebrities and organizations with whom we
have contracts include: FIFA, FIFPRO Foundation, FAPL (Football Association
Premier League Limited), and DFL Deutsche Fußball Liga GmbH (German Soccer
League) (professional soccer); National Basketball Association (professional
basketball); PGA TOUR, Tiger Woods and Augusta National (professional golf);
National Hockey League and NHL Players' Association (professional hockey);
National Football League Properties, PLAYERS Inc., and Red Bear Inc.
(professional football); Collegiate Licensing Company (collegiate football);
ESPN (content in EA SPORTS games); Hasbro, Inc. (most of Hasbro's toy and game
intellectual properties); and LucasArts and Lucas Licensing (Star Wars: The Old
Republic). These developer and content license commitments represent the sum of
(1) the cash payments due under non-royalty-bearing licenses and services
agreements and (2) the minimum guaranteed payments and advances against
royalties due under royalty-bearing licenses and services agreements, the
majority of which are conditional upon performance by the counterparty. These
minimum guarantee payments and any related marketing commitments are included in
the table below.
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The following table summarizes our unrecognized minimum contractual obligations
as of March 31, 2012, and the effect we expect them to have on our liquidity and
cash flow in future periods (in millions):
Contractual Obligations
Developer/ Other
Fiscal Year Licensor Convertible Notes Purchase
Ending March 31, Leases(a) Commitments Marketing Interest(b) Obligations Total
2013 $ 54 $ 158 $ 52 $ 5 $ 15 $ 284
2014 48 123 51 5 7 234
2015 40 116 32 5 - 193
2016 28 166 33 5 - 232
2017 15 8 18 2 - 43
Thereafter 26 239 77 - - 342
Total $ 211 $ 810 $ 263 $ 22 $ 22 $ 1,328
(a) See discussion on operating leases in the "Off-Balance Sheet Commitments"
section below for additional information. Lease commitments have not been
reduced by minimum sub-lease rentals for unutilized office space resulting
from our reorganization activities of approximately $7 million due in the
future under non-cancelable sub-leases.
(b) In addition to the interest payments reflected in the table above, we will
be obligated to pay the $632.5 million principal amount of the 0.75%
Convertible Senior Notes due 2016 and any excess conversion value in shares
of our common stock upon redemption after the maturity of the Notes on
July 15, 2016 or earlier. See Note 11 for additional information related to
our 0.75% Convertible Senior Notes due 2016.
The amounts represented in the table above reflect our unrecognized minimum cash
obligations for the respective fiscal years, but do not necessarily represent
the periods in which they will be recognized and expensed in our Consolidated
Financial Statements. In addition, the amounts in the table above are presented
based on the dates the amounts are contractually due; however, certain payment
obligations may be accelerated depending on the performance of our operating
results.
In addition to what is included in the table above as of March 31, 2012, we had
a liability for unrecognized tax benefits and an accrual for the payment of
related interest totaling $251 million, of which approximately $43 million is
offset by prior cash deposits to tax authorities for issues pending resolution.
For the remaining liability, we are unable to make a reasonably reliable
estimate of when cash settlement with a taxing authority will occur.
In addition to what is included in the table above as of March 31, 2012,
primarily in connection with our PopCap, KlickNation, and Chillingo
acquisitions, we may be required to pay an additional $572 million of cash
consideration based upon the achievement of certain performance milestones
through March 31, 2015. As of March 31, 2012, we have accrued $112 million of
contingent consideration on our Consolidated Balance Sheet representing the
estimated fair value of the contingent consideration.
OFF-BALANCE SHEET COMMITMENTS
Lease Commitments
As of March 31, 2012, we leased certain of our current facilities, furniture and
equipment under non-cancelable operating lease agreements. We were required to
pay property taxes, insurance and normal maintenance costs for certain of these
facilities and any increases over the base year of these expenses on the
remainder of our facilities.
Director Indemnity Agreements
We entered into indemnification agreements with each of the members of our Board
of Directors at the time they joined the Board to indemnify them to the extent
permitted by law against any and all liabilities, costs, expenses, amounts paid
in settlement and damages incurred by the Directors as a result of any lawsuit,
or any judicial, administrative or investigative proceeding in which the
Directors are sued or charged as a result of their service as members of our
Board of Directors.
INFLATION
We believe the impact of inflation on our results of operations has not been
significant in any of the past three fiscal years.
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